UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
((Mark One)
| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2011
or
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to
Commission file number 001-32293
HARTFORD LIFE INSURANCE COMPANY
(Exact name of registrant as specified in its charter)
| Connecticut | 06-0974148 | |
| (State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) |
200 Hopmeadow Street, Simsbury, Connecticut 06089
(Address of principal executive offices)
(860) 547-5000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: None
| Indicate by check mark: | Yes | No | ||||||||
| • if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. |
x | ¨ | ||||||||
| • if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. |
¨ | x | ||||||||
| • whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. |
x | ¨ | ||||||||
| • whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). |
x | ¨ | ||||||||
| • if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. |
x | ¨ | ||||||||
| • whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. | ||||||||||
|
Large accelerated filer ¨ |
Accelerated filer ¨ | Non Accelerated filer x |
Smaller reporting company ¨ | |||||||
| • whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.) |
¨ | x | ||||||||
The aggregate market value of the shares of Common Stock held by non-affiliates of the registrant as of June 30, 2011 was $0, because all of the outstanding shares of Common Stock were owned by Hartford Life and Accident Insurance Company, a direct wholly owned subsidiary of Hartford Life, Inc.
As of February 17, 2012, there were outstanding 1,000 shares of Common Stock, $5,690 par value per share, of the registrant.
The registrant meets the conditions set forth in General Instruction (I) (1) (a) and (b) of Form 10-K and is therefore filing this Form
with the reduced disclosure format.
HARTFORD LIFE INSURANCE COMPANY
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2011
| * | Item prepared in accordance with General Instruction I (2) of Form 10-K. |
2
Forward-Looking Statements
Certain of the statements contained herein are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by words such as “anticipates,” “intends,” “plans,” “seeks,” “believes,” “estimates,” “expects,” “projects,” and similar references to future periods.
Forward-looking statements are based on our current expectations and assumptions regarding economic, competitive and legislative developments. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. They have been made based upon management’s expectations and beliefs concerning future developments and their potential effect upon Hartford Life Insurance Company and its subsidiaries (collectively, the “Company”). Future developments may not be in line with management’s expectations or have unanticipated effects. Actual results could differ materially from expectations, depending on the evolution of various factors, including those set forth in Part I, Item 1A. Risk Factors and those identified from time to time in our other filings with the Securities and Exchange Commission. These important risks and uncertainties include:
| • | challenges related to the Company’s current operating environment, including continuing uncertainty about the strength and speed of the recovery in the United States and other key economies and the impact of governmental stimulus, and austerity initiatives, sovereign credit concerns, including the potential consequences associated with recent and further potential downgrades to the credit ratings of debt issued by the United States government, European sovereigns and other adverse developments on financial, commodity and credit markets and consumer spending and investment, including in respect of Europe, and the effect of these events on our returns in our life investment portfolios and our hedging costs associated with our variable annuities business; |
| • | the potential impact or consequences of our ongoing evaluation of the Company’s strategy and business portfolio, which may lead us to pursue one or more transactions or take other actions, including the discontinuance or placing in run-off of certain lines of business and/or the pursuit of strategic acquisitions, divestitures or restructurings, and the potential that any of the foregoing transactions or actions may not be achievable or that the benefits anticipated to be gained thereby may not be obtained; |
| • | the success of our initiatives relating to the realignment of our business, including the continuing realignment of our hedge program for our variable annuity business and plans to improve the profitability and long-term growth prospects of our key divisions, including through opportunistic acquisitions or divestitures or other actions or initiatives and the impact of regulatory or other constraints on our ability to complete these initiatives and deploy capital among our businesses as and when planned; |
| • | market risks associated with our business, including changes in interest rates, credit spreads, equity prices, market volatility and foreign exchange rates, and implied volatility levels, as well as continuing uncertainty in key sectors such as the global real estate market; |
| • | the impact on our investment portfolio if our investment portfolio is concentrated in any particular segment of the economy; |
| • | volatility in our earnings and potential material changes to our results resulting from our adjustment of our risk management program to emphasize protection of statutory surplus and cash flows; |
| • | the impact on our statutory capital of various factors, including many that are outside the Company’s control, which can in turn affect our credit and financial strength ratings, cost of capital, regulatory compliance and other aspects of our business and results; |
| • | risks to our business, financial position, prospects and results associated with negative rating actions or downgrades in the Company’s financial strength and credit ratings or negative rating actions or downgrades relating to our investments; |
| • | the potential for differing interpretations of the methodologies, estimations and assumptions that underlie the valuation of the Company’s financial instruments that could result in changes to investment valuations; |
| • | the subjective determinations that underlie the Company’s evaluation of other-than-temporary impairments on available-for-sale securities; |
| • | losses due to nonperformance or defaults by others; |
| • | the potential for further acceleration of deferred policy acquisition cost amortization; |
| • | the potential for further impairments of our goodwill or the potential for changes in valuation allowances against deferred tax assets; |
| • | the possible occurrence of terrorist attacks and the Company’s ability to contain its exposure, including the effect of the absence or insufficiency of applicable terrorism legislation on coverage; |
| • | the possibility of a pandemic, earthquake or other natural or man-made disaster that may adversely affect our businesses and cost and availability of reinsurance; |
3
| • | weather and other natural physical events, including the severity and frequency of storms, hail, winter storms, hurricanes and tropical storms, as well as climate change and its potential impact on weather patterns; |
| • | the response of reinsurance companies under reinsurance contracts and the availability, pricing and adequacy of reinsurance to protect the Company against losses; |
| • | actions by our competitors, many of which are larger or have greater financial resources than we do; |
| • | the Company’s ability to distribute its products through distribution channels both current and future; |
| • | the cost and other effects of increased regulation as a result of the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), which, among other effects has resulted in the establishment of a newly created Financial Services Oversight Council with the power to designate “systemically important” institutions, will require central clearing of, and/or impose new margin and capital requirements on, derivatives transactions and created a new “Federal Insurance Office” within the U.S. Department of the Treasury (“Treasury”); |
| • | unfavorable judicial or legislative developments; |
| • | the potential effect of other domestic and foreign regulatory developments, including those that could adversely impact the demand for the Company’s products, operating costs and required capital levels, including changes to statutory reserves and/or risk-based capital requirements related to secondary guarantees under universal life and variable annuity products or changes in U.S. federal or other tax laws that affect the relative attractiveness of our investment products; |
| • | regulatory limitations on the ability of the Company and certain of its subsidiaries to declare and pay dividends |
| • | the Company’s ability to maintain the availability of its systems and safeguard the security of its data in the event of a disaster, cyber or other information security incident or other unanticipated event; |
| • | the risk that our framework for managing business risks may not be effective in mitigating material risk and loss to the Company; |
| • | the potential for difficulties arising from outsourcing relationships; |
| • | the impact of potential changes in federal or state tax laws, including changes affecting the availability of the separate account dividend received deduction; |
| • | the impact of potential changes in accounting principles and related financial reporting requirements; |
| • | the Company’s ability to protect its intellectual property and defend against claims of infringement; and |
| • | other factors described in such forward-looking statements. |
Any forward-looking statement made by the Company in this document speaks only as of the date of the filing of this Form 10-K. Factors or events that could cause the Company’s actual results to differ may emerge from time to time, and it is not possible for the Company to predict all of them. The Company undertakes no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise.
4
(Dollar amounts in millions, except for per share data, unless otherwise stated)
General
Hartford Life Insurance Company (together with its subsidiaries, “HLIC”, “the Company”, “we” or “our”), is an indirect wholly-owned subsidiary of The Hartford Financial Services Group, Inc. (“The Hartford”), an insurance and financial services company. HLIC is among the largest providers of insurance and investment products in the United States. The Company also assumes fixed annuity products and living and death benefit riders on variable annuities from The Hartford’s Japan operations and also cedes insurance risks to affiliates and third party reinsurance companies. At December 31, 2011, total assets and total stockholder’s equity were $222.5 billion and $9.7 billion, respectively.
Reporting Segments
The Company is organized into five reporting segments: Individual Annuity, Individual Life, Retirement Plans, Mutual Funds and Runoff Operations. In 2011, the Company made changes to its reporting segments, forming a Runoff Operations segment, to reflect the manner in which it is currently organized for purposes of making operating decisions and assessing performance. Segment data for prior reporting periods has been adjusted accordingly. The Company’s Other category includes corporate items not directly allocated to any of its reporting segments, certain direct group life and group disability insurance that is ceded to an affiliate, as well as certain fee income and commission expense associated with sales of non-proprietary products by broker-dealer subsidiaries.
For further discussion on the reporting segments, including financial disclosures on revenues by product, net income (loss), and assets for each reporting segment, see Note 2 of the Notes to Consolidated Financial Statements.
The Company provides investment products for over 6 million customers and life insurance for approximately 692,000 customers.
As part of The Hartford’s strategic decision to focus on its U.S. businesses, the Company suspended all new sales in its European operations in the second quarter of 2009 and divested its Brazil joint venture, Canadian mutual fund business and its offshore insurance business in 2010. The Company’s remaining runoff businesses, previously reported as part of the Global Annuity and Life Insurance segments, are now included in the Runoff Operations segment formed in 2011.
Principal Products
Individual Annuity offers individual variable, fixed market value adjusted (“MVA”), fixed index and single premium immediate annuities in the U.S.
Individual Life offers a variety of life insurance products, including variable universal life, universal life, and term life.
Retirement Plans provides retirement products and services to businesses pursuant to Section 401(k) of the Internal Revenue Code of 1986 (“the IRS Code”), as well as, products and services to municipalities and not-for-profit organizations pursuant to Section 457 and 403(b) of the IRS Code.
Mutual Funds offer retail, proprietary, investment-only mutual funds and 529 college savings plans to investors.
Marketing and Distribution
Individual Annuity’s distribution network includes national and regional broker-dealer organizations, banks and other financial institutions and independent financial advisors. The Company periodically negotiates provisions and terms of its relationships with unaffiliated parties. The Company’s primary wholesaler of its individual annuities is Hartford Life Distributors, LLC, and its affiliate, PLANCO, LLC (collectively “HLD”) which are indirect wholly-owned subsidiaries of Hartford Life, Inc. HLD provides sales support to registered representatives, financial planners and broker-dealers at brokerage firms and banks across the United States.
Individual Life’s distribution network includes national and regional broker-dealer organizations, banks, independent agents, independent life and property-casualty agents, and Woodbury Financial Services, an indirect, wholly-owned subsidiary retail broker-dealer.
Retirement Plans distribution network includes The Hartford’s employees with extensive retirement experience selling its products and services through national and regional broker-dealer firms, banks and other financial institutions.
Mutual Funds sales professionals are segmented into two teams; a retail team and an institutional team. The retail team, through it’s internal wholesaler HLD, distributes The Hartford’s open-end funds and markets 529 college savings plans to national and regional broker-dealer organizations, banks and other financial institutions, independent financial advisors and registered investment advisors. The institutional team distributes The Hartford’s funds to professional buyers, such as broker-dealers, consultants, record keepers, and bank trust groups.
5
Competition
Individual Annuity competes with other life insurance companies, as well as certain banks, securities brokerage firms, independent financial advisors, asset managers, and other financial intermediaries marketing annuities, mutual funds and other retirement-oriented products. Product sales are affected by competitive factors such as investment performance ratings, product design, visibility in the marketplace, financial strength ratings, distribution capabilities, levels of charges and credited rates, reputation and customer service. Individual Annuity’s annuity deposits continue to decline due to competitive activity and the Company’s product and risk decisions. Many competitors have responded to the equity market volatility by increasing the price of their living benefit products and changing the level of the guarantee offered. Management believes that the most significant industry de-risking changes have occurred. In 2011, the Company enhanced product design for variable annuities to meet customers future income needs while abiding by the risk tolerances of the Company.
Individual Life competes with other life insurance companies in the United States, as well as other financial intermediaries marketing insurance products. Product sales are affected primarily by the availability and price of reinsurance, volatility in the equity markets, breadth and quality of life insurance products being offered, pricing, relationships with third-party distributors, effectiveness of wholesaling support, and the quality of underwriting and customer service. The individual life industry continues to see a distribution shift away from the traditional life insurance sales agents to the consultative financial advisor as the place people go to buy their life insurance. Individual Life’s regional sales office system is a differentiator in the market and allows it to compete effectively across multiple distribution outlets.
Retirement Plans compete with other insurance carriers, large investment brokerage companies and large mutual fund companies. The 401(k), 457, and 403(b) products offer mutual funds wrapped in variable annuities, variable funding agreements, or mutual fund retirement products. Plan sponsors seek a diversity of available funds and favorable fund performance. Consolidation among industry providers has continued as competitors increase scale advantages.
Mutual Funds compete with other mutual fund companies along with investment brokerage companies and differentiate themselves through product solutions, performance, and service. In this non-proprietary broker sold market, the Company and its competitors compete aggressively for net sales.
Reserves
The Company and its insurance subsidiaries establish and carry as liabilities, predominantly, five types of reserves: (1) a liability equal to the balance that accrues to the benefit of the policyholder as of the financial statement date, otherwise known as the account value, (2) a liability for unpaid losses, including those that have been incurred but not yet reported, (3) a liability for future policy benefits, representing the present value of future benefits to be paid to or on behalf of policyholders less the present value of future net premiums, (4) fair value reserves for living benefits embedded derivative guarantees; and (5) death and living benefit reserves which are computed based on a percentage of revenues less actual claim costs. The liabilities for unpaid losses and future policy benefits are calculated based on actuarially recognized methods using morbidity and mortality tables, which are modified to reflect the Company’s actual experience when appropriate. Liabilities for unpaid losses include estimates of amounts to fully settle known reported claims as well as claims related to insured events that the Company estimates have been incurred but have not yet been reported. Future policy benefit reserves are computed at amounts that, with additions from estimated net premiums to be received and with interest on such reserves compounded annually at certain assumed rates, are expected to be sufficient to meet the Company’s policy obligations at their maturities or in the event of an insured’s disability or death. Other insurance liabilities include those for unearned premiums and benefits in excess of account value. Reserves for assumed reinsurance are computed in a manner that is comparable to direct insurance reserves.
Reinsurance
The Company cedes insurance to affiliated and unaffiliated insurers to enable the Company to manage capital and risk exposure. Such arrangements do not relieve the Company of its primary liability to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the risk transfer of its reinsurance contracts, the financial condition of its reinsurers and concentrations of credit risk. Reinsurance accounting is followed for ceded transactions that provide indemnification against loss or liability relating to insurance risk (i.e. risk transfer). If the ceded transactions do not provide risk transfer, the Company accounts for these transactions as financing transactions. The Company’s procedures include careful initial selection of its reinsurers, structuring agreements to provide collateral funds where necessary, and regularly monitoring the financial condition and ratings of its reinsurers. For further discussion of reinsurance, see Note 5 and Note 16 of the Notes to Consolidated Financial Statements.
6
Investment Operations
The majority of the Company’s investment portfolios are managed by Hartford Investment Management Company (“HIMCO”). HIMCO manages the portfolios to maximize economic value, while attempting to generate the income necessary to support the Company’s various product obligations, within internally established objectives, guidelines and risk tolerances. The portfolio objectives and guidelines are developed based upon the asset/liability profile, including duration, convexity and other characteristics within specified risk tolerances. The risk tolerances considered include, for example, asset and credit issuer allocation limits, maximum portfolio limits for below investment grade holdings and foreign currency exposure limits. The Company attempts to minimize adverse impacts to the portfolio and the Company’s results of operations from changes in economic conditions through asset allocation limits, asset/liability duration matching and through the use of derivatives. For further discussion of HIMCO’s portfolio management approach, see the Part II, Item 7, MD&A – Enterprise Risk Management – Credit Risk.
Enterprise Risk Management
The Company’s risk management function is part of The Hartford’s overall risk management program. The Hartford maintains an enterprise risk management function (“ERM”) that is charged with providing analyses of The Hartford’s risks on an individual and aggregated basis and with ensuring that The Hartford’s risks remain within its risk appetite and tolerances. ERM plays an integral role at The Hartford by fostering a strong risk management culture and discipline. The mission of ERM is to support The Hartford in achieving its strategic priorities by:
| • | Providing a comprehensive view of the risks facing The Hartford, including risk concentrations and correlations; |
| • | Helping management define The Hartford’s overall capacity and appetite for risk by evaluating the risk return profile of the business relative to The Hartford’s strategic intent and financial underpinning; |
| • | Assisting management in setting specific risk tolerances and limits that are measurable, actionable, and comply with The Hartford’s overall risk philosophy; |
| • | Communicating and monitoring The Hartford’s risk exposures relative to set limits and recommending, or implementing as appropriate, mitigating strategies; and |
| • | Providing insight to assist leaders in growing the businesses and achieving optimal risk-adjusted returns within established guidelines. |
Enterprise Risk Management Structure and Governance
At The Hartford, the Board of Directors (“the Board”) has ultimate responsibility for risk oversight. It exercises its oversight function through its standing committees, each of which has primary risk oversight responsibility with respect to all matters within the scope of its duties as contemplated by its charter. In addition, the Finance, Investment and Risk Management Committee (“FIRMCo”), which is comprised of all members of the Board, has responsibility for oversight of all financial risk exposures facing The Hartford, and all risks that do not fall within the oversight responsibility of any other standing committee. The Audit Committee is responsible for discussing with management risk assessment policies and overseeing enterprise operational risk.
At the corporate level, The Hartford’s Enterprise Chief Risk Officer (“ECRO” or “Chief Risk Officer”) leads ERM. The Chief Risk Officer reports directly to The Hartford’s Chief Executive Officer (“CEO”). Reporting to the ECRO are the Chief Insurance Risk Officer (“CIRO”), Chief Operational Risk Officer (“CORO”), and the Chief Market Risk Officer (“CMRO”). The Hartford has established the Enterprise Risk and Capital Committee (“ERCC”) that includes The Hartford’s CEO, Chief Financial Officer (“CFO”), Chief Investment Officer (“CIO”), Chief Risk Officer, the divisional Presidents and the General Counsel. The ERCC is responsible for managing The Hartford’s risks and overseeing the enterprise risk management program. The ERCC reports to the Board primarily through FIRMCo and through interactions with the Audit Committee.
The Hartford also has committees that manage specific risks and recommend risk mitigation strategies to the ERCC. These committees include The Hartford and Division Asset Liability Committees, Catastrophe Risk Committee, Emerging Risk Committees, and Operational Risk Committee (“ORC”).
7
Risk Management Framework
At The Hartford, risk is managed at multiple levels. The first line of risk management is generally the responsibility of the lines of business. Senior business leaders are responsible for identifying and managing risks specific to their business objectives and business environment. In many cases, the second line of risk management is the principal responsibility of ERM. ERM has the responsibility to ensure The Hartford has insight into its aggregate risk and that risks are managed within The Hartford’s overall risk tolerance. Internal Audit forms the third line of risk management by helping assess and ensure that risk controls are present and effective.
The Hartford’s Risk Management Framework consists of four core elements:
| 1. | Risk Culture and Governance: The Hartford has established policies for its major risks and a formal governance structure with leadership oversight and an assignment of accountability and authority. The governance structure starts at the Board and cascades to a central executive risk management committee and then to individual risk committees across The Hartford. In addition, The Hartford promotes a strong risk management culture and high expectations around ethical behavior. |
| 2. | Risk Identification and Assessment: Through its ERM organization, The Hartford has developed processes for the identification, assessment, and, when appropriate, response to internal and external risks to The Hartford’s operations and business objectives. Risk identification and prioritization has been established within each area, including processes around emerging risks. |
| 3. | Risk Appetite and Limits: The Hartford has a formal risk appetite statement that is approved by The Hartford’s ERCC and reviewed by the Board. Based on its risk appetite, The Hartford has implemented stated risk tolerances and an associated limit structure for each of its major financial and insurance risks. These formal limits are encapsulated in formal risk policies that are reviewed at least annually by the ERCC. |
| 4. | Risk Monitoring, Controls and Communication: The Hartford monitors its major risks at the enterprise level through a number of enterprise reports, including but not limited to, a monthly risk dashboard, tracking the return on risk-capital across products, and regular stress testing. ERM communicates The Hartford’s risk exposures to senior and executive management and the Board, and reviews key business performance metrics, risk indicators, audit reports, risk/control self assessments and risk event data. |
For further discussion on risk management, see Part II, Item 7, MD&A – Enterprise Risk Management.
Regulation
Insurance companies are subject to comprehensive and detailed regulation and supervision throughout the United States. The extent of such regulation varies, but generally has its source in statutes which delegate regulatory, supervisory and administrative powers to state insurance departments. Such powers relate to, among other things, the standards of solvency that must be met and maintained; the licensing of insurers and their agents; the nature of and limitations on investments; establishing premium rates; claim handling and trade practices; restrictions on the size of risks which may be insured under a single policy; deposits of securities for the benefit of policyholders; approval of policy forms; periodic examinations of the affairs of companies; annual and other reports required to be filed on the financial condition of companies or for other purposes; fixing maximum interest rates on life insurance policy loans and minimum rates for accumulation of surrender values; and the adequacy of reserves and other necessary provisions for unearned premiums, unpaid losses and loss adjustment expenses and other liabilities, both reported and unreported.
Most states have enacted legislation that regulates insurance holding company systems such as Hartford Life Insurance Company. This legislation provides that each insurance company in the system is required to register with the insurance department of its state of domicile and furnish information concerning the operations of companies within the holding company system that may materially affect the operations, management or financial condition of the insurers within the system. All transactions within a holding company system affecting insurers must be fair and equitable. Notice to the insurance departments is required prior to the consummation of transactions affecting the ownership or control of an insurer and of certain material transactions between an insurer and any entity in its holding company system. In addition, certain of such transactions cannot be consummated without the applicable insurance department’s prior approval. In the jurisdictions in which the Company is domiciled, the acquisition of more than 10% of its outstanding common stock would require the acquiring party to make various regulatory filings.
The Company and certain of its subsidiaries sell variable life insurance, variable annuity, and some fixed guaranteed products that are “securities” registered with the SEC under the Securities Act of 1933, as amended. Some of the products have separate accounts that are registered as investment companies under the Investment Company Act of 1940, as amended (the “1940 Act”) and/or are regulated by state law. Separate account investment products are also subject to state insurance regulation. Moreover, each separate account is generally divided into sub-accounts, each of which invests in an underlying mutual fund that is also registered as an investment company under the 1940 Act (“Underlying Funds”). The Company offers these Underlying Funds and retail mutual funds that are registered with and regulated by the SEC.
8
In addition, other subsidiaries of the Company are involved in the offering, selling and distribution of the Company’s variable insurance products, Underlying Funds and retail mutual funds as broker dealers and are subject to regulation promulgated and enforced by the Financial Industry Regulatory Authority (“FINRA”), the SEC and/or in, some instances, state securities administrators. Other entities operate as investment advisers registered with the SEC under the Investment Advisers Act of 1940 and are registered as investment advisers under certain state laws, as applicable. Because federal and state laws and regulations are primarily intended to protect investors in securities markets, they generally grant regulators broad rulemaking and enforcement authority. Some of these regulations include among other things regulations impacting sales methods, trading practices, suitability of investments, use and safekeeping of customers’ funds, corporate governance, capital, record keeping, and reporting requirements.
The extent of insurance regulation on business outside the United States varies significantly among the countries in which the Company’s subsidiaries operate. Some countries have minimal regulatory requirements, while others regulate insurers extensively. Foreign insurers in certain countries are faced with greater restrictions than domestic competitors domiciled in that particular jurisdiction. The Company’s international operations are comprised of insurers licensed in their respective countries.
Failure to comply with federal and state laws and regulations may result in censure, fines, the issuance of cease-and-desist orders or suspension, termination or limitation of the activities of our operations and/or our employees. We cannot predict the impact of these actions on our businesses, results of operations or financial condition.
Intellectual Property
We rely on a combination of contractual rights and copyright, trademark, patent and trade secret laws to establish and protect our intellectual property.
We have a worldwide trademark portfolio that we consider important in the marketing of our products and services, including, among others, the trademarks of The Hartford name, the Stag Logo and the combination of these two marks. The duration of trademark registrations varies from country to country and may be renewed indefinitely subject to country-specific use and registration requirements. We regard our trademarks as extremely valuable assets in marketing our products and services and vigorously seek to protect them against infringement.
9
In deciding whether to invest in securities of the Company, you should carefully consider the following risk factors, any of which could have a significant or material adverse effect on the business, financial condition, results of operations, or liquidity of the Company. The Company may also be subject to other general risks that are not specifically enumerated. This information should be considered carefully together with the other information contained in this report and the other reports and materials filed by The Company with the Securities and Exchange Commission (“SEC”). The following risk factors are not necessarily listed in order of importance.
Our operating environment remains subject to uncertainty about the timing and strength of an economic recovery. The steps we have taken to realign our businesses and strengthen our capital position may not be adequate to mitigate the financial, competitive and other risks associated with our operating environment, which could adversely affect our business and results of operations.
The decline of certain global economies, including Europe, and the possible contagion effect, cast uncertainty regarding the timing and strength of an economic recovery, which negatively affected our operating environment in 2011. Continued high unemployment, lower family income, lower business investment and lower consumer spending in most geographic markets we serve have adversely affected the demand for financial and insurance products, as well as their profitability in some cases. Our results, financial condition and statutory capital remain sensitive to equity and credit market performance and effects of interest rates and foreign currency, and we expect that market conditions will put pressure on returns in our life investment portfolios and that our hedging costs (in particular with respect to our variable annuities businesses) will remain higher than historical levels. If global economies continue to decline, economic conditions do not broadly improve and real estate valuations do not stabilize and over time increase, we would expect to experience additional realized and unrealized investment losses, particularly in the real estate and financial services sectors. Negative rating agency actions with respect to our investments could also indirectly adversely affect our statutory capital and risk-based capital (“RBC”) ratios, which could in turn have other negative consequences for our business and results.
The steps we have taken to realign our businesses and strengthen our capital position may not be adequate if economic conditions do not continue to improve in line with our forecasts. These steps include ongoing initiatives, particularly the execution risk relating to the continued repositioning of our investment portfolios and the continuing refinement of our hedge programs for our variable annuity businesses. If our actions are not adequate, our ability to support the scale of our business and to absorb operating losses and liabilities under our customer contracts could be impaired, which would in turn adversely affect our overall competitiveness and the capital position of the Company.
Even if the measures we have taken (or take in the future) are effective to mitigate the risks associated with our current operating environment, they may have unintended consequences. For example, rebalancing our hedging program to protect economic value, while being mindful of statutory surplus, may result in greater earnings volatility under generally accepted accounting principles in the U.S. (“U.S. GAAP”). We could be required to consider actions to manage our capital position and liquidity or further reduce our exposure to market and financial risks. We may also be forced to sell assets on unfavorable terms that could cause us to incur charges or lose the potential for market upside on those assets in a market recovery. We could also face other pressures, such as employee recruitment and retention issues and potential loss of distribution for our products. Additionally, if there was concern over the Company’s capital position that creates an anticipation of the Company issuing additional common stock or equity linked instruments, trading prices for our common stock could decline.
As a result of The Hartford’s ongoing evaluation of its strategy and business portfolio, it may pursue one or more transactions or take other actions, which may include discontinuance or placing in run-off certain lines of business and/or pursuing strategic acquisitions, divestitures or restructurings, any of which could subject it and the Company to a number of challenges, uncertainties and risks or negatively impact our business, financial condition, results of operations or liquidity.
As previously announced, The Hartford is evaluating its strategy and business portfolio with the goal of delivering greater shareholder value. In particular, it noted that while we recognize there are potential benefits to a separation of its P&C and life companies, there are challenges to successfully executing such a separation.
10
As a result of these or other evaluations of The Hartford’s strategy and business portfolio, The Hartford may pursue one or more transactions or take other actions, which may include discontinuing or placing in run-off certain lines of business of the Company and/or pursuing strategic acquisitions, divestitures or restructurings. Because these transactions involve a number of challenges, uncertainties and risks, it may not be able to consummate any such transaction or, if concluded, achieve some or all of the benefits, including in respect of shareholder value, that it expects to derive from it. Pursuit of these initiatives may also, among other things, divert The Hartford’s and the Company’s management’s attention and resources or result in a loss of employees or clients, surrenders, withdrawals, contract terminations or potential adverse capital or tax impacts. Completion of certain divestitures or restructurings might require consents under the covenants of The Hartford’s indentures (including in respect of allocation of our indebtedness), might require actions to satisfy certain rating agency criteria and could result in our retaining insurance or reinsurance obligations or result in recognition of other contingent liabilities (including in respect of intercompany guarantees). In addition, the completion of an acquisition may require use of capital and may involve difficulty integrating acquired businesses into our existing operations. Moreover, completion of an acquisition, divestiture or restructuring may require regulatory approvals or other third-party approvals (including the consents noted above), and these may not be able to be obtained or may involve significant additional cost, time, regulatory capital commitments and other regulatory conditions and obligations. Any such transactions may also be subject to additional significant execution risks, costs and delays. As a result of any of the foregoing, our business, financial condition, results of operations and liquidity could be negatively impacted.
We are exposed to significant financial and capital markets risk, including changes in interest rates, credit spreads, equity prices, market volatility, foreign exchange rates and global real estate market deterioration that may have a material adverse effect on our business, financial condition, results of operations, and liquidity.
One important exposure to equity risk relates to the potential for lower earnings associated with certain of our Wealth Management and Run-Off businesses, such as U.S. and international variable annuities, where fee income is earned based upon the fair value of the assets under management. Should equity markets decline from current levels, assets under management and related fee income will be reduced. Such a decline would also place greater stress on the variable annuities businesses, which requires significant allocated capital due to rating agencies and regulatory requirements, including with respect to stress scenarios. Furthermore, certain of our products offer guaranteed benefits that increase our potential obligation and statutory capital exposure should equity markets continue to decline. Sustained declines in equity markets may result in the need to devote significant additional capital to support these products. We are also exposed to interest rate and equity risk based upon the discount rate and expected long-term rate of return assumptions associated with our pension and other post-retirement benefit obligations. Prolonged low interest rates or market returns are likely to have a negative effect on the funded status of these plans.
Our exposure to interest rate risk relates primarily to the market price and cash flow variability associated with changes in interest rates. A rise in interest rates, in the absence of other countervailing changes, will increase the net unrealized loss position of our investment portfolio and, if long-term interest rates were to rise dramatically within a six-to-twelve month time period, certain of our Wealth Management businesses might be exposed to disintermediation risk. Disintermediation risk refers to the risk that our policyholders may surrender their contracts in a rising interest rate environment, requiring us to liquidate assets in an unrealized loss position. Although our products have features such as surrender charges, market-value adjustments and put options on certain retirement plans, we are subject to disintermediation risk. An increase in interest rates can also impact our tax planning strategies and in particular our ability to utilize tax benefits to offset certain previously recognized realized capital losses. In a declining rate environment, due to the long-term nature of the liabilities associated with certain of our life businesses, such as structured settlements and guaranteed benefits on variable annuities, sustained declines in long-term interest rates may subject us to reinvestment risks, increased hedging costs, spread compression and capital volatility.
Our exposure to credit spreads primarily relates to market price and cash flow variability associated with changes in credit spreads. If issuer credit spreads widen significantly or retain historically wide levels over an extended period of time, additional other-than-temporary impairments and increases in the net unrealized loss position of our investment portfolio will likely result. In addition, losses have also occurred due to the volatility in credit spreads. When credit spreads widen, we incur losses associated with the credit derivatives where the Company assumes exposure. When credit spreads tighten, we incur losses associated with derivatives where the Company has purchased credit protection. If credit spreads tighten significantly, the Company’s net investment income associated with new purchases of fixed maturities may be reduced. In addition, a reduction in market liquidity can make it difficult to value certain of our securities when trading becomes less frequent. As such, valuations may include assumptions or estimates that may be more susceptible to significant period-to-period changes, which could have a material adverse effect on our business, financial condition, results of operations or liquidity.
11
Our statutory surplus is also affected by widening credit spreads as a result of the accounting for the assets and liabilities on our fixed market value adjusted (“MVA”) annuities. Statutory separate account assets supporting the fixed MVA annuities are recorded at fair value. In determining the statutory reserve for the fixed MVA annuities we are required to use current crediting rates in the U.S. and Japanese LIBOR in Japan. In many capital market scenarios, current crediting rates in the U.S. are highly correlated with market rates implicit in the fair value of statutory separate account assets. As a result, the change in the statutory reserve from period to period will likely substantially offset the change in the fair value of the statutory separate account assets. However, in periods of volatile credit markets, actual credit spreads on investment assets may increase sharply for certain sub-sectors of the overall credit market, resulting in statutory separate account asset market value losses. As actual credit spreads are not fully reflected in current crediting rates in the U.S. or Japanese LIBOR in Japan, the calculation of statutory reserves will not substantially offset the change in fair value of the statutory separate account assets resulting in reductions in statutory surplus. This has resulted and may continue to result in the need to devote significant additional capital to support the fixed MVA product.
Our primary foreign currency exchange risk is related to certain guaranteed benefits associated with the Japan and U.K. variable annuities. The strengthening of the yen compared with other currencies will substantially increase our exposure to pay yen-denominated obligations. In addition, our foreign currency exchange risk relates to net income from foreign operations, non-U.S. dollar denominated investments, investments in foreign subsidiaries, and our yen-denominated individual fixed annuity product. In general, the weakening of foreign currencies versus the U.S.-dollar will unfavorably affect net income from foreign operations, the value of non-U.S.-dollar denominated investments, investments in foreign subsidiaries and realized gains or losses on the yen denominated annuity products. A strengthening of the U.S. dollar compared to foreign currencies will increase our exposure to the U.S. variable annuity guarantee benefits where policyholders have elected to invest in international funds, generating losses and statutory surplus strain.
Our real estate market exposure includes investments in commercial mortgage-backed securities, residential mortgage-backed securities, commercial real estate collateralized debt obligations, mortgage and real estate partnerships, and mortgage loans. Significant deterioration in the real estate market in the recent past has adversely affected our business and results of operations. Further deterioration in the real estate market, including increases in property vacancy rates, delinquencies and foreclosures, could have a negative impact on property values and sources of refinancing resulting in reduced market liquidity and higher risk premiums. This could result in impairments of real estate backed securities, a reduction in net investment income associated with real estate partnerships, and increases in our valuation allowance for mortgage loans.
Significant declines in equity prices, changes in U.S. interest rates, changes in credit spreads, inflation, the strengthening or weakening of foreign currencies against the U.S. dollar, or global real estate market deterioration, individually or in combination, could have a material adverse effect on our business, financial condition, results of operations and liquidity.
Concentration of our investment portfolio in any particular segment of the economy may have adverse effects on our business, financial condition, results of operations and liquidity.
The concentration of our investment portfolios in any particular industry, collateral type, group of related industries or geographic sector could have an adverse effect on our investment portfolios and consequently on our business, financial condition, results of operations and liquidity. Events or developments that have a negative impact on any particular industry, group of related industries or geographic region may have a greater adverse effect on our investment portfolio to the extent that the portfolio is concentrated rather than diversified.
Our adjustment of our risk management program relating to products we offer with guaranteed benefits to emphasize protection of statutory surplus and cash flows will likely result in greater U.S. GAAP volatility in our earnings and potentially material charges to net income in periods of rising equity market pricing levels.
Some of the products offered by our four ongoing businesses and previously offered by our runoff business, especially variable annuities, offer guaranteed benefits which, in the event of a decline in equity markets, would not only result in lower earnings, but will also increase our exposure to liability for benefit claims. We are also subject to equity market volatility related to these benefits, including the guaranteed minimum withdrawal benefit (“GMWB”), guaranteed minimum accumulation benefit (“GMAB”), guaranteed minimum death benefit (“GMDB”) and guaranteed minimum income benefit (“GMIB”) offered with variable annuity products. We use reinsurance structures and have modified benefit features to mitigate the exposure associated with GMDB. We also use reinsurance in combination with a modification of benefit features and derivative instruments to attempt to minimize the claim exposure and to reduce the volatility of net income associated with the GMWB liability. However, due to the severe economic conditions starting in the fourth quarter of 2008, we have adjusted our risk management program to place greater relative emphasis on the protection of statutory surplus and cash flows. This shift in relative emphasis has resulted in greater U.S. GAAP earnings volatility and, based upon the types of hedging instruments used, can result in potentially material charges to net income in periods of rising equity market pricing levels, lower interest rates, rises in volatility and weakening of the yen against other currencies. While we believe that these actions have improved the efficiency of our risk management related to these benefits, we remain liable for the guaranteed benefits in the event that reinsurers or derivative counterparties are unable or unwilling to pay. We are also subject to the risk that these management procedures prove ineffective or that unanticipated policyholder behavior, combined with adverse market events, produces economic losses beyond the scope of the risk management techniques employed, which individually or collectively may have a material adverse effect on our business, financial condition, results of operations and liquidity.
12
The amount of statutory capital that we have, and the amount of statutory capital that we must hold to maintain our financial strength and credit ratings and meet other requirements, can vary significantly from time to time and is sensitive to a number of factors outside of our control, including equity market, credit market, interest rate and foreign currency conditions, changes in policyholder behavior and changes in rating agency models.
Accounting standards and statutory capital and reserve requirements for these entities are prescribed by the applicable insurance regulators and the National Association of Insurance Commissioners (“NAIC”). Insurance regulators have established regulations that provide minimum capitalization requirements based on RBC formulas for life companies. The RBC formula for life companies establishes capital requirements relating to insurance, business, asset and interest rate risks, including equity, interest rate and expense recovery risks associated with variable annuities and group annuities that contain death benefits or certain living benefits. Our international operations are subject to regulation in the relevant jurisdiction in which they operate, which in many ways is similar to the state regulation outlined above, with similar related restrictions and obligations.
In any particular year, statutory surplus amounts and RBC ratios may increase or decrease depending on a variety of factors, including the amount of statutory income or losses generated by our insurance subsidiaries (which itself is sensitive to equity market and credit market conditions), the amount of additional capital our insurance subsidiaries must hold to support business growth, changes in equity market levels, the value of certain fixed-income and equity securities in our investment portfolio, the value of certain derivative instruments, changes in interest rates and foreign currency exchange rates, the impact of internal reinsurance arrangements, and changes to the NAIC RBC formulas. Most of these factors are outside of the Company’s control. The Company’s financial strength and credit ratings are significantly influenced by the statutory surplus amounts and RBC ratios of our insurance company subsidiaries. In addition, rating agencies may implement changes to their internal models that have the effect of increasing the amount of statutory capital we must hold in order to maintain our current ratings. Also, in extreme scenarios of equity market declines and other capital market volatility, the amount of additional statutory reserves that we are required to hold for our variable annuity guarantees increases at a greater than linear rate. This reduces the statutory surplus used in calculating our RBC ratios. When equity markets increase, surplus levels and RBC ratios will generally increase. This may be offset, however, as a result of a number of factors and market conditions, including the level of hedging costs and other risk transfer activities, reserve requirements for death and living benefit guarantees and RBC requirements could also increase, lowering RBC ratios. For example, in 2012 our statutory surplus is expected to be flat to negative primarily due to high variable annuity hedge losses compared to fees earned, and a depression on statutory earnings in other of our businesses due largely to continued low interest rates. Our statutory surplus is expected to be flat to negative in 2012 compared to 2011 primarily due to high variable annuity hedge losses compared to fees earned. Due to these factors, projecting statutory capital and the related RBC ratios is complex. If our statutory capital resources are insufficient to maintain a particular rating by one or more rating agencies, The Hartford may seek to raise capital through public or private equity or debt financing. If we were not to raise additional capital, either at our discretion or because we were unable to do so, our financial strength and credit ratings might be downgraded by one or more rating agencies.
Downgrades in our financial strength or credit ratings, which may make our products less attractive could increase our cost of capital and inhibit our ability to refinance our debt, which would have a material adverse effect on our business, financial condition, results of operations and liquidity.
Financial strength and credit ratings, including commercial paper ratings, are important in establishing the competitive position of insurance companies. Rating agencies assign ratings based upon several factors. While most of the factors relate to the rated company, some of the factors relate to the views of the rating agency, general economic conditions, and circumstances outside the rated company’s control. In addition, rating agencies may employ different models and formulas to assess the financial strength of a rated company, and from time to time rating agencies have, at their discretion, altered these models. Changes to the models, general economic conditions, or circumstances outside our control could impact a rating agency’s judgment of its rating and the rating it assigns us. We cannot predict what actions rating agencies may take, or what actions we may take in response to the actions of rating agencies, which may adversely affect us.
Our financial strength ratings, which are intended to measure our ability to meet policyholder obligations, are an important factor affecting public confidence in most of our products and, as a result, our competitiveness. A downgrade or a potential downgrade in the rating of our financial strength or of one of our principal insurance subsidiaries could affect our competitive position and reduce future sales of our products.
Our credit ratings also affect our cost of capital. A downgrade or a potential downgrade of our credit ratings could make it more difficult or costly to refinance maturing debt obligations, to support business growth at our insurance subsidiaries and to maintain or improve the financial strength ratings of our principal insurance subsidiaries. Downgrades could begin to trigger potentially material collateral calls on certain of our derivative instruments and counterparty rights to terminate derivative relationships, both of which could limit our ability to purchase additional derivative instruments. These events could materially adversely affect our business, financial condition, results of operations and liquidity.
13
Our valuations of many of our financial instruments include methodologies, estimations and assumptions that are subject to differing interpretations and could result in changes to investment valuations that may materially adversely affect our results of operations and financial condition.
The following financial instruments are carried at fair value in the Company’s consolidated financial statements: fixed maturities, equity securities, freestanding and embedded derivatives, and separate account assets. The determination of fair values is made at a specific point in time, based on available market information and judgments about financial instruments, including estimates of the timing and amounts of expected future cash flows and the credit standing of the issuer or counterparty. The use of different methodologies and assumptions may have a material effect on the estimated fair value amounts.
During periods of market disruption, including periods of rapidly widening credit spreads or illiquidity, it may be difficult to value certain of our securities if trading becomes less frequent and/or market data becomes less observable. There may be certain asset classes that were in active markets with significant observable data that become illiquid due to the financial environment. In such cases, securities may require more subjectivity and management judgment in determining their fair values and those fair values may differ materially from the value at which the investments may be ultimately sold. Further, rapidly changing or unprecedented credit and equity market conditions could materially impact the valuation of securities and the period-to-period changes in value could vary significantly. Decreases in value could have a material adverse effect on our results of operations and financial condition.
Evaluation of available-for-sale securities for other-than-temporary impairment involves subjective determinations and could materially impact our results of operations.
The evaluation of impairments is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether a credit and/or non-credit impairment exists and whether an impairment should be recognized in current period earnings or in other comprehensive income. The risks and uncertainties include changes in general economic conditions, the issuer’s financial condition or future recovery prospects, the effects of changes in interest rates or credit spreads and the expected recovery period. For securitized financial assets with contractual cash flows, the Company currently uses its best estimate of cash flows over the life of the security. In addition, estimating future cash flows involves incorporating information received from third-party sources and making internal assumptions and judgments regarding the future performance of the underlying collateral and assessing the probability that an adverse change in future cash flows has occurred. The determination of the amount of other-than-temporary impairments is based upon our quarterly evaluation and assessment of known and inherent risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available.
Additionally, our management considers a wide range of factors about the security issuer and uses their best judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for recovery. Inherent in management’s evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Considerations in the impairment evaluation process include, but are not limited to:
| • | the length of time and the extent to which the fair value has been less than cost or amortized cost; |
| • | changes in the financial condition, credit rating and near-term prospects of the issuer; |
| • | whether the issuer is current on contractually obligated interest and principal payments; |
| • | changes in the financial condition of the security’s underlying collateral; |
| • | the payment structure of the security; |
| • | the potential for impairments in an entire industry sector or sub-sector; |
| • | the potential for impairments in certain economically depressed geographic locations; |
| • | the potential for impairments of securities where the issuer, series of issuers or industry has suffered a catastrophic type of loss or has exhausted natural resources; |
| • | unfavorable changes in forecasted cash flows on mortgage-backed and asset-backed securities; |
| • | for mortgage-backed and asset-backed securities, commercial and residential property value declines that vary by property type and location and average cumulative collateral loss rates that vary by vintage year; |
| • | other subjective factors, including concentrations and information obtained from regulators and rating agencies; |
| • | our intent to sell a debt or an equity security with debt-like characteristics (collectively, “debt security”) or whether it is more likely than not that the Company will be required to sell the debt security before its anticipated recovery; and |
| • | our intent and ability to retain an equity security without debt-like characteristics for a period of time sufficient to allow for the recovery of its value. |
Impairment losses in earnings could materially adversely affect our results of operation and financial condition.
14
Losses due to nonperformance or defaults by others, including issuers of investment securities (which include structured securities such as commercial mortgage backed securities and residential mortgage backed securities, European private and sovereign issuers, or other high yielding bonds) mortgage loans or reinsurance and derivative instrument counterparties, could have a material adverse effect on the value of our investments, business, financial condition, results of operations and liquidity.
Issuers or borrowers whose securities or loans we hold, customers, trading counterparties, counterparties under swaps and other derivative contracts, reinsurers, clearing agents, exchanges, clearing houses and other financial intermediaries and guarantors may default on their obligations to us due to bankruptcy, insolvency, lack of liquidity, adverse economic conditions, operational failure, fraud, government intervention or other reasons. Such defaults could have a material adverse effect on our business, financial condition, results of operations and liquidity. Additionally, the underlying assets supporting our structured securities or loans may deteriorate causing these securities or loans to incur losses.
Our investment portfolio includes securities backed by real estate assets the value of which have been adversely impacted by the recent recessionary period, high unemployment rates and the associated property value declines, ultimately resulting in a reduction in expected future cash flows for certain securities. The Company also has exposure to European based issuers of securities and providers of reinsurance, as well as indirect European exposure resulting from the variable annuity products that it has sold in Japan and the United Kingdom. Further details of the European private and sovereign issuers held within the investment portfolio and indirect variable annuity exposures can be found in Part II, Item 7, MD&A – Enterprise Risk Management—Investment Portfolio Risks and Risk Management.
Further property value declines and loss rates that exceed our current estimates, as outlined in Part II, Item 7, MD&A – Investment Portfolio Risks and Risk Management – Other-Than-Temporary Impairments, a worsening of general economic conditions, including the European financial crisis could have a material adverse effect on our business, financial condition, results of operations and liquidity.
To the extent the investment portfolio is not adequately diversified, concentrations of credit risk may exist which could negatively impact the Company if significant adverse events or developments occur in any particular industry, group of related industries or geographic regions. The Company is not exposed to any credit concentration risk of a single issuer greater than 10% of the Company’s stockholders’ equity other than U.S. government and U.S. government agencies backed by the full faith and credit of the U.S. government. However, if issuers of securities or loans we hold are acquired, merge or otherwise consolidate with other issuers of securities or loans held by the Company, the Company’s credit concentration risk could increase above the 10% threshold, for a period of time, until the Company is able to sell securities to get back in compliance with the established investment credit policies.
If assumptions used in estimating future gross profits differ from actual experience, we may be required to accelerate the amortization of DAC and increase reserves for guaranteed minimum death and income benefits, which could have a material adverse effect on our results of operations and financial condition.
The Company defers acquisition costs associated with the sales of its universal and variable life and variable annuity products. These costs are amortized over the expected life of the contracts. The remaining deferred but not yet amortized cost is referred to as the Deferred Acquisition Cost (“DAC”) asset. We amortize these costs in proportion to the present value of estimated gross profits (“EGPs”). The Company evaluates the EGPs compared to the DAC asset to determine if an impairment exists. The Company also establishes reserves for GMDB and GMIB using components of EGPs. The projection of estimated gross profits or components of estimated gross profits requires the use of certain assumptions, principally related to separate account fund returns in excess of amounts credited to policyholders, surrender and lapse rates, interest margin (including impairments), mortality, benefit utilization, annuitization and hedging costs. Of these factors, we anticipate that changes in investment returns are most likely to impact the rate of amortization of such costs. However, other factors such as those the Company might employ to reduce risk, such as the cost of hedging or other risk mitigating techniques, could also significantly reduce estimates of future gross profits. Estimating future gross profits is a complex process requiring considerable judgment and the forecasting of events well into the future. If our assumptions regarding policyholder behavior, including lapse rates, benefit utilization, surrenders, and annuitization, hedging costs or costs to employ other risk mitigating techniques prove to be inaccurate or if significant or sustained equity market declines occur, we could be required to accelerate the amortization of DAC related to variable annuity and variable universal life contracts, and increase reserves for GMDB and GMIB which would result in a charge to net income. Such adjustments could have a material adverse effect on our results of operations and financial condition.
15
If our businesses do not perform well, we may be required to recognize an impairment of our goodwill or to establish a valuation allowance against the deferred income tax asset, which could have a material adverse effect on our results of operations and financial condition.
Goodwill represents the excess of the amounts we paid to acquire subsidiaries and other businesses over the fair value of their net assets at the date of acquisition. We test goodwill at least annually for impairment. Impairment testing is performed based upon estimates of the fair value of the “reporting unit” to which the goodwill relates. The reporting unit is the operating segment or a business one level below that operating segment if discrete financial information is prepared and regularly reviewed by management at that level. The fair value of the reporting unit is impacted by the performance of the business and could be adversely impacted by any efforts made by the Company to limit risk. If it is determined that the goodwill has been impaired, the Company must write down the goodwill by the amount of the impairment, with a corresponding charge to net income. These write downs could have a material adverse effect on our results of operations or financial condition.
Deferred income tax represents the tax effect of the differences between the book and tax basis of assets and liabilities. Deferred tax assets are assessed periodically by management to determine if they are realizable. Factors in management’s determination include the performance of the business including the ability to generate capital gains, to offset previously recognized capital losses, from a variety of sources and tax planning strategies. If based on available information, it is more likely than not that we are unable to recognize a full tax benefit on realized capital losses, then a valuation allowance will be established with a corresponding charge to net income. Charges to increase our valuation allowance could have a material adverse effect on our results of operations and financial condition. As previously announced, we are evaluating our strategy and business portfolio with the goal of delivering greater shareholder value. Certain strategic transactions may adversely affect our ability to realize our deferred tax assets.
The occurrence of one or more terrorist attacks in the geographic areas we serve or the threat of terrorism in general may have a material adverse effect on our business, financial condition, results of operations and liquidity.
The occurrence of one or more terrorist attacks in the geographic areas we serve could result in substantially higher claims under our insurance policies than we have anticipated. Private sector catastrophe reinsurance is extremely limited and generally unavailable for terrorism losses caused by attacks with nuclear, biological, chemical or radiological weapons. Reinsurance coverage from the federal government under the Terrorism Risk Insurance Program Reauthorization Act of 2007 is also limited. Accordingly, the effects of a terrorist attack in the geographic areas we serve may result in claims and related losses for which we do not have adequate reinsurance. This would likely cause us to increase our reserves, adversely affect our results during the period or periods affected and, could adversely affect our business, financial condition, results of operations and liquidity. Further, the continued threat of terrorism and the occurrence of terrorist attacks, as well as heightened security measures and military action in response to these threats and attacks or other geopolitical or military crises, may cause significant volatility in global financial markets, disruptions to commerce and reduced economic activity. These consequences could have an adverse effect on the value of the assets in our investment portfolio as well as those in our separate accounts. The continued threat of terrorism also could result in increased reinsurance prices and potentially cause us to retain more risk than we otherwise would retain if we were able to obtain reinsurance at lower prices. Terrorist attacks also could disrupt our operations centers in the U.S. or abroad. As a result, it is possible that any, or a combination of all, of these factors may have a material adverse effect on our business, financial condition, results of operations and liquidity.
We are particularly vulnerable to losses from catastrophes, both natural and man-made, which could materially and adversely affect our business, financial condition, results of operations and liquidity.
Our operations are also exposed to risk of loss from catastrophes associated with pandemics and other events that could significantly increase our mortality and morbidity exposures. Policyholders may be unable to meet their obligations to pay premiums on our insurance policies or make deposits on our investment products.
Our liquidity could be constrained by a catastrophe, or multiple catastrophes, which could result in extraordinary losses. In addition, in part because accounting rules do not permit insurers to reserve for such catastrophic events until they occur, claims from catastrophic events could have a material adverse effect on our business, financial condition, results of operations and liquidity. To the extent that loss experience unfolds or models improve, we will seek to reflect any increased risk in the design and pricing of our products. However, the Company may be exposed to regulatory or legislative actions that prevent a full accounting of loss expectations in the design or pricing of our products or result in additional risk-shifting to the insurance industry.
16
We may incur losses due to our reinsurers’ unwillingness or inability to meet their obligations under reinsurance contracts and the availability, pricing and adequacy of reinsurance may not be sufficient to protect us against losses.
As an insurer, we frequently seek to reduce the losses that may arise from catastrophes, or other events that can cause unfavorable results of operations, through reinsurance. Under these reinsurance arrangements, other insurers assume a portion of our losses and related expenses; however, we remain liable as the direct insurer on all risks reinsured. Consequently, ceded reinsurance arrangements do not eliminate our obligation to pay claims, and we are subject to our reinsurers’ credit risk with respect to our ability to recover amounts due from them. Although we regularly evaluate the financial condition of our reinsurers to minimize our exposure to significant losses from reinsurer insolvencies, our reinsurers may become financially unsound or choose to dispute their contractual obligations by the time their financial obligations become due. The inability or unwillingness of any reinsurer to meet its financial obligations to us could have a material adverse effect on our results of operations. In addition, market conditions beyond our control determine the availability and cost of the reinsurance we are able to purchase. Historically, reinsurance pricing has changed significantly from time to time. No assurances can be made that reinsurance will remain continuously available to us to the same extent and on the same terms as are currently available. If we were unable to maintain our current level of reinsurance or purchase new reinsurance protection in amounts that we consider sufficient and at prices that we consider acceptable, we would have to either accept an increase in our net liability exposure, reduce the amount of business we write, or develop other alternatives to reinsurance.
Competitive activity may adversely affect our market share and financial results, which could have a material adverse effect on our business, results of operations and financial condition.
The insurance industry is highly competitive. Our competitors include other insurers and, because many of our products include an investment component, securities firms, investment advisers, mutual funds, banks and other financial institutions. These competitors compete with us for producers such as brokers and independent agents and for our employees. Larger competitors may have lower operating costs and an ability to absorb greater risk while maintaining their financial strength ratings, thereby allowing them to price their products more competitively. These highly competitive pressures could result in increased pricing pressures on a number of our products and services and may harm our ability to maintain or increase our profitability. Because of the highly competitive nature of the insurance industry, there can be no assurance that we will continue to effectively compete with our industry rivals, or that competitive pressure will not have a material adverse effect on our business, results of operations and financial condition.
We may experience difficulty in marketing, distributing and providing investment advisory services in relation to our products through current and future distribution channels and advisory firms.
We distribute our annuity and life insurance products and mutual funds through a variety of distribution channels, including brokers, independent agents, broker-dealers, banks, wholesalers, affinity partners, our own internal sales force and other third-party organizations. In some areas of our business, we generate a significant portion of our business through or in connection with individual third-party arrangements. In addition, we work with a number of key investment advisers in managing our products and mutual funds. In December 2011, for example, we entered into a 5-year agreement with Wellington Management Company as the preferred sub-advisor for The Hartford Mutual Funds. We periodically negotiate provisions and renewals of these relationships, and there can be no assurance that such terms will remain acceptable to us or such third parties. An interruption in our continuing relationship with certain of these third parties, including potentially as a result of a strategic transaction, could materially affect our ability to market our products and could have a material adverse effect on our business, financial condition, results of operations and liquidity.
The impact of regulatory initiatives, including the enactment of The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), could have a material adverse impact on our business, financial condition, results of operations and liquidity.
Regulatory developments relating to the recent financial crisis may significantly affect our operations and prospects in ways that we cannot predict. U.S. and overseas governmental and regulatory authorities, including the SEC, The Federal Reserve, the Federal Deposit Insurance Corporation (“FDIC”), the New York Stock Exchange and the Financial Industry Regulatory Authority are considering enhanced or new regulatory requirements intended to prevent future crises or otherwise stabilize the institutions under their supervision. Such measures are likely to lead to stricter regulation of financial institutions generally, and heightened prudential requirements for systemically important companies in particular. Such measures could include taxation of financial transactions and restrictions on employee compensation.
The Dodd-Frank Act was enacted on July 21, 2010, mandating changes to the regulation of the financial services industry. The Dodd-Frank Act may affect our operations and governance in ways that could adversely affect our financial condition and results of operations.
Certain provisions of the Dodd-Frank Act will require central clearing of, and/or impose new margin and capital requirements on, derivatives transactions, which we expect will increase the costs of our hedging program. Other provisions in the Dodd-Frank Act that may impact us include: a new “Federal Insurance Office” within Treasury; discretionary authority for the SEC to impose a harmonized standard of care for investment advisers and broker-dealers who provide personalized advice about securities to retail customers; possible adverse impact on the pricing and liquidity of the securities in which we invest resulting from the proprietary trading and market making limitation of the Volker Rule; possible prohibition of certain asset-backed securities transactions that could adversely impact our ability to offer insurance-linked securities; and enhancements to corporate governance, especially regarding risk management.
17
In particular, the Dodd-Frank Act vests a newly created Financial Services Oversight Council (“FSOC”) with the power to designate “systemically important” institutions, which will be subject to special regulatory supervision and other provisions intended to prevent, or mitigate the impact of, future disruptions in the U.S. financial system. Systemically important institutions are limited to large bank holding companies and nonbank financial companies that are so important that their potential failure could “pose a threat to the financial stability of the United States.” The FSOC released a second notice of proposed rulemaking setting forth the process they propose to follow when designating systemically important nonbank financial companies in October 2011, but has not yet released a final rule or indicated when the FSOC will begin designating systemically important nonbank financial companies.
If our parent is designated as a systemically important institution, it could be subject to higher capital requirements and additional regulatory oversight imposed by The Federal Reserve, as well as to post-event assessments imposed by the FDIC to recoup the costs associated with the orderly liquidation of other systemically important institutions in the event one or more such institutions fails. Further, the FDIC is authorized to petition a state court to commence an insolvency proceeding to liquidate an insurance company that fails in the event the insurer’s state regulator fails to act. We may also be restricted from sponsoring and investing in private equity and hedge funds, which would limit our discretion in managing our general account. The Federal Reserve issued a proposed rule in December 2011 that would apply capital and liquidity requirements, single-counterparty credit limits, and stress testing and risk management requirements to systemically important institutions, and subject such institutions to an early remediation regime based on these requirements. The Federal Reserve has noted that they may tailor the application of the proposed rule to the particular attributes of systemically important nonbank financial companies. If our parent were to be designated as systemically important by the FSOC, these requirements could apply to it. However, it is not yet clear how or to what extent these requirements would be applied to systemically important nonbank financial companies.
We may experience unfavorable judicial or legislative developments involving claim litigation that could have a material adverse effect on our business, financial condition, results of operations and liquidity.
The Company is involved in claims litigation arising in the ordinary course of business. The Company is also involved in legal actions that do not arise in the ordinary course of business, some of which assert claims for substantial amounts. Pervasive or significant changes in the judicial environment relating to matters such as trends in the size of jury awards, developments in the law relating to the liability of insurers, or tort defendants and rulings concerning the availability or amount of certain types of damages could cause our ultimate liabilities to change from our current expectations. Changes in federal or state tort litigation laws or other applicable law could have a similar effect. It is not possible to predict changes in the judicial and legislative environment and their impact on the outcome of litigation filed against the Company. Our business, financial condition, results of operations and liquidity could also be adversely affected if judicial or legislative developments cause our ultimate liabilities to increase from current expectations.
Potential changes in domestic and foreign regulation may increase our business costs and required capital levels, which could have a material adverse effect on our business, financial condition, results of operations and liquidity.
We are subject to extensive U.S. and non-U.S. laws and regulations that are complex, subject to change and often conflicting in their approach or intended outcomes. Compliance with these laws and regulations is costly and can affect our strategy, as well as the demand for and profitability of the products we offer.
18
State insurance laws regulate most aspects of our U.S. insurance businesses, and our insurance subsidiaries are regulated by the insurance departments of the states in which they are domiciled, licensed or authorized to conduct business. U.S. state laws grant insurance regulatory authorities broad administrative powers with respect to, among other things:
| • | licensing companies and agents to transact business; |
| • | calculating the value of assets to determine compliance with statutory requirements; |
| • | mandating certain insurance benefits; |
| • | regulating certain premium rates; |
| • | reviewing and approving policy forms; |
| • | regulating unfair trade and claims practices, including through the imposition of restrictions on marketing and sales practices, distribution arrangements and payment of inducements; |
| • | protecting privacy; |
| • | establishing statutory capital and reserve requirements and solvency standards; |
| • | fixing maximum interest rates on insurance policy loans and minimum rates for guaranteed crediting rates on life insurance policies and annuity contracts; |
| • | approving changes in control of insurance companies; |
| • | approving acquisitions, divestitures and similar transactions; |
| • | restricting the payment of dividends to the parent company and other transactions between affiliates; |
| • | establishing assessments and surcharges for guaranty funds, second-injury funds and other mandatory pooling arrangements; |
| • | requiring insurers to dividend any excess profits to policy holders; and |
| • | regulating the types, amounts and valuation of investments. |
Because these laws and regulations are complex and sometimes inexact, there is also a risk that any particular regulator’s or enforcement authority’s interpretation of a legal, accounting, or reserving issue may change over time to our detriment, or expose us to different or additional regulatory risks. For example, the Company and certain of our life insurance subsidiaries use the NAIC’s Model Regulation entitled “Valuation of Life Insurance Policies,” commonly known as Regulation XXX, in setting statutory reserves for term life insurance policies with long-term premium guarantees and universal life policies with secondary guarantees. In addition, Actuarial Guideline 38 (“AG38” or “AXXX”) clarifies the application of Regulation XXX with respect to universal life insurance policies with secondary guarantees, i.e., a guaranteed death benefit for a specified period of time, often for life. Virtually all of our in force universal life insurance products are now affected by Regulation XXX and AXXX. The application of these regulations and guidelines by insurers involves interpretations and judgments that may not be consistent with the opinion of state insurance departments. We cannot provide assurance that such differences of opinion will not result in regulatory, tax or other challenges to the actions we have taken to date. The result of those potential challenges could require us to increase statutory reserves or incur higher operating and/or tax costs. Moreover, it is possible that the reinsurance and capital management actions we have taken to mitigate the impact of Regulation XXX and AXXX on our universal life insurance business may face regulatory, rating agency or other challenges. Furthermore, we may be unable to continue to implement actions to mitigate the impact of these regulations on future sales of term life insurance and universal life policies, resulting in lower returns on such products than we currently anticipate or reduce our sales of these products.
Our international operations are also subject to regulation in the relevant jurisdictions in which they operate (primarily the Japan Financial Services Agency and the U.K. Financial Services Authority), which in many ways is similar to the state regulation outlined above, with similar related restrictions and obligations. Our asset management businesses are also subject to extensive regulation in the various jurisdictions where they operate.
These laws and regulations are primarily intended to protect investors in the securities markets or investment advisory clients and generally grant supervisory authorities broad administrative powers. Compliance with these laws and regulations is costly, time consuming and personnel intensive, and may have an adverse effect on our business, financial condition, results of operations and liquidity. See the risk factor “The impact of regulatory initiatives, including the enactment of The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), could have a material adverse impact on our business, financial condition, results of operations and liquidity.”
19
If we are unable to maintain the availability of our systems and safeguard the security of our data due to the occurrence of disasters or a cyber or other information security incident, our ability to conduct business may be compromised, we may incur substantial costs and suffer other negative consequences, all of which may have a material adverse effect on our business, financial condition, results of operations and liquidity.
We use computer systems to process, store, retrieve, evaluate and utilize customer and company data and information. Our computer, information technology and telecommunications systems, in turn, interface with and rely upon third-party systems. Our business is highly dependent on our ability, and the ability of certain third parties, to access these systems to perform necessary business functions, including, without limitation, conducting our financial reporting and analysis, providing insurance quotes, processing premium payments, making changes to existing policies, filing and paying claims, administering variable annuity products and mutual funds, providing customer support and managing our investment portfolios and hedging programs. Systems failures or outages could compromise our ability to perform these functions in a timely manner, which could harm our ability to conduct business and hurt our relationships with our business partners and customers. In the event of a disaster such as a natural catastrophe, a pandemic, an industrial accident, a blackout, a terrorist attack or war, systems upon which we rely may be inaccessible to our employees, customers or business partners for an extended period of time. Even if our employees and business partners are able to report to work, they may be unable to perform their duties for an extended period of time if our data or systems used to conduct our business are disabled or destroyed.
Moreover, our systems may be subject to a computer virus or other malicious code, unauthorized access, a cyber-attack or other computer related violation. Such an event could compromise our confidential information as well as that of our clients and third parties with whom we interact, impede or interrupt our business operations and may result in other negative consequences, including remediation costs, loss of revenue, additional regulatory scrutiny and litigation and reputational damage.
In addition, we routinely transmit, receive and store personal, confidential and proprietary information by email and other electronic means. Although we attempt to keep such information confidential, we may be unable to utilize such capabilities in all events, especially with clients, vendors, service providers, counterparties and other third parties who may not have or use appropriate controls to protect confidential information. Furthermore, certain of our businesses are subject to compliance with regulations enacted by U.S. federal and state governments, the European Union, Japan or other jurisdictions or enacted by various regulatory organizations or exchanges relating to the privacy of the information of clients, employees or others. A misuse or mishandling of confidential or proprietary information being sent to or received from an employee or third party could result in legal liability, regulatory action and reputational harm.
Third parties to whom we outsource certain of our functions are also subject to the risks outlined above, any one of which may result in our incurring substantial costs and other negative consequences, including a material adverse effect on our business, financial condition, results of operations and liquidity.
Our framework for managing business risks may not be effective in mitigating risk and loss to us that could adversely affect our businesses.
Our business performance is highly dependent on our ability to manage risks that arise from a large number of day-to-day business activities, including insurance underwriting, claims processing, servicing, investment, financial and tax reporting, compliance with regulatory requirements and other activities, many of which are very complex and for some of which we rely on third parties. We seek to monitor and control our exposure to risks arising out of these activities through a risk control framework encompassing a variety of reporting systems, internal controls, management review processes and other mechanisms. We cannot be completely confident that these processes and procedures will effectively control all known risks or effectively identify unforeseen risks, or that our employees and third-party agents will effectively implement them. Management of business risks can fail for a number of reasons, including design failure, systems failure, failures to perform, cyber security attacks or unlawful activities on the part of employees or third parties. In the event that our controls are not effective or not properly implemented, we could suffer financial or other loss, disruption of our businesses, regulatory sanctions or damage to our reputation. Losses resulting from these failures can vary significantly in size, scope and scale and may have material adverse effects on our business, financial condition, results of operations and liquidity.
If we experience difficulties arising from outsourcing relationships, our ability to conduct business may be compromised.
We outsource certain technology and business functions to third parties and expect to do so selectively in the future. If we do not effectively develop and implement our outsourcing strategy, third-party providers do not perform as anticipated, or we experience problems with a transition, we may experience operational difficulties, inability to meet obligations, including, but not limited to, policyholder obligations, increased costs and a loss of business that may have a material adverse effect on our results of operations. For other risks associated with our outsourcing of certain functions, see the risk factor, “If we are unable to maintain the availability of our systems and safeguard the security of our data due to the occurrence of disasters or a cyber or other information security incident, our ability to conduct business may be compromised, we may incur substantial costs and suffer other negative consequences, all of which may have a material adverse effect on our business, financial condition, results of operations and liquidity.”
20
Potential changes in federal or state tax laws, including changes impacting the availability of the separate account dividend received deduction, could adversely affect our business, financial condition, results of operations and liquidity.
Many of the products that the Company sells benefit from one or more forms of tax-favored status under current federal and state income tax regimes. For example, the Company sells life insurance policies that benefit from the deferral or elimination of taxation on earnings accrued under the policy, as well as permanent exclusion of certain death benefits that may be paid to policyholders’ beneficiaries. We also sell annuity contracts that allow the policyholders to defer the recognition of taxable income earned within the contract. Other products that the Company sells also enjoy similar, as well as other, types of tax advantages. The Company also benefits from certain tax items, including but not limited to, tax-exempt bond interest, dividends-received deductions, tax credits (such as foreign tax credits), and insurance reserve deductions.
Due in large part to the recent financial crisis that has affected many governments, there is an increasing risk that federal and/or state tax legislation could be enacted that would result in higher taxes on insurance companies and/or their policyholders. For example, on February 13, 2012, the Obama Administration released its “FY 2013 Budget of the United States Government” that includes proposals which, if enacted, would adversely affect the Company’s sale of variable annuities and variable life products and its profits on corporate owned life insurance policies. Although the specific form of any such potential legislation is uncertain, it could include lessening or eliminating some or all of the tax advantages currently benefiting the Company or its policyholders including, but not limited to, those mentioned above. This could occur in the context of deficit reduction or other tax reforms. The effects of any such changes could have a material adverse effect on our profitability and financial condition, and could result in materially lower product sales, lapses of policies currently held, and/or our incurrence of materially higher corporate taxes.
Changes in accounting principles and financial reporting requirements could result in material changes to our reported results and financial condition.
U.S. GAAP and related financial reporting requirements are complex, continually evolving and may be subject to varied interpretation by the relevant authoritative bodies. Such varied interpretations could result from differing views related to specific facts and circumstances. Changes in U.S. GAAP and financial reporting requirements, or in the interpretation of U.S. GAAP or those requirements, could result in material changes to our reported results and financial condition. Moreover, the SEC is currently evaluating International Financial Reporting Standards (“IFRS”) to determine whether IFRS should be incorporated into the financial reporting system for U.S. issuers. Certain of these standards could result in material changes to our reported results of operation.
We may not be able to protect our intellectual property and may be subject to infringement claims.
We rely on a combination of contractual rights and copyright, trademark, patent and trade secret laws to establish and protect our intellectual property. Although we use a broad range of measures to protect our intellectual property rights, third parties may infringe or misappropriate our intellectual property. We may have to litigate to enforce and protect our copyrights, trademarks, patents, trade secrets and know-how or to determine their scope, validity or enforceability, which represents a diversion of resources that may be significant in amount and may not prove successful. The loss of intellectual property protection or the inability to secure or enforce the protection of our intellectual property assets could have a material adverse effect on our business and our ability to compete.
We also may be subject to costly litigation in the event that another party alleges our operations or activities infringe upon another party’s intellectual property rights. Third parties may have, or may eventually be issued, patents that could be infringed by our products, methods, processes or services. Any party that holds such a patent could make a claim of infringement against us. We may also be subject to claims by third parties for breach of copyright, trademark, trade secret or license usage rights. Any such claims and any resulting litigation could result in significant liability for damages. If we were found to have infringed a third-party patent or other intellectual property rights, we could incur substantial liability, and in some circumstances could be enjoined from providing certain products or services to our customers or utilizing and benefiting from certain methods, processes, copyrights, trademarks, trade secrets or licenses, or alternatively could be required to enter into costly licensing arrangements with third parties, all of which could have a material adverse effect on our business, results of operations and financial condition.
21
Item 1B. UNRESOLVED STAFF COMMENTS
None.
The Company has operations located throughout the U.S. and Europe, with its principal executive offices located in Simsbury, Connecticut. The executive offices are owned by our parent company, Hartford Life and Accident Insurance Company (“HLA”). The Company owns the facilities located in Windsor, Connecticut and Woodbury, Minnesota. The Company believes its properties and facilities are suitable and adequate for current operations.
Litigation
The Company is involved in claims litigation arising in the ordinary course of business, both as a liability insurer defending or providing indemnity for third-party claims brought against insureds and as an insurer defending coverage claims brought against it. The Company accounts for such activity through the establishment of unpaid loss and loss adjustment expense reserves. Management expects that the ultimate liability, if any, with respect to such ordinary-course claims litigation, after consideration of provisions made for potential losses and costs of defense, will not be material to the consolidated financial condition, results of operations or cash flows of the Company.
The Company is also involved in other kinds of legal actions, some of which assert claims for substantial amounts. These actions include, among others and in addition to the matter described below, putative state and federal class actions seeking certification of a state or national class. Such putative class actions have alleged, for example, improper sales practices in connection with the sale of life insurance and other investment products; and improper fee arrangements in connection with investment products and structured settlements. The Company also is involved in individual actions in which punitive damages are sought, such as claims alleging bad faith in the handling of insurance claims. Management expects that the ultimate liability, if any, with respect to such lawsuits, after consideration of provisions made for estimated losses, will not be material to the consolidated financial condition of the Company. Nonetheless, given the large or indeterminate amounts sought in certain of these actions, and the inherent unpredictability of litigation, the outcome in certain matters could, from time to time, have a material adverse effect on the Company’s results of operations or cash flows in particular quarterly or annual periods.
Apart from the inherent difficulty of predicting litigation outcomes, particularly the matter specifically identified below purports to seek substantial damages for unsubstantiated conduct spanning a multi-year period based on novel and complex legal theories. The alleged damages are not quantified or factually supported in the complaint, and, in any event, the Company’s experience shows that demands for damages often bear little relation to a reasonable estimate of potential loss. The matter is in the earliest stages of litigation, with no substantive legal decisions by the court defining the scope of the claims or the potentially available damages. The Company has not yet answered the complaint or asserted its defenses, and fact discovery has not yet begun. Accordingly, management cannot reasonably estimate the possible loss or range of loss, if any, or predict the timing of the eventual resolution of this matter.
Mutual Fund Fees Litigation – In October 2010, a derivative action was brought on behalf of six Hartford retail mutual funds in the United States District Court for the District of Delaware, alleging that Hartford Investment Financial Services, LLC (“HIFSCO”) received excessive advisory and distribution fees in violation of its statutory fiduciary duty under Section 36(b) of the Investment Company Act of 1940. In February 2011, a nearly identical derivative action was brought against HIFSCO in the United States District Court for the District of New Jersey, on behalf of six additional Hartford retail mutual funds. Both actions were assigned to the Honorable Renee Marie Bumb, a judge in the District of New Jersey who was sitting by designation with respect to the Delaware action. Plaintiffs in each action seek to rescind the investment management agreements and distribution plans between HIFSCO and the funds and to recover the total fees charged thereunder or, in the alternative, to recover any improper compensation HIFSCO received. In addition, plaintiffs in the New Jersey action seek recovery of lost earnings. HIFSCO moved to dismiss both actions and, in September 2011, the motions to dismiss were granted in part and denied in part, with leave to amend the complaints. In November 2011, a stipulation of voluntary dismissal was filed in the Delaware action and plaintiffs in the New Jersey action filed an amended complaint on behalf of six mutual funds, seeking the same relief as in their original complaint. HIFSCO disputes the allegations and has filed a partial motion to dismiss.
Item 4. MINE SAFETY DISCLOSURES
Not applicable.
22
Item 5. MARKET FOR HARTFORD LIFE INSURANCE COMPANY’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
All of the Company’s outstanding shares are ultimately owned by Hartford Life and Accident Insurance Company, which is ultimately a subsidiary of The Hartford. As of February 17, 2012, the Company had issued and outstanding 1,000 shares of common stock, $5,690 par value per share. There is no established public trading market for the Company’s common stock.
For a discussion regarding the Company’s payment of dividends, and the restrictions related thereto, see the Capital Resources and Liquidity section of the MD&A under “Dividends”.
Item 6. SELECTED FINANCIAL DATA
Omitted pursuant to General Instruction I(2)(a) of Form 10-K.
23
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Dollar amounts in millions, except for per share data, unless otherwise stated)
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) addresses the financial condition of Hartford Life Insurance Company and its subsidiaries (“Hartford Life Insurance Company” or the “Company”) as of and for the year ended December 31, 2011 compared with the comparable December 31, 2010 period. Management’s narrative analysis of the results of operations is presented pursuant to General Instruction I(2)(a) of Form 10-K. This discussion should be read in conjunction with the Consolidated Financial Statements and related Notes beginning on page F-1. Certain reclassifications have been made to prior year financial information to conform to the current year presentation.
| Description |
Page | |||
| 25 | ||||
| 27 | ||||
| 32 | ||||
| 34 | ||||
| 53 | ||||
| 58 | ||||
24
CONSOLIDATED RESULTS OF OPERATIONS
Operating Summary
| 2011 | 2010 | |||||||
| Fee income and other |
$ | 3,802 | $ | 3,806 | ||||
| Earned premiums |
234 | 260 | ||||||
| Net investment income |
||||||||
| Securities available-for-sale and other |
2,580 | 2,621 | ||||||
| Equity securities, trading [1] |
(14 | ) | 238 | |||||
|
|
|
|
|
|||||
| Total net investment income |
2,566 | 2,859 | ||||||
| Net realized capital gains (losses) |
1 | (944 | ) | |||||
|
|
|
|
|
|||||
| Total revenues |
6,603 | 5,981 | ||||||
| Benefits, losses and loss adjustment expenses |
3,107 | 2,948 | ||||||
| Benefits, losses and loss adjustment expenses — returns credited on International unit — linked bonds and pension products [1] |
(14 | ) | 238 | |||||
| Amortization of deferred policy acquisition costs and present value of future profits |
616 | 215 | ||||||
| Insurance operating costs and other expenses |
2,896 | 1,610 | ||||||
| Dividends to policyholders |
17 | 21 | ||||||
|
|
|
|
|
|||||
| Total benefits, losses and expenses |
6,622 | 5,032 | ||||||
|
|
|
|
|
|||||
| Income (loss) from continuing operations before income taxes |
(19 | ) | 949 | |||||
| Income tax expense (benefit) |
(263 | ) | 228 | |||||
|
|
|
|
|
|||||
| Income from continuing operations, net of tax |
244 | 721 | ||||||
| Income from discontinued operations, net of tax |
— | 31 | ||||||
|
|
|
|
|
|||||
| Net income |
244 | 752 | ||||||
| Net income attributable to the noncontrolling interest |
— | 8 | ||||||
|
|
|
|
|
|||||
| Net income attributable to Hartford Life Insurance Company |
$ | 244 | $ | 744 | ||||
|
|
|
|
|
|||||
| [1] | Net investment income includes investment income and mark-to-market effects of equity securities, trading, supporting international unit — linked bonds and pension products business, which are classified in net investment income with corresponding amounts credited to policyholders. |
Year ended December 31, 2011 compared to the year ended December 31, 2010
Net income declined for the year ended December 31, 2011 due to losses from the affiliate modco reinsurance agreement and the third quarter Unlock, which resulted in an increase in DAC amortization and Benefits, losses and loss adjustment expenses. These expenses were partially offset by favorable net realized capital gains.
The affiliate modco reinsurance agreement decreased earnings by $893 for the year ended December 31, 2011 for a net loss of $(323), compared to net income of $570 in 2010. The most significant fluctuation of the modco agreement was within insurance operating costs and other expenses which is primarily a reflection of the change in reserves and hedging costs associated with the reinsured block of business. For further discussion on the affiliate modco reinsurance agreement see Note 16 of the Notes to Consolidated Financial Statements.
The Company recorded an Unlock charge of $137, after-tax, for 2011 compared to an Unlock benefit of $149, after-tax, for 2010. The charge in 2011 was attributable to actual separate account returns being below our aggregated estimated return and the impact of assumption updates. The Unlock benefit in 2010 was attributable to actual separate account returns being above our aggregated estimated return. For further discussion of Unlocks see the Critical Accounting Estimates within the MD&A.
Net realized gains (losses), excluding the impacts of the modco reinsurance agreement improved by $989 for the year ended December 31, 2011 compared to 2010 for a net realized loss of $501. For further discussion on the Net realized gains, see Net Realized Capital Gains (Losses) within the MD&A.
In addition to the income tax benefit recognized from the dividends received deduction, income tax expense (benefit) includes a $50 income tax benefit for the release of the income tax valuation allowance associated with investment realized capital losses for the year ended December 31, 2011. This valuation allowance was recorded during the third quarter of 2010. Also included in the income tax expense (benefit) for the year ended December 31, 2011 is a $52 income tax benefit related to a resolution of a tax matter with the Internal Revenue Service (“IRS”) for the computation of dividends received deduction for years 1998, 2000 and 2001. See Note 11 of the Notes to Consolidated Financial Statements for a reconciliation of the tax provision at the U.S. Federal statutory rate to the provision for income taxes.
25
Income Taxes
The effective tax rates for 2011 and 2010 were 1384% and 24%, respectively. The difference between the effective rate and the U.S. statutory rate of 35% for 2011 and 2010 was due principally to the separate account dividends received deduction (“DRD”). The DRD caused an increase in the tax benefit on the 2011 pre-tax loss and a decrease in the tax on the 2010 pre-tax income. The 2011 effective tax rate also includes a deferred tax asset valuation allowance decrease, and the 2010 effective tax rate includes a deferred tax asset valuation allowance increase.
The separate account DRD is estimated for the current year using information from the most recent return, adjusted for current year equity market performance and other appropriate factors, including estimated levels of corporate dividend payments and level of policy owner equity account balances. The actual current year DRD can vary from estimates based on, but not limited to, changes in eligible dividends received in the mutual funds, amounts of distributions from these mutual funds, amounts of short-term capital gains at the mutual fund level and the Company’s taxable income before the DRD. The Company recorded benefits of $201 and $145 related to the separate account DRD in the years ended December 31, 2011 and 2010, respectively. These amounts included benefits (charges) related to prior years’ tax returns of $3 and $(3) in 2011 and 2010, respectively. In addition, during 2011 the Company settled the separate account dividends received deduction (DRD) issue related to prior periods and recorded a $52 tax benefit.
In Revenue Ruling 2007-61, issued on September 25, 2007, the IRS announced its intention to issue regulations with respect to certain computational aspects of the DRD on separate account assets held in connection with variable annuity contracts. Revenue Ruling 2007-61 suspended Revenue Ruling 2007-54, issued in August 2007 that purported to change accepted industry and IRS interpretations of the statutes governing these computational questions. No regulations have been issued to date. Any regulations that the IRS may ultimately propose for issuance in this area will be subject to public notice and comment, at which time insurance companies and other members of the public will have the opportunity to raise legal and practical questions about the content, scope and application of such regulations. As a result, the ultimate timing and substance of any such regulations are unknown, but they could result in the elimination of some or all of the separate account DRD tax benefit that the Company receives. Management believes that it is highly likely that any such regulations would apply prospectively only.
The Company receives a foreign tax credit for foreign taxes paid including payments from its separate account assets. This credit reduces the company’s U.S. tax liability. The separate account foreign tax credit is estimated for the current year using information from the most recent filed return, adjusted for the change in the allocation of separate account investments to the international equity markets during the current year. The actual current year foreign tax credit can vary from the estimates due to actual foreign tax credits passed through from the mutual funds. The Company recorded benefits of $11and $4 related to separate account foreign tax credit in the years ended December 31, 2011 and 2010, respectively. These amounts included benefits (charges) related prior years’ tax returns of $2 and $(4) in 2011 and 2010, respectively.
26
The preparation of financial statements, in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”), requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ, and in the past has differed, 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:
| • | estimated gross profits used in the valuation and amortization of assets and liabilities associated with variable annuity and other universal life-type contracts; |
| • | living benefits required to be fair valued (in other policyholder funds and benefits payable); |
| • | valuation of investments and derivative instruments; |
| • | evaluation of other-than-temporary impairments on available-for-sale securities and valuation allowances on mortgage loans; |
| • | goodwill impairment; |
| • | valuation allowance on deferred tax assets; and |
| • | contingencies relating to corporate litigation and regulatory matters. |
Certain of these estimates are particularly sensitive to market conditions, and deterioration and/or volatility in the worldwide debt or equity markets could have a material impact on the Consolidated Financial Statements. 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.
Estimated Gross Profits Used in the Valuation and Amortization of Assets and Liabilities Associated with Variable Annuity and Other Universal Life-Type Contracts
Estimated gross profits (“EGPs”) are used in the amortization of: the Company’s deferred policy acquisition cost (“DAC”) asset, which includes the present value of future profits; sales inducement assets (“SIA”); and unearned revenue reserves (“URR”). See Note 6 of the Notes to Consolidated Financial Statements for additional information on DAC. See Note 9 of the Notes to Consolidated Financial Statements for additional information on SIA. EGPs are also used in the valuation of reserves for death and other insurance benefit features on variable annuity and universal life-type contracts. See Note 8 of the Notes to Consolidated Financial Statements for additional information on death and other insurance benefit feature reserves.
For most contracts, the Company estimates gross profits over 20 years as EGPs emerging subsequent to that timeframe are immaterial. Products sold in a particular year are aggregated into cohorts. Future gross profits for each cohort are projected over the estimated lives of the underlying contracts, based on future account value projections for variable annuity and variable universal life products. The projection of future account values requires the use of certain assumptions including: separate account returns; separate account fund mix; fees assessed against the contract holder’s account balance; surrender and lapse rates; interest margin; mortality; and hedging costs. Changes in these assumptions and, in addition, changes to other policyholder behavior assumptions such as resets, partial surrenders, reaction to price increases, and asset allocations causes EGPs to fluctuate which impacts earnings.
The Company determines EGPs from a single deterministic reversion to mean (“RTM”) separate account return projection which is an estimation technique commonly used by insurance entities to project future separate account returns. Through this estimation technique, the Company’s DAC model is adjusted to reflect actual account values at the end of each quarter. Through a consideration of recent market returns, the Company will unlock, or adjust, projected returns over a future period so that the account value returns to the long-term expected rate of return, providing that those projected returns do not exceed certain caps or floors. This DAC Unlock, for future separate account returns, is determined each quarter. Under RTM, the expected long term rate of return is 8.3%.
In the third quarter of each year, the Company completes a comprehensive non-market related policyholder behavior assumption study and incorporates the results of those studies into its projection of future gross profits. Additionally, throughout the year, the Company evaluates various aspects of policyholder behavior and periodically revises its policyholder assumptions as credible emerging data indicates that changes are warranted. Upon completion of the assumption study or evaluation of credible new information, the Company will revise its assumptions to reflect its current best estimate. These assumption revisions will change the projected account values and the related EGPs in the DAC, SIA and URR amortization models, as well as the death and other insurance benefit reserving model.
27
All assumption changes that affect the estimate of future EGPs including: the update of current account values; the use of the RTM estimation technique; and policyholder behavior assumptions, are considered an Unlock in the period of revision. An Unlock adjusts DAC, SIA, URR and death and other insurance benefit reserve balances in the Consolidated Balance Sheets with an offsetting benefit or charge in the Consolidated Statements of Operations in the period of the revision. An Unlock that results in an after-tax benefit generally occurs as a result of actual experience or future expectations of product profitability being favorable compared to previous estimates. An Unlock that results in an after-tax charge generally occurs as a result of actual experience or future expectations of product profitability being unfavorable compared to previous estimates.
EGPs are also used to determine the expected excess benefits and assessments included in the measurement of death and other insurance benefit reserves. These excess benefits and assessments are derived from a range of stochastic scenarios that have been calibrated to the Company’s RTM separate account returns. The determination of death and other insurance benefit reserves is also impacted by discount rates, lapses, volatilities and mortality assumptions and benefit utilization, including assumptions around annuitization rates.
An Unlock revises EGPs, on a quarterly basis, to reflect market updates of policyholder account value and the Company’s current best estimate assumptions. Modifications to the Company’s hedging programs may impact EGPs, and correspondingly impact DAC recoverability. After each quarterly Unlock, the Company also tests the aggregate recoverability of DAC by comparing the DAC balance to the present value of future EGPs. As of December 31, 2011, the margin between the DAC balance and the present value of future EGPs for U.S. individual variable annuities was 3.0%, reflective of the reinsurance of a block of individual variable annuities with an affiliated captive reinsurer. If the margin between the DAC asset and the present value of future EGPs is exhausted, then further reductions in EGPs would cause portions of DAC to be unrecoverable and the DAC asset would be written down to equal future EGPs.
In 2009, a subsidiary of HLIC, Hartford Life and Annuity Insurance Company (“HLAI”) entered into a reinsurance agreement with an affiliated captive reinsurer, White River Life Reinsurance Company (“the affiliated captive reinsurer” or “WRR”). This agreement provides that HLAI will cede, and WRR will reinsure 100% of the in-force and prospective U.S. variable annuities and the associated GMDB and GMWB riders. This transaction resulted in an Unlock charge of $2.0 billion, pre-tax, and $1.3 billion, after-tax, as the related EGP’s were ceded to the affiliate. See Note 16 of the Notes to Consolidated Financial Statements for further information on the transaction.
Unlocks
The after-tax (charge) benefit to net income (loss) by asset and liability as a result of the Unlocks for 2011, 2010 and 2009 were:
For the year ended December 31, 2011
|
Segment After-tax (Charge) Benefit |
DAC | URR | Death and Insurance Benefit Reserves |
SIA | Total | |||||||||||||||
| Individual Annuity |
$ | (26 | ) | $ | — | $ | — | $ | (2 | ) | $ | (28 | ) | |||||||
| Individual Life |
(50 | ) | 21 | (40 | ) | — | (69 | ) | ||||||||||||
| Retirement Plans |
(44 | ) | — | — | (1 | ) | (45 | ) | ||||||||||||
| Runoff Operations |
(3 | ) | — | 5 | 2 | 4 | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Total |
$ | (123 | ) | $ | 21 | $ | (35 | ) | $ | (1 | ) | $ | (138 | ) | ||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
The Unlock charge for the year ended December 31, 2011 was driven primarily by assumption changes which reduced expected future gross profits including additional costs associated with implementing the U.S. variable annuity macro hedge program, as well as actual separate account returns below our aggregated estimated return.
For the year ended December 31, 2010
|
Segment After-tax (Charge) Benefit |
DAC | URR | Death and Insurance Benefit Reserves |
SIA | Total | |||||||||||||||
| Individual Annuity |
$ | 82 | $ | — | $ | 39 | $ | 2 | $ | 123 | ||||||||||
| Individual Life |
23 | 5 | 1 | (1 | ) | 28 | ||||||||||||||
| Retirement Plans |
18 | — | — | — | 18 | |||||||||||||||
| Runoff Operations |
(20 | ) | (1 | ) | 1 | (20 | ) | |||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Total |
$ | 103 | $ | 5 | $ | 39 | $ | 2 | $ | 149 | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
The Unlock benefit for the year ended December 31, 2010 was driven primarily by actual separate account returns above our aggregated estimated return and the impacts of assumption updates.
28
For the year ended December 31, 2009
|
Segment After-tax (Charge) Benefit |
DAC | URR | Death and Insurance Benefit Reserves |
SIA | Total | |||||||||||||||
| Individual Annuity |
$ | (1,681 | ) | $ | 78 | $ | (159 | ) | $ | (180 | ) | $ | (1,942 | ) | ||||||
| Individual Life |
(100 | ) | 54 | (4 | ) | — | (50 | ) | ||||||||||||
| Retirement Plans |
(55 | ) | — | — | (1 | ) | (56 | ) | ||||||||||||
| Runoff Operations |
(79 | ) | 6 | (16 | ) | (8 | ) | (97 | ) | |||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Total |
$ | (1,915 | ) | $ | 138 | $ | (179 | ) | $ | (189 | ) | $ | (2,145 | ) | ||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
The Unlock charge for the year ended December 31, 2009 was driven primarily by $(1.3) billion related to reinsurance of a block of in-force and prospective U.S. variable annuities and the associated GMDB and GMWB riders with an affiliated captive reinsurer, as well as actual separate account returns significantly below our aggregated estimated return for the first quarter of 2009, partially offset by actual returns greater than our aggregated estimated return for the period from April 1, 2009 to December 31, 2009. Also included in the unlock was $(49) related to DAC recoverability impairment associated with the decision to suspend sales in the U.K. variable annuity business.
Living Benefits Required to be Fair Valued (in Other Policyholder Funds and Benefits Payable)
Fair values for direct, assumed and ceded GMWB, GMIB and GMAB contracts are calculated based upon internally developed models because active, observable markets do not exist for those items. The fair value of those guaranteed benefit liabilities classified as embedded derivatives, and the related reinsurance and customized freestanding derivatives is calculated as an aggregation of the following components: Best Estimate Claims Costs; Credit Standing Adjustment; and Margins. The resulting aggregation is reconciled or calibrated, if necessary, to market information that is, or may be, available to the Company, but may not be observable by other market participants, including reinsurance discussions and transactions. The Company believes the aggregation of each of these components, as necessary and as reconciled or calibrated to the market information available to the Company, results in an amount that the Company would be required to transfer, or receive, to or from market participants in an active liquid market, if one existed, for those market participants to assume the risks associated with the guaranteed minimum benefits and the related reinsurance and customized derivatives. The fair value is likely to materially diverge from the ultimate settlement of the liability as the Company believes settlement will be based on our best estimate assumptions rather than those best estimate assumptions plus risk margins. In the absence of any transfer of the guaranteed benefit liability to a third party, the release of risk margins is likely to be reflected as realized gains in future periods’ net income. For further discussion on the impact of fair value changes from living benefits see Note 3 of the Notes to Consolidated Financial Statements and for a discussion on the sensitivities of certain living benefits due to capital market factors see Variable Product Guarantee Risks and Risk Management.
Valuation of Investments and Derivative Instruments
The fair value of AFS securities, fixed maturities, at fair value using the fair value option (“FVO”), equity securities, trading, and short-term investments in an active and orderly market (i.e., not distressed or forced liquidation) is determined by management after considering one of three primary sources of information: third-party pricing services, independent broker quotations or pricing matrices. Security pricing is applied using a “waterfall” approach whereby prices are first sought from third-party pricing services, the remaining unpriced securities are submitted to independent brokers for prices, or lastly, securities are priced using a pricing matrix. Typical inputs used by these pricing methods include, but are not limited to, reported trades, benchmark yields, issuer spreads, bids, offers, and/or estimated cash flows and prepayments speeds. Based on the typical trading volumes and the lack of quoted market prices for fixed maturities, third-party pricing services will normally derive the security prices through recent reported trades for identical or similar securities making adjustments through the reporting date based upon available market observable information as outlined above. If there are no recent reported trades, the third party pricing services and brokers may use matrix or model processes to develop a security price where future cash flow expectations are developed based upon collateral performance and discounted at an estimated market rate. For further discussion, see the Available-for-Sale, Fixed Maturities, FVO, Equity Securities, Trading, and Short-Term Investments Section in Note 3 of the Notes to Consolidated Financial Statements.
The Company has analyzed the third-party pricing services valuation methodologies and related inputs, and has also evaluated the various types of securities in its investment portfolio to determine an appropriate fair value hierarchy level based upon trading activity and the observability of market inputs. For further discussion of fair value measurement, see Note 3 of the Notes to Consolidated Financial Statements.
29
Valuation of Derivative Instruments, excluding embedded derivatives within liability contracts and reinsurance related derivatives
Derivative instruments are reported on the Consolidated Balance Sheets at fair value and are reported in Other Investments and Other Liabilities. The fair value of derivative instruments is determined using pricing valuation models, which utilize market data inputs or independent broker quotations. Excluding embedded and reinsurance related derivatives, as of December 31, 2011 and 2010, 98% and 97%, respectively, of derivatives based upon notional values, were priced by valuation models, which utilize independent market data. The remaining derivatives were priced by broker quotations. The derivatives are valued using mid-market level inputs that are predominantly observable in the market with the exception of the customized swap contracts that hedge guaranteed minimum withdrawal benefits (“GMWB”) liabilities. Inputs used to value derivatives include, but are not limited to, swap interest rates, foreign currency forward and spot rates, credit spreads and correlations, interest and equity volatility and equity index levels. The Company performs a monthly analysis on derivative valuations which includes both quantitative and qualitative analysis. Examples of procedures performed include, but are not limited to, review of pricing statistics and trends, back testing recent trades, analyzing the impacts of changes in the market environment, and review of changes in market value for each derivative including those derivatives priced by brokers. For further discussion, see the Derivative Instruments, including embedded derivatives within the investments section in Note 3 of the Notes to Consolidated Financial Statements.
Evaluation of Other-Than-Temporary Impairments on Available-for-Sale Securities and Valuation Allowances on Mortgage Loans
The Company has a monitoring process overseen by a committee of investment and accounting professionals that identifies investments that are subject to an enhanced evaluation on a quarterly basis to determine if an other-than-temporary impairment (“impairment”) is present for AFS securities or a valuation allowance is required for mortgage loans. This evaluation is a quantitative and qualitative process, which is subject to risks and uncertainties. For further discussion of the accounting policies, see the Significant Investment Accounting Policies Section in Note 4 of the Notes to Consolidated Financial Statements. For a discussion of impairments recorded, see the Other-Than-Temporary Impairments within the Investment Portfolio Risks and Risk Management section of the MD&A.
Goodwill Impairment
Goodwill balances are reviewed for impairment at least annually or more frequently if events occur or circumstances change that would indicate that a triggering event for a potential impairment has occurred. During the fourth quarter of 2011, the Company changed the date of its annual impairment test for all reporting units to October 31st from January 1st. As a result, all reporting units performed an impairment test on October 31, 2011 in addition to the annual impairment test performed January 1, 2011. The change was made to be consistent across all of the parent company’s reporting units and to more closely align the impairment testing date with the long-range planning and forecasting process. The Company has determined that this change in accounting principle is preferable under the circumstances and does not result in any delay, acceleration or avoidance of impairment. As it was impracticable to objectively determine projected cash flows and related valuation estimates as of each October 31 for periods prior to October 31, 2011 without applying information that has been learned since those periods, the Company has prospectively applied the change in the annual goodwill impairment testing date from October 31, 2011.
The goodwill impairment test follows a two-step process. In the first step, the fair value of a reporting unit is compared to its carrying value. If the carrying value of a reporting unit exceeds its fair value, the second step of the impairment test is performed for purposes of measuring the impairment. In the second step, the fair value of the reporting unit is allocated to all of the assets and liabilities of the reporting unit to determine an implied goodwill value. If the carrying amount of the reporting unit’s goodwill exceeds the implied goodwill value, an impairment loss is recognized in an amount equal to that excess.
Management’s determination of the fair value of each reporting unit incorporates multiple inputs into discounted cash flow calculations including assumptions that market participants would make in valuing the reporting unit. Assumptions include levels of economic capital, future business growth, earnings projections, assets under management for certain reporting units and the weighted average cost of capital used for purposes of discounting. Decreases in the amount of economic capital allocated to a reporting unit, decreases in business growth, decreases in earnings projections and increases in the weighted average cost of capital will all cause a reporting unit’s fair value to decrease.
A reporting unit is defined as an operating segment or one level below an operating segment. Most of the Company’s reporting units, for which goodwill has been allocated, are equivalent to the Company’s operating segments as there is no discrete financial information available for the separate components of the segment or all of the components of the segment have similar economic characteristics. In 2011 and 2010, The Hartford changed its reporting segments with no change to reporting units. The variable life, universal life and term life components have been aggregated into one reporting unit of Individual Life; and the 401(k), 457 and 403(b) components of Retirement Plans have been aggregated into one reporting unit; the retail mutual funds component of Mutual Funds has been aggregated into one reporting unit.
The carrying amount of goodwill has been allocated to the following reporting units:
| December 31, 2011 | December 31, 2010 | |||||||
| Individual Life |
$ | 224 | $ | 224 | ||||
| Retirement Plans |
87 | 87 | ||||||
| Mutual Funds |
159 | 159 | ||||||
|
|
|
|
|
|||||
| Total |
$ | 470 | $ | 470 | ||||
|
|
|
|
|
|||||
30
The Company completed its annual goodwill assessment for the individual reporting units on January 1, 2011 and October 31, 2011, which resulted in no impairment of goodwill. All reporting units passed the first step of both impairment tests with a significant margin.
See Note 7 of the Notes to Consolidated Financial Statements for information on the results of goodwill impairment tests performed in 2010 and 2009.
Valuation Allowance on Deferred Tax Assets
Deferred tax assets represent the tax benefit of future deductible temporary differences and operating loss and tax credit carryforwards. Deferred tax assets are measured using the enacted tax rates expected to be in effect when such benefits are realized if there is no change in tax law. Under U.S. GAAP, we test the value of deferred tax assets for impairment on a quarterly basis at the entity level within each tax jurisdiction, consistent with our filed tax returns. Deferred tax assets are reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion, or all, of the deferred tax assets will not be realized. The determination of the valuation allowance for our deferred tax assets requires management to make certain judgments and assumptions. In evaluating the ability to recover deferred tax assets, we have considered all available evidence as of December 31, 2011 including past operating results, the existence of cumulative losses in the most recent years, forecasted earnings, future taxable income, and prudent and feasible tax planning strategies. In the event we determine it is not more likely than not that we will be able to realize all or part of our deferred tax assets in the future, an increase to the valuation allowance would be charged to earnings in the period such determination is made. Likewise, if it is later determined that it is more likely than not that those deferred tax assets would be realized, the previously provided valuation allowance would be reversed. Our judgments and assumptions are subject to change given the inherent uncertainty in predicting future performance and specific industry and investment market conditions.
The Company recorded a deferred tax asset valuation allowance that is adequate to reduce the total deferred tax asset to an amount that will more likely than not be realized. The deferred tax asset valuation allowance was $89, relating mostly to foreign net operating losses, as of December 31, 2011 and $139 as of December 31, 2010. In assessing the need for a valuation allowance, management considered future taxable temporary difference reversals, future taxable income exclusive of reversing temporary differences and carryforwards, taxable income in open carryback years, as well as other tax planning strategies. These tax planning strategies include holding a portion of debt securities with market value losses until recovery, selling appreciated securities to offset capital losses, business considerations such as asset-liability matching, and the sales of certain corporate assets. Management views such tax planning strategies as prudent and feasible and will implement them, if necessary, to realize the deferred tax asset. Based on the availability of additional tax planning strategies identified in the second quarter of 2011, the Company released $56, or 100% of the valuation allowance associated with investment realized capital losses. Future economic conditions and debt market volatility, including increases in interest rates, can adversely impact the Company’s tax planning strategies and in particular the Company’s ability to utilize tax benefits on previously recognized realized capital losses.
Contingencies Relating to Corporate Litigation and Regulatory Matters
Management evaluates each contingent matter separately. A loss is recorded if probable and reasonably estimable. Management establishes reserves for these contingencies at its “best estimate,” or, if no one number within the range of possible losses is more probable than any other, the Company records an estimated reserve at the low end of the range of losses.
The Company has a quarterly monitoring process involving legal and accounting professionals. Legal personnel first identify outstanding corporate litigation and regulatory matters posing a reasonable possibility of loss. These matters are then jointly reviewed by accounting and legal personnel to evaluate the facts and changes since the last review in order to determine if a provision for loss should be recorded or adjusted, the amount that should be recorded, and the appropriate disclosure. The outcomes of certain contingencies currently being evaluated by the Company, which relate to corporate litigation and regulatory matters, are inherently difficult to predict, and the reserves that have been established for the estimated settlement amounts are subject to significant changes. Management expects that the ultimate liability, if any, with respect to such lawsuits, after consideration of provisions made for estimated losses, will not be material to the consolidated financial condition of the Company. In view of the uncertainties regarding the outcome of these matters, as well as the tax-deductibility of payments, it is possible that the ultimate cost to the Company of these matters could exceed the reserve by an amount that would have a material adverse effect on the Company’s consolidated results of operations and liquidity in a particular quarterly or annual period.
31
Composition of Invested Assets
| December 31, 2011 | December 31, 2010 | |||||||||||||||
| Amount | Percent | Amount | Percent | |||||||||||||
| Fixed maturities, AFS, at fair value |
$ | 47,778 | 76.0 | % | $ | 44,834 | 78.7 | % | ||||||||
| Fixed maturities, at fair value using the fair value option |
1,317 | 2.1 | % | 639 | 1.1 | % | ||||||||||
| Equity securities, AFS, at fair value |
398 | 0.6 | % | 340 | 0.6 | % | ||||||||||
| Mortgage loans |
4,182 | 6.7 | % | 3,244 | 5.7 | % | ||||||||||
| Policy loans, at outstanding balance |
1,952 | 3.1 | % | 2,128 | 3.7 | % | ||||||||||
| Limited partnerships and other alternative investments |
1,376 | 2.2 | % | 838 | 1.5 | % | ||||||||||
| Other investments [1] |
1,974 | 3.1 | % | 1,461 | 2.6 | % | ||||||||||
| Short-term investments |
3,882 | 6.2 | % | 3,489 | 6.1 | % | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total investments excluding equity securities, trading |
62,859 | 100.0 | % | 56,973 | 100.0 | % | ||||||||||
| Equity securities, trading, at fair value [2] |
1,967 | 2,279 | ||||||||||||||
|
|
|
|
|
|||||||||||||
| Total investments |
$ | 64,826 | $ | 59,252 | ||||||||||||
|
|
|
|
|
|||||||||||||
| [1] | Primarily relates to derivative instruments. |
| [2] | These assets primarily support the European variable annuity business. Changes in these balances are also reflected in the respective liabilities. |
Total investments increased since December 31, 2010 primarily due to increases in fixed maturities, AFS, mortgage loans and fixed maturities at fair value using the fair value option (“FVO”), partially offset by a decline in equity securities, trading. The increase in fixed maturities, AFS, was largely the result of improved valuations as a result of declining interest rates, partially offset by credit spread widening. The increase in mortgage loans related to the funding of commercial whole loans and the increase in fixed maturities, FVO, related to purchases of foreign government securities to support yen-based fixed annuity liabilities. These increases were partially offset by a decline in equity securities, trading, primarily due to deteriorations in market performance of the underlying investments and net outflows, partially offset by the Japanese yen strengthening in comparison to the euro.
Net Investment Income (Loss)
| For the years ended December 31, | ||||||||||||||||
| 2011 | 2010 | |||||||||||||||
| Amount | Yield [1] | Amount | Yield [1] | |||||||||||||
| Fixed maturities [2] |
$ | 1,941 | 4.3 | % | $ | 1,977 | 4.4 | % | ||||||||
| Equity securities, AFS |
10 | 2.6 | % | 14 | 3.7 | % | ||||||||||
| Mortgage loans |
206 | 5.5 | % | 199 | 5.5 | % | ||||||||||
| Policy loans |
128 | 6.1 | % | 129 | 6.1 | % | ||||||||||
| Limited partnerships and other alternative investments |
143 | 15.1 | % | 121 | 16.7 | % | ||||||||||
| Other [3] |
226 | 253 | ||||||||||||||
| Investment expense |
(74 | ) | (72 | ) | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total securities AFS and other |
$ | 2,580 | 4.6 | % | $ | 2,621 | 4.6 | % | ||||||||
| Equity securities, trading |
(14 | ) | 238 | |||||||||||||
|
|
|
|
|
|||||||||||||
| Total net investment income (loss), before-tax |
$ | 2,566 | $ | 2,859 | ||||||||||||
|
|
|
|
|
|||||||||||||
| Total securities, AFS and other excluding limited partnerships and other alternative investments |
$ | 2,437 | 4.4 | % | $ | 2,500 | 4.4 | % | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| [1] | Yields calculated using annualized investment income before investment expenses divided by the monthly average invested assets at cost, amortized cost, or adjusted carrying value, as applicable, excluding consolidated variable interest entity noncontrolling interests. Included in the fixed maturity yield is Other, which primarily relates to derivatives (see footnote [3] below). Included in the total net investment income yield is investment expense. |
| [2] | Includes net investment income on short-term investments. |
| [3] | Includes income from derivatives that qualify for hedge accounting and hedge fixed maturities. |
Year ended December 31, 2011 compared to the year ended December 31, 2010
Total net investment income declined largely due to equity securities, trading, resulting from a market decline of the underlying investment funds supporting the Japanese variable annuity product and net outflows, partially offset by the Japanese yen strengthening in comparison to the euro. Also contributing to the decline was lower income on fixed maturities resulting from the proceeds from sales being reinvested at lower rates. These declines were partially offset by an increase in limited partnership and other alternative investment income due to additional allocations to this asset class and strong private equity and real estate returns, as well as an increase in mortgage loan income due to additional investments in commercial whole loans. The Company’s expectation for 2012, based on the current interest rate and credit environment, is that reinvestment rates will be slightly lower than maturing securities; however, the Company has increased its investment in certain higher yielding asset classes, such as commercial mortgage loans and a modest amount of high-yield securities. Therefore, the Company expects the 2012 portfolio yield, excluding limited partnerships, to be relatively consistent with 2011.
32
Net Realized Capital Gains (Losses)
| For the years ended December 31, | ||||||||
| 2011 | 2010 | |||||||
| Gross gains on sales |
$ | 405 | $ | 486 | ||||
| Gross losses on sales |
(200 | ) | (336 | ) | ||||
| Net OTTI losses recognized in earnings |
(125 | ) | (336 | ) | ||||
| Valuation allowances on mortgage loans |
25 | (108 | ) | |||||
| Japanese fixed annuity contract hedges, net [1] |
3 | 27 | ||||||
| Periodic net coupon settlements on credit derivatives/Japan |
— | (3 | ) | |||||
| Results of variable annuity hedge program |
||||||||
| U.S. GMWB derivatives, net |
(397 | ) | 89 | |||||
| U.S. macro hedge program |
(216 | ) | (445 | ) | ||||
|
|
|
|
|
|||||
| Total U.S. program |
(613 | ) | (356 | ) | ||||
| International program |
723 | (13 | ) | |||||
|
|
|
|
|
|||||
| Total results of variable annuity hedge program |
110 | (369 | ) | |||||
| GMAB/GMWB/GMIB reinsurance |
(326 | ) | (769 | ) | ||||
| Coinsurance and modified coinsurance reinsurance contracts |
373 | 284 | ||||||
| Other, net [2] |
(264 | ) | 180 | |||||
|
|
|
|
|
|||||
| Net realized capital gains (losses), before-tax |
$ | 1 | $ | (944 | ) | |||
|
|
|
|
|
|||||
| [1] | Relates to the Japanese fixed annuity product (adjustment of product liability for changes in spot currency exchange rates, related derivative hedging instruments, excluding net period coupon settlements, and Japan FVO securities). |
| [2] | Primarily consists of losses on non-qualifying derivatives and fixed maturities, FVO, Japan 3Win related foreign currency swaps and other investment gains and losses. |
Details on the Company’s net realized capital gains and losses are as follows:
| Gross gains and losses on sales |
• Gross gains and losses on sales for the year ended December 31, 2011 were predominately from investment grade corporate securities, U.S. Treasuries and commercial real estate related securities. These sales were the result of reinvestment into spread product well-positioned for modest economic growth, as well as the purposeful reduction of certain exposures.
• Gross gains and losses on sales for the year ended December 31, 2010 were predominantly from sales of investment grade corporate securities in order to take advantage of attractive market opportunities, as well as sales of U.S. Treasuries related to tactical repositioning of the portfolio. | |
| Net OTTI losses | • For further information, see Other-Than-Temporary Impairments within the Investment Portfolio Risks and Risk Management section of the MD&A. | |
| Valuation allowances on mortgage loans |
• For further information, see Valuation Allowances on Mortgage Loans within the Investment Portfolio Risks and Risk Management section of the MD&A. | |
| Variable annuity hedge program |
• For the year ended December 31, 2011, the loss on U.S. GMWB related derivatives, net, was primarily due to a decrease in long-term interest rates that resulted in a charge of ($283) and a higher interest rate volatility that resulted in a charge of ($84). The loss on the U.S. macro hedge program for the year ended December 31, 2011 was primarily driven by time decay and a decrease in equity market volatility since the purchase date of certain options during the fourth quarter. The gain associated with the international program for the year ended December 31, 2011 was primarily driven by the Japanese yen strengthening, lower global equity markets, and a decrease in interest rates.
• For the year ended December 31, 2010, the gain on U.S. GMWB derivatives, net, was primarily due to liability model assumption updates of $159 and lower implied market volatility of $118, and outperformance of the underlying actively managed funds as compared to their respective indices of $104, partially offset by losses due to a general decrease in long-term rates of ($158) and rising equity markets of ($90). The net loss on the U.S. macro hedge program was primarily the result of a higher equity market valuation and the impact of trading activity. | |
| Other, net | • Other, net loss for the year ended December 31, 2011, was primarily due to losses of ($123) on credit derivatives and fair value option securities driven by credit spread widening and losses of ($73) on equity futures and options used to hedge equity market risk in the investment portfolio due to an increase in the equity market during the hedged period. Also included were losses of ($69) on Japan 3Win foreign currency swaps primarily driven by a decrease in long-term U.S. interest rates.
• Other, net gains for the year ended December 31, 2010 was primarily due to gains of $190 on credit derivatives and fair value option securities driven by credit spreads tightening. | |
33
The Company’s risk management function is part of The Hartford’s overall risk management program. The Hartford maintains an enterprise risk management function (“ERM”) that is charged with providing analysis of The Hartford’s risks on an individual and aggregated basis and with ensuring that The Hartford’s risks remain within its risk appetite and tolerances. The Hartford has established the Enterprise Risk and Capital Committee (“ERCC”) that includes The Hartford’s CEO, Chief Financial Officer (“CFO”), Chief Investment Officer (“CIO”), Chief Risk Officer, the divisional Presidents and the General Counsel. The ERCC is responsible for managing The Hartford’s risks and overseeing the enterprise risk management program.
Financial Risk Management
The Company is exposed to financial risk associated with changes in interest rates, credit spreads including issuer defaults, equity prices or market indices, and foreign currency exchange rates. The Company is also exposed to credit and counterparty repayment risk. Derivative instruments are utilized in compliance with established Company policy and regulatory requirements and are monitored internally and reviewed by senior management.
Interest Rate Risk
Interest rate risk is the risk of financial loss due to adverse changes in the value of assets and liabilities arising from movements in interest rates. Interest rate risk encompasses exposures with respect to changes in the level of interest rates, the shape of the term structure of rates and the volatility of interest rates. Interest rate risk does not include exposure to changes in credit spreads. The Company has exposure to interest rates arising from its fixed income securities, interest sensitive liabilities and discount rate assumptions associated with the Hartford’s pension and other post retirement benefit obligations.
An increase in interest rates from current levels is generally a favorable development for the Company. Rate increases are expected to provide additional net investment income, increase sales of fixed rate investment products, reduce the cost of the variable annuity hedging program, limit the potential risk of margin erosion due to minimum guaranteed crediting rates in certain products and, if sustained, could reduce the Company’s prospective pension expense. Conversely, a rise in interest rates will reduce the fair value of the investment portfolio, increase interest expense on the Company’s variable rate debt obligations and, if long-term interest rates rise dramatically within a six to twelve month time period, certain businesses may be exposed to disintermediation risk. Disintermediation risk refers to the risk that policyholders will surrender their contracts in a rising interest rate environment requiring the Company to liquidate assets in an unrealized loss position. In conjunction with the interest rate risk measurement and management techniques, certain fixed income product offerings have market value adjustment provisions at contract surrender. An increase in interest rates may also impact the Company’s tax planning strategies and in particular its ability to utilize tax benefits to offset certain previously recognized realized capital losses.
A decline in interest rates results in certain mortgage-backed securities being more susceptible to paydowns and prepayments. During such periods, the Company generally will not be able to reinvest the proceeds at comparable yields. Lower interest rates will also likely result in lower net investment income, increased hedging cost associated with variable annuities and, if declines are sustained for a long period of time, it may subject the Company to reinvestment risks, higher pension costs expense and possibly reduced profit margins associated with guaranteed crediting rates on certain products. Conversely, the fair value of the investment portfolio will increase when interest rates decline and the Company’s interest expense will be lower on its variable rate debt obligations.
The Company manages its exposure to interest rate risk by constructing investment portfolios that maintain asset allocation limits and asset/liability duration matching targets which may include the use of derivatives. The Company analyzes interest rate risk using various models including parametric models and cash flow simulation under various market scenarios of the liabilities and their supporting investment portfolios, which may include derivative instruments. Measures the Company uses to quantify its exposure to interest rate risk inherent in its invested assets and interest rate sensitive liabilities include duration, convexity and key rate duration. Duration is the price sensitivity of a financial instrument or series of cash flows to a parallel change in the underlying yield curve used to value the financial instrument or series of cash flows. For example, a duration of 5 means the price of the security will change by approximately 5% for a 100 basis point change in interest rates. Convexity is used to approximate how the duration of a security changes as interest rates change in a parallel manner. Key rate duration analysis measures the price sensitivity of a security or series of cash flows to each point along the yield curve and enables the Company to estimate the price change of a security assuming non-parallel interest rate movements.
To calculate duration, convexity, and key rate durations, 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 the entire yield curve for duration and convexity, or a particular point on the yield curve for key rate duration. Cash flows from corporate obligations are assumed to be consistent with the contractual payment streams on a yield to worst basis. Yield to worst is a basis that represents the lowest potential yield that can be received without the issuer actually defaulting. 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. Mortgage-backed and asset-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 by incorporating collateral surveillance and anticipated future market dynamics. Actual prepayment experience may vary from these estimates.
34
The Company is also exposed to interest rate risk based upon the discount rate assumption associated with The Hartford’s pension and other postretirement benefit obligations. The discount rate assumption is based upon an interest rate yield curve comprised of bonds rated Aa with maturities primarily between zero and thirty years. For further discussion of interest rate risk associated with the benefit obligations, Note 14 of the Notes to Consolidated Financial Statements.
The investments and liabilities primarily associated with interest rate risk are included in the following discussion. Certain product liabilities, including those containing GMWB, GMIB, GMAB, or GMDB, 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 investment portfolios primarily consist of investment grade fixed maturity securities. The fair value of these investments was $49.1 billion and $45.5 billion at December 31, 2011 and 2010, respectively. The fair value of these and other invested assets fluctuates depending on the interest rate environment and other general economic conditions. The weighted average duration of the fixed maturity portfolio was approximately 5.4 years and 5.2 years as of December 31, 2011 and 2010, 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 contracts, other investment and universal life-type contracts and certain insurance products such as long-term disability.
Asset accumulation vehicles primarily require a fixed rate payment, often for a specified period of time, such as fixed rate annuities with a market value adjustment feature. The term to maturity 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 variable annuity products, credit interest to policyholders subject to market conditions and minimum interest rate guarantees. The term to maturity of the asset portfolio supporting these products may range from short to intermediate.
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 certain 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 reliance upon actuarial (including mortality and morbidity) pricing assumptions and do have some element of cash flow uncertainty. Product examples include structured settlement contracts, and on-benefit annuities (i.e., the annuitant is currently receiving benefits thereon). The cash outflows 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 will differ from those anticipated, or interest rate levels may deviate from those assumed in product pricing, ultimately resulting in an investment return lower than that assumed in pricing. The average duration of the liability cash flow payments can range from less than one year to in excess of fifteen years.
Derivatives
The Company utilizes a variety of derivative instruments to mitigate interest rate risk. Interest rate swaps are primarily used to convert interest receipts or payments to a fixed or variable rate. The use of such swaps enables the Company to customize contract terms and conditions to customer objectives and manage the interest rate risk profile within established tolerances. Interest rate swaps are also used to hedge the variability in the cash flow of a forecasted purchase or sale of fixed rate securities due to changes in interest rates. Forward rate agreements are used to convert interest receipts on floating-rate securities to fixed rates. These derivatives are used to lock in the forward interest rate curve and reduce income volatility that results from changes in interest rates. Interest rate caps, floors, swaptions, and futures may be used to manage portfolio duration.
At December 31, 2011 and 2010, notional amounts pertaining to derivatives utilized to manage interest rate risk totaled $13.6 billion and $14.2 billion, respectively ($13.3 billion and $13.8 billion, respectively, related to investments and $0.3 billion and $0.4 billion, respectively, related liabilities). The fair value of these derivatives was ($237) and ($158) as of December 31, 2011 and 2010, respectively
Interest Rate Sensitivity
The before-tax change in the net economic value of investment contracts (e.g., fixed annuity contracts) and certain insurance product liabilities for which the payment rates are fixed at contract issuance and the investment experience is substantially absorbed by the Company’s operations, along with the corresponding invested assets are included in the following table. Also included in this analysis are the interest rate sensitive derivatives used by the Company to hedge its exposure to interest rate risk in the investment portfolios supporting these contracts. This analysis does not include the assets and corresponding liabilities of certain insurance products such as whole and term life insurance, and certain life contingent annuities. Certain financial instruments, such as limited partnerships and other alternative investments, have been omitted from the analysis due to the fact that the investments are accounted for under the equity method and generally lack sensitivity to interest rate changes. Separate account assets and liabilities, equity securities, trading and the
35
corresponding liabilities associated with the variable annuity products sold in Europe are excluded from the analysis because gains and losses in separate accounts accrue to policyholders. The calculation of the estimated hypothetical change in net economic value below assumes a 100 basis point upward and downward parallel shift in the yield curve.
| Change in Net Economic Value as of December 31, | ||||||||||||||||
| 2011 | 2010 | |||||||||||||||
| Basis point shift |
- 100 | + 100 | - 100 | + 100 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Amount |
$ | (460 | ) | $ | 266 | $ | (184 | ) | $ | 99 | ||||||
|
|
|
|
|
|
|
|
|
|||||||||
The fixed liabilities included above represented approximately 52% and 58% of the Company’s general account liabilities as of December 31, 2011 and 2010, respectively. The assets supporting the fixed liabilities are monitored and managed within set duration guidelines, and are evaluated on a daily basis, as well as annually using scenario simulation techniques in compliance with regulatory requirements.
The following table provides an analysis showing the estimated before-tax change in the fair value of the Company’s fixed maturity investments and related derivatives, not included in the table above, assuming 100 basis point upward and downward parallel shifts in the yield curve as of December 31, 2011 and 2010. Certain financial instruments, such as limited partnerships and other alternative investments, have been omitted from the analysis due to the fact that the investments are accounted for under the equity method and generally lack sensitivity to interest rate changes
| Change in Fair Value as of December 31, | ||||||||||||||||
| 2011 | 2010 | |||||||||||||||
| Basis point shift |
- 100 | + 100 | - 100 | + 100 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Amount |
$ | 1,669 | $ | (1,476 | ) | $ | 1,406 | $ | (1,275 | ) | ||||||
|
|
|
|
|
|
|
|
|
|||||||||
The selection of the 100 basis point parallel shift in the yield curve was made only as an illustration of the potential hypothetical 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
Equity risk is defined as the risk of financial loss due to changes in the value of global equities or equity indices. The Company has exposure to equity risk from assets under management, embedded derivatives within the Company’s variable annuities and assets that support the Company’s pension plans. Equity Risk on the Company’s Variable Annuity products is mitigated through various hedging programs. For further information see the Variable Annuity Hedging Program Section.
The Company does not have significant equity risk exposure from invested assets. The Company’s exposure to equity risk includes the potential for lower earnings associated with certain of its businesses such as variable annuities where fee income is earned based upon the fair value of the assets under management. For further discussion of equity risk, see the Variable Product Guarantee Risk and Risk Management section. 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.
Foreign Currency Exchange Risk
Foreign currency exchange risk is defined as the risk of financial loss due to changes in the relative value between currencies. The Company’s foreign currency exchange risk is related to non-U.S. dollar denominated liability contracts, including its GMDB, GMAB, GMWB and GMIB benefits associated with its reinsurance of Japanese variable annuities and direct U.K. variable annuities, the investment in and net income of the Japanese and U.K. operations, non-U.S. dollar denominated investments, which primarily consist of fixed maturity investments, and a yen denominated individual fixed annuity product. In addition, the Company’s issued non-U.S. dollar denominated funding agreement liability contracts. A portion of the Company’s foreign currency exposure is mitigated through the use of derivatives.
The company manages the market risk, including foreign currency exchange risk, associated with the guaranteed benefits related to the Japanese and U.K. variable annuities through its comprehensive International Hedge Program. For more information on the International Hedge Program, including the foreign currency exchange risk sensitivity analysis, see the Variable Product Guarantee Risks and Risk Management section.
36
In order to manage the currency exposure related to non-U.S. dollar denominated investments and the non-U.S. dollar denominated funding agreement liability contracts, the Company enters into foreign currency swaps and forwards to hedge the variability in cash flows or fair value. These foreign currency swap and forward agreements are structured to match the foreign currency cash flows of the hedged foreign denominated securities and liabilities.
The yen denominated individual fixed annuity product was written by Hartford Life Insurance KK (“HLIKK”), a Japanese affiliate of the Company, and ceded to the Company. During 2009, the Company suspended new sales of the Japan business. The underlying investment involves investing in U.S. securities markets, which offer favorable credit spreads. The yen denominated fixed annuity product (“yen fixed annuities”) is recorded in the consolidated balance sheets with invested assets denominated in dollars while policyholder liabilities are denominated in yen and converted to U.S. dollars based upon the December 31 yen to U.S. dollar spot rate. The difference between U.S. dollar denominated investments and yen denominated liabilities exposes the Company to currency risk. The Company manages this currency risk associated with the yen fixed annuities primarily with pay variable U.S. dollar and receive fixed yen currency swaps.
Although economically an effective hedge, a divergence between the yen denominated fixed annuity product liability and the currency swaps exists primarily due to the difference in the basis of accounting between the liability and the derivative instruments (i.e. historical cost versus fair value). The yen denominated fixed annuity product liabilities are recorded on a historical cost basis and are only adjusted for changes in foreign spot rates and accrued income. The currency swaps are recorded at fair value, incorporating changes in value due to changes in forward foreign exchange rates, interest rates and accrued income. A portion of the Company’s foreign currency exposure is mitigated through the use of derivatives.
Fixed Maturity Investments
The risk associated with the non-U.S. dollar denominated fixed maturities relates to potential decreases in value and income resulting from unfavorable changes in foreign exchange rates. The fair value of the non-U.S. dollar denominated fixed maturities, which are primarily denominated in euro, sterling, yen and Canadian dollars, at December 31, 2011 and 2010, were approximately $1.6 billion and $792, respectively. Included in these amounts are $1.3 billion and $0.4 billion at December 31. 2011 and 2010, respectively, related to non-U.S. dollar denominated fixed maturity securities that directly support liabilities denominated in the same currencies. At December 31, 2011 and 2010, the derivatives used to hedge currency exchange risk related to the remaining non-U.S. dollar denominated fixed maturities had a total notional amount of $252 and $266, respectively, and total fair value of $3 and ($8), respectively.
Based on the fair values of the Company’s non-U.S. dollar denominated securities. including the associated yen denominated fixed annuity product liabilities, and derivative instruments as of December 31, 2011 and 2010, management estimates that a 10% unfavorable change in exchange rates would decrease the fair values by a before-tax total of approximately $58 and $26, 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 illustration of the potential hypothetical 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.
Liabilities
The Company issued non-U.S. dollar denominated funding agreement liability contracts. The Company hedges the foreign currency risk associated with these liability contracts with currency rate swaps. At December 31, 2011 and 2010, the derivatives used to hedge foreign currency exchange risk related to foreign denominated liability contracts had a total notional amount of $771 and a total fair value of ($57) and ($17), respectively.
The Company uses currency swaps to manage the foreign currency risk associated with the yen denominated individual fixed annuity product. As of December 31, 2011 and 2010, the notional value of the currency swaps was $1.9 billion and $2.1 billion and the fair value was $514 and $608, respectively. The currency swaps are recorded at fair value, incorporating changes in value due to changes in forward foreign exchange rates, interest rates and accrued income. A before-tax net gain of $3 and $27 for the years ended December 31, 2011 and 2010, respectively, which includes the changes in value of the currency swaps, excluding net periodic coupon settlements, and the yen fixed annuity contract remeasurement, was recorded in net realized capital gains and losses.
Credit Risk
Credit risk is defined as the risk of financial loss due to uncertainty of obligor’s or counterparty’s ability or willingness to meet its obligations in accordance with agreed upon terms. The majority of the Company’s credit risk is concentrated in its investment holdings but is also present in reinsurance and insurance portfolios. Credit risk is comprised of three major factors: the risk of change in credit quality, or credit migration risk; the risk of default; and the risk of a change in value of a financial instrument due to changes in credit spread that are unrelated to changes in obligor credit quality. A decline in creditworthiness is typically associated with an increase in an investment’s credit spread, potentially resulting in an increase in other-than-temporary impairments and an increased probability of a realized loss upon sale.
37
The objective of the Company’s enterprise credit risk management strategy is to identify, quantify, and manage credit risk on an aggregate portfolio basis and to limit potential losses in accordance with an established credit risk appetite. The Company manages to its risk appetite by primarily holding a diversified mix of investment grade issuers and counterparties across its investment, reinsurance, and insurance portfolios. Potential losses are also limited within portfolios by diversifying across geographic regions, asset types, and sectors.
The Company manages a credit exposure from its inception to its maturity or sale. Both the investment and reinsurance areas have formulated and implemented policies and procedures for counterparty approvals and authorizations. Although approval processes may vary by area and type of credit risk, approval processes establish minimum levels of creditworthiness and financial stability. Eligible credits are subjected to prudent and conservative underwriting reviews. Within the investment portfolio, private securities, such as commercial mortgages, and private placements, must be presented to their respective review committees for approval.
Credit risks are managed on an on-going basis through the use of various processes and analyses. At the investment, reinsurance, and insurance product levels, fundamental credit analyses are performed at the issuer/counterparty level on a regular basis. To provide a holistic review within the investment portfolio, fundamental analyses are supported by credit ratings, assigned by nationally recognized rating agencies or internally assigned, and by quantitative credit analyses. The Company utilizes a credit Value at Risk (“VaR”) to measure default and migration risk on a monthly basis. Issuer and security level risk measures are also utilized. In the event of deterioration in credit quality, the Company maintains watch lists of problem counterparties within the investment and reinsurance portfolios. The watch lists are updated based on regular credit examinations and management reviews. The Company also performs quarterly assessments of probable expected losses in the investment portfolio. The process is conducted on a sector basis and is intended to promptly assess and identify potential problems in the portfolio and to recognize necessary impairments.
Credit risk policies at the enterprise and operation level ensure comprehensive and consistent approaches to quantifying, evaluating, and managing credit risk under expected and stressed conditions. These policies define the scope of the risk, authorities, accountabilities, terms, and limits, and are regularly reviewed and approved by senior management and ERM. Aggregate counterparty credit quality and exposure is monitored on a daily basis utilizing an enterprise-wide credit exposure information system that contains data on issuers, ratings, exposures, and credit limits. Exposures are tracked on a current and potential basis. Credit exposures are reported regularly to the ERCC and to the Finance, Investment and Risk Management Committee (“FIRMCo”). Exposures are aggregated by ultimate parent across investments, reinsurance receivables, insurance products with credit risk, and derivative counterparties. The credit database and reporting system are available to all key credit practitioners in the enterprise.
The Company exercises various and differing methods to mitigate its credit risk exposure within its investment and reinsurance portfolios. Some of the reasons for mitigating credit risk include financial instability or poor credit, avoidance of arbitration or litigation, future uncertainty, and exposure in excess of risk tolerances. Credit risk within the investment portfolio is most commonly mitigated through the use of derivative instruments or asset sales. Counterparty credit risk is mitigated through the practice of entering into contracts only with highly creditworthy institutions and through the practice of holding and posting of collateral. Systemic credit risk is mitigated through the construction of high-quality, diverse portfolios that are subject to regular underwriting of credit risks. For further discussion of the Company’s investment and derivative instruments, see Investment Management section and Note 4 of the Notes to Consolidated Financial Statements. See Reinsurance section for further discussion on managing and mitigating credit risk from the use of reinsurance via an enterprise security review process.
The Company is not exposed to any credit concentration risk of a single issuer greater than 10% of the Company’s stockholders’ equity other than U.S. government and government agencies backed by the full faith and credit of the U.S. government. For further discussion of concentration of credit risk, see the Concentration of Credit Risk section in Note 4 of the Notes to Consolidated Financial Statements.
Derivative Instruments
The Company utilizes a variety of over-the-counter and exchange traded derivative instruments as a part of its overall risk management strategy, as well as to enter into replication transactions. Derivative instruments are used to manage risk associated with interest rate, equity market, credit spread, issuer default, price, and currency exchange rate risk or volatility. Replication transactions are used as an economical means to synthetically replicate the characteristics and performance of assets that would otherwise be permissible investments under the Company’s investment policies. For further information on the Company’s use of derivatives, see Note 4 of the Notes to Consolidated Financial Statements.
Derivative activities are monitored and evaluated by the Company’s compliance and risk management teams and reviewed by senior management. In addition, the Company monitors counterparty credit exposure on a monthly basis to ensure compliance with Company policies and statutory limitations. The notional amounts of derivative contracts represent the basis upon which pay or receive amounts are calculated and are not reflective of credit risk. Downgrades to the credit ratings of The Hartford’s insurance operating companies may have adverse implications for its use of derivatives including those used to hedge benefit guarantees of variable annuities. In some cases, downgrades may give derivative counterparties the unilateral contractual right to cancel and settle outstanding derivative trades or require additional collateral to be posted. In addition, downgrades may result in counterparties becoming unwilling to engage in additional over-the-counter (“OTC”) derivatives or may require collateralization before entering into any new trades. This will restrict the supply of derivative instruments commonly used to hedge variable annuity guarantees, particularly long-dated equity derivatives and interest rate swaps. Under these circumstances, the Company’s operating subsidiaries could conduct hedging activity using a combination of cash and exchange-traded instruments, in addition to using the available OTC derivatives.
38
The Company uses various derivative counterparties in executing its derivative transactions. The use of counterparties creates credit risk that the counterparty may not perform in accordance with the terms of the derivative transaction. The Company has developed a derivative counterparty exposure policy which limits the Company’s exposure to credit risk.
The derivative counterparty exposure policy establishes market-based credit limits, favors long-term financial stability and creditworthiness of the counterparty and typically requires credit enhancement/credit risk reducing agreements. The Company minimizes the credit risk of derivative instruments by entering into transactions with high quality counterparties primarily rated A or better, which are monitored and evaluated by the Company’s risk management team and reviewed by senior management. In addition, the Company monitors counterparty credit exposure on a monthly basis to ensure compliance with Company policies and statutory limitations. The Company also generally requires that derivative contracts, other than exchange traded contracts, certain forward contracts, and certain embedded and reinsurance derivatives, 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 has developed credit exposure thresholds which are based upon counterparty ratings. Credit exposures are measured using the market value of the derivatives, resulting in amounts owed to the Company by its counterparties or potential payment obligations from the Company to its counterparties. Credit exposures are generally quantified daily based on the prior business day’s market value and collateral is pledged to and held by, or on behalf of, the Company to the extent the current value of the derivatives exceed the contractual thresholds. In accordance with industry standard and the contractual agreements, collateral is typically settled on the next business day. The Company has exposure to credit risk for amounts below the exposure thresholds which are uncollateralized, as well as for market fluctuations that may occur between contractual settlement periods of collateral movements.
The maximum uncollateralized threshold for a derivative counterparty for a single legal entity is $10. The Company currently transacts OTC derivatives in two legal entities and therefore the maximum combined threshold for a single counterparty across all legal entities that use derivatives is $20. In addition, the Company may have exposure to multiple counterparties in a single corporate family due to a common credit support provider. As of December 31, 2011, the maximum combined threshold for all counterparties under a single credit support provider across all legal entities that use derivatives is $40. Based on the contractual terms of the collateral agreements, these thresholds may be immediately reduced due to a downgrade in either party’s credit rating. For further discussion, see the Derivative Commitments section of Note 9 of the Notes to Consolidated Financial Statements.
For the year ended December 31, 2011, the Company has incurred no losses on derivative instruments due to counterparty default.
In addition to counterparty credit risk, the Company may also introduce credit risk through the use of credit default swaps that are entered into to manage credit exposure. Credit default swaps involve a transfer of credit risk of one or many referenced entities from one party to another in exchange for periodic payments. The party that purchases credit protection will make periodic payments based on an agreed upon rate and notional amount, and for certain transactions there will also be an upfront premium payment. The second party, who assumes credit risk, will typically only make a payment if there is a credit event as defined in the contract and such payment will be typically equal to the notional value of the swap contract less the value of the referenced security issuer’s debt obligation. A credit event is generally defined as default on contractually obligated interest or principal payments or bankruptcy of the referenced entity.
The Company uses credit derivatives to purchase credit protection and to assume credit risk with respect to a single entity, referenced index, or asset pool. The Company purchases credit protection through credit default swaps to economically hedge and manage credit risk of certain fixed maturity investments across multiple sectors of the investment portfolio. The Company also enters into credit default swaps that assume credit risk as part of replication transactions. Replication transactions are used as an economical means to synthetically replicate the characteristics and performance of assets that would otherwise be permissible investments under the Company’s investment policies. These swaps reference investment grade single corporate issuers and baskets, which include customized diversified portfolios of corporate issuers, which are established within sector concentration limits and may be divided into tranches which possess different credit ratings.
As of December 31, 2011 and 2010, the notional amount related to credit derivatives that purchase credit protection was $1.1 billion and $1.7 billion, respectively, while the fair value was $23 and ($5), respectively. As of December 31, 2011 and 2010, the notional amount related to credit derivatives that assume credit risk was $2.2 billion and $2.0 billion, respectively, while the fair value was ($545) and ($376), respectively. For further information on credit derivatives, see the Credit Risk section of the MD&A and Note 4 of the Notes to Consolidated Financial Statements.
39
Investment Portfolio Risks and Risk Management
Investment Portfolio Composition
The following table presents the Company’s fixed maturities, AFS, by credit quality. 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 |
||||||||||||||||||||||||
| December 31, 2011 | December 31, 2010 | |||||||||||||||||||||||
| Amortized Cost |
Fair Value |
Percent of Total Fair Value |
Amortized Cost |
Fair Value |
Percent of Total Fair Value |
|||||||||||||||||||
| United States Government/Government agencies |
$ | 5,687 | 6,018 | 12.6 | % | $ | 6,074 | $ | 6,040 | 13.5 | % | |||||||||||||
| AAA |
4,807 | 5,065 | 10.6 | % | 5,175 | 5,216 | 11.6 | % | ||||||||||||||||
| AA |
6,246 | 6,196 | 13.0 | % | 6,560 | 6,347 | 14.2 | % | ||||||||||||||||
| A |
12,659 | 13,805 | 28.9 | % | 12,396 | 12,552 | 28.1 | % | ||||||||||||||||
| BBB |
13,549 | 14,066 | 29.4 | % | 11,878 | 12,059 | 26.8 | % | ||||||||||||||||
| BB & below |
3,288 | 2,628 | 5.5 | % | 3,240 | 2,620 | 5.8 | % | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Total fixed maturities |
$ | 46,236 | 47,778 | 100.0 | % | $ | 45,323 | $ | 44,834 | 100.0 | % | |||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
The movement in the overall credit quality of the Company’s portfolio was primarily attributable to sales of U.S. Treasuries as the Company continues to reinvest in spread product and purchase investment grade corporate securities concentrated in industrial and utility issuers. Fixed maturities, FVO, are not included in the above table. For further discussion on fair value option securities, see Note 3 of the Notes to Consolidated Financial Statements.
40
The following table presents the Company’s AFS securities by type, as well as fixed maturities, FVO.
| Securities by Type | ||||||||||||||||||||||||||||||||||||||||
| December 31, 2011 | December 31, 2010 | |||||||||||||||||||||||||||||||||||||||
| Cost or Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair Value |
Percent of Total Fair Value |
Cost or Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair Value |
Percent of Total Fair Value |
|||||||||||||||||||||||||||||||
| Asset-backed securities (“ABS”) |
||||||||||||||||||||||||||||||||||||||||
| Consumer loans |
$ | 1,767 | $ | 18 | $ | (193 | ) | $ | 1,592 | 3.3 | % | $ | 1,761 | $ | 14 | $ | (199 | ) | $ | 1,576 | 3.5 | % | ||||||||||||||||||
| Small business |
345 | 2 | (112 | ) | 235 | 0.5 | % | 369 | — | (125 | ) | 244 | 0.5 | % | ||||||||||||||||||||||||||
| Other |
249 | 18 | (1 | ) | 266 | 0.6 | % | 265 | 15 | (32 | ) | 248 | 0.6 | % | ||||||||||||||||||||||||||
| CDOs |
||||||||||||||||||||||||||||||||||||||||
| Collateralized loan obligations (“CLOs”) |
1,630 | 1 | (129 | ) | 1,502 | 3.1 | % | 1,713 | — | (151 | ) | 1,562 | 3.5 | % | ||||||||||||||||||||||||||
| CREs |
425 | 14 | (143 | ) | 296 | 0.6 | % | 562 | — | (228 | ) | 334 | 0.7 | % | ||||||||||||||||||||||||||
| Other |
— | — | — | — | — | 3 | — | — | 3 | — | ||||||||||||||||||||||||||||||
| CMBS |
||||||||||||||||||||||||||||||||||||||||
| Agency backed [1] |
345 | 23 | — | 368 | 0.8 | % | 295 | 5 | (2 | ) | 298 | 0.7 | % | |||||||||||||||||||||||||||
| Bonds |
3,747 | 118 | (303 | ) | 3,562 | 7.5 | % | 4,519 | 91 | (383 | ) | 4,227 | 9.4 | % | ||||||||||||||||||||||||||
| Interest only (“IOs”) |
326 | 28 | (15 | ) | 339 | 0.7 | % | 469 | 50 | (16 | ) | 503 | 1.1 | % | ||||||||||||||||||||||||||
| Corporate |
||||||||||||||||||||||||||||||||||||||||
| Basic industry [2] |
2,499 | 222 | (15 | ) | 2,705 | 5.7 | % | 2,006 | 127 | (20 | ) | 2,113 | 4.7 | % | ||||||||||||||||||||||||||
| Capital goods |
2,217 | 241 | (21 | ) | 2,437 | 5.1 | % | 2,095 | 154 | (15 | ) | 2,234 | 5.0 | % | ||||||||||||||||||||||||||
| Consumer cyclical |
1,518 | 149 | (5 | ) | 1,662 | 3.5 | % | 1,259 | 79 | (8 | ) | 1,330 | 3.0 | % | ||||||||||||||||||||||||||
| Consumer non-cyclical |
4,182 | 483 | (11 | ) | 4,654 | 9.6 | % | 4,262 | 316 | (25 | ) | 4,553 | 10.2 | % | ||||||||||||||||||||||||||
| Energy |
2,389 | 307 | (10 | ) | 2,686 | 5.6 | % | 2,421 | 167 | (14 | ) | 2,574 | 5.7 | % | ||||||||||||||||||||||||||
| Financial services |
5,385 | 263 | (393 | ) | 5,255 | 11.0 | % | 4,999 | 189 | (345 | ) | 4,843 | 10.8 | % | ||||||||||||||||||||||||||
| Tech./comm. |
2,861 | 313 | (40 | ) | 3,134 | 6.6 | % | 2,844 | 188 | (45 | ) | 2,987 | 6.7 | % | ||||||||||||||||||||||||||
| Transportation |
963 | 100 | (4 | ) | 1,059 | 2.2 | % | 845 | 56 | (9 | ) | 892 | 2.0 | % | ||||||||||||||||||||||||||
| Utilities |
5,507 | 622 | (28 | ) | 6,101 | 12.7 | % | 4,661 | 259 | (40 | ) | 4,880 | 10.9 | % | ||||||||||||||||||||||||||
| Other [2] |
563 | 29 | (12 | ) | 536 | 1.2 | % | 542 | 10 | (17 | ) | 509 | 1.1 | % | ||||||||||||||||||||||||||
| Foreign govt./govt. agencies |
1,121 | 106 | (3 | ) | 1,224 | 2.6 | % | 963 | 48 | (9 | ) | 1,002 | 2.2 | % | ||||||||||||||||||||||||||
| Municipal – Taxable |
1,504 | 104 | (51 | ) | 1,557 | 3.3 | % | 1,149 | 7 | (124 | ) | 1,032 | 2.3 | % | ||||||||||||||||||||||||||
| Residential mortgage-backed securities (“RMBS”) |
||||||||||||||||||||||||||||||||||||||||
| Agency |
2,718 | 147 | — | 2,865 | 6.0 | % | 2,908 | 78 | (16 | ) | 2,970 | 6.6 | % | |||||||||||||||||||||||||||
| Non-agency |
51 | — | (2 | ) | 49 | 0.1 | % | 64 | — | (2 | ) | 62 | 0.1 | % | ||||||||||||||||||||||||||
| Alt-A |
105 | 3 | (21 | ) | 87 | 0.2 | % | 144 | — | (18 | ) | 126 | 0.3 | % | ||||||||||||||||||||||||||
| Sub-prime |
1,195 | 20 | (393 | ) | 822 | 1.7 | % | 1,334 | 1 | (375 | ) | 960 | 2.1 | % | ||||||||||||||||||||||||||
| U.S. Treasuries |
2,624 | 162 | (1 | ) | 2,785 | 5.8 | % | 2,871 | 11 | (110 | ) | 2,772 | 6.3 | % | ||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
| Fixed maturities, AFS |
46,236 | 3,493 | (1,906 | ) | 47,778 | 100.0 | % | 45,323 | 1,865 | (2,328 | ) | 44,834 | 100.0 | % | ||||||||||||||||||||||||||
| Equity securities |
||||||||||||||||||||||||||||||||||||||||
| Financial services |
129 | — | (54 | ) | 75 | 151 | — | (40 | ) | 111 | ||||||||||||||||||||||||||||||
| Other |
314 | 21 | (12 | ) | 323 | 169 | 61 | (1 | ) | 229 | ||||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||
| Equity securities, AFS |
443 | 21 | (66 | ) | 398 | 320 | 61 | (41 | ) | 340 | ||||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||
| Total AFS securities |
$ | 46,679 | $ | 3,514 | $ | (1,972 | ) | $ | 48,176 | $ | 45,643 | $ | 1,926 | $ | (2,369 | ) | $ | 45,174 | ||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||
| Fixed maturities, FVO |
$ | 1,317 | $ | 639 | ||||||||||||||||||||||||||||||||||||
|
|
|
|
|
|||||||||||||||||||||||||||||||||||||
| [1] | Represents securities with pools of loans issued by the Small Business Administration which are backed by the full faith and credit of the U.S. government. |
| [2] | Gross unrealized gains (losses) exclude the fair value of bifurcated embedded derivative features of certain securities. Subsequent changes in value will be recorded in net realized capital gains (losses). |
The Company continues to invest in a diversified portfolio with a focus on investment grade basic industry and utility issuers, while reducing its exposure to U.S. Treasuries, commercial real estate securities and subordinated financial services securities. The Company’s AFS net unrealized position improved primarily as a result of improved security valuations largely due to declining interest rates, partially offset by credit spread widening. Fixed maturities, FVO, represents Japan government securities supporting the Japan fixed annuity product, as well as securities containing an embedded credit derivative for which the Company elected the fair value option. The underlying credit risk of the securities containing credit derivatives are primarily investment grade CRE CDOs and a subordinated position on a basket of corporate bonds. For further discussion on fair value option securities, see Note 3 of the Notes to Consolidated Financial Statements.
41
European Exposure
Many economies within Europe continue to experience significant adverse economic conditions which have been precipitated in part by high unemployment rates and government debt levels. As a result, issuers in several European countries have experienced credit deterioration and rating downgrades and a reduced ability to access capital markets and/or higher borrowing costs. The concerns regarding the European countries have impacted the capital markets which, in turn, has made it more difficult to contain the European financial crisis. Austerity measures aimed at reducing sovereign debt levels, along with steps taken by the European Central Bank to provide liquidity and credit support to certain countries issuing debt, have helped to stabilize markets recently. However, risks remain elevated.
The Company manages the credit risk associated with the European securities within the investment portfolio on an on-going basis using several processes which are supported by macroeconomic analysis and issuer credit analysis. For additional details regarding the Company’s management of credit risk, see the Credit Risk section of this MD&A. The Company considers alternate scenarios, including a base-case and both a positive and negative “tail” scenario that includes a partial or full break-up of the Eurozone. The outlook for key factors is evaluated, including the economic prospects for key countries, the potential for the spread of sovereign debt contagion, and the likelihood that policymakers and politicians pursue sufficient fiscal discipline and introduce appropriate backstops. Given the inherent uncertainty in the outcome of developments in the Eurozone, however, the Company has been focused on controlling both absolute levels of exposure and the composition of that exposure through both bond and derivative transactions.
The Company has limited direct European exposure, totaling only 7% of total invested assets as of December 31, 2011. The following tables present the Company’s European securities included in the Securities by Type table above. The Company identifies exposures with the issuers’ ultimate parent country of domicile, which may not be the country of the security issuer. Certain European countries were separately listed below, Greece, Italy, Ireland, Portugal and Spain (“GIIPS”), because of the current significant economic strains persisting in these countries. The criteria used for indentifying the countries separately listed includes credit default spreads that exceed the iTraxx SovX index level and an S&P credit quality rating of A or lower.
The following tables present the Company’s European securities included in the Securities by Type table above.
| December 31, 2011 | ||||||||||||||||||||||||||||||||
| Corporate & Equity, AFS Non-Finan. [1] |
Corporate & Equity, AFS Financials |
Foreign Govt./ Govt. Agencies |
Total | |||||||||||||||||||||||||||||
| Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value |
|||||||||||||||||||||||||
| Italy |
$ | 185 | $ | 149 | $ | — | $ | — | $ | — | $ | — | $ | 185 | $ | 149 | ||||||||||||||||
| Spain |
150 | 148 | 20 | 19 | — | — | 170 | 167 | ||||||||||||||||||||||||
| Ireland |
120 | 119 | — | — | — | — | 120 | 119 | ||||||||||||||||||||||||
| Portugal |
15 | 15 | — | — | — | — | 15 | 15 | ||||||||||||||||||||||||
| Greece |
— | — | — | — | — | — | — | — | ||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Higher risk |
470 | 431 | 20 | 19 | — | — | 490 | 450 | ||||||||||||||||||||||||
| Europe excluding higher risk |
2,771 | 3,081 | 828 | 758 | 613 | 681 | 4,212 | 4,520 | ||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Total Europe |
$ | 3,241 | $ | 3,512 | $ | 848 | 777 | $ | 613 | $ | 681 | $ | 4,702 | $ | 4,970 | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Europe exposure net of credit default swap protection [2] |
$ | 4,261 | $ | 4,987 | ||||||||||||||||||||||||||||
|
|
|
|
|
|||||||||||||||||||||||||||||
42
| December 31, 2010 | ||||||||||||||||||||||||||||||||
| Corporate & Equity, AFS Non-Finan. [1] |
Corporate & Equity, AFS Financials |
Foreign Govt./ Govt. Agencies |
Total | |||||||||||||||||||||||||||||
| Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value |
|||||||||||||||||||||||||
| Italy |
$ | 220 | $ | 212 | $ | 5 | $ | 5 | $ | — | $ | — | $ | 225 | $ | 217 | ||||||||||||||||
| Spain |
194 | 202 | 21 | 19 | — | — | 215 | 221 | ||||||||||||||||||||||||
| Ireland |
136 | 130 | — | — | — | — | 136 | 130 | ||||||||||||||||||||||||
| Portugal |
31 | 28 | — | — | — | — | 31 | 28 | ||||||||||||||||||||||||
| Greece |
— | — | — | — | — | — | — | — | ||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Higher risk |
581 | 572 | 26 | 24 | — | — | 607 | 596 | ||||||||||||||||||||||||
| Europe excluding higher risk |
3,306 | 3,591 | 963 | 953 | 414 | 429 | 4,683 | 4,973 | ||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Total Europe |
$ | 3,887 | $ | 4,163 | $ | 989 | 977 | $ | 414 | $ | 429 | $ | 5,290 | $ | 5,569 | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Europe exposure net of credit default swap protection [2] |
$ | 4,395 | $ | 5,561 | ||||||||||||||||||||||||||||
|
|
|
|
|
|||||||||||||||||||||||||||||
| [1] | Includes amortized cost and fair value of $42 and $42 as of December 31, 2011 and $19 and $19, respectively, as of December 31, 2010 related to limited partnerships and other alternative investments, the majority of which is domiciled in the United Kingdom. |
| [2] | Includes a notional amount and fair value of $441 and $17, respectively, as of December 31, 2011 and $895 and ($8), respectively, as of December 31, 2010 related to credit default swap protection. This includes a notional amount of $66 and $17 as of December 31, 2011 and 2010, respectively, related to single name corporate issuers in the financial services sector. |
The Company’s European investment exposure largely relates to corporate entities which are domiciled in or generated a significant portion of its revenue within the United Kingdom, Germany, the Netherlands and Switzerland. As of December 31, 2011 and 2010, exposure to the United Kingdom totals less than 3.5% of total invested assets. The majority of investments are U.S. dollar-denominated, and those securities that are pound and euro-denominated are hedged to U.S. dollars or support foreign-denominated liabilities. For a discussion of foreign currency risks, see the Foreign Currency Exchange Risk section of this MD&A. The Company does not hold any sovereign exposure to the higher risk countries and does not hold any exposure to issuers in Greece. As of December 31, 2011 and 2010, the Company’s unfunded commitments associated with its investment portfolio was immaterial, and the weighted average credit quality of European investments was A.
As of December 31, 2011 and 2010, the Company’s total credit default swaps that provide credit protection had a notional amount of $441 and $895, respectively, and a fair value of $17 and ($8), respectively. Included in those notional amounts as of December 31, 2011 and 2010 were $250 and $347, respectively, on credit default swaps referencing single name corporate and financial European issuers, of which $88 and $32, respectively, related to the higher risk countries. The maturity dates of the credit defaults swaps are primarily consistent with the hedged bonds. Also included are credit default swaps with a notional amount of $191 and $548, respectively, as of December 31, 2011 and 2010 which reference a standard basket of European corporate and financial issuers. For further information on the use of the Company’s credit derivatives and counterparty credit quality, see Derivative Instruments within the Credit Risk section in this MD&A.
Included in the Company’s equity securities, trading portfolio are certain investments in European sovereign debt totaling $582. These investments do not include any holdings in GIIPS nations. These assets support the U.K. variable annuity business and, therefore, changes in the fair value of these investments are reflected in the corresponding policyholder liabilities. The Company’s indirect exposure to these holdings is through any guarantees issued on the underlying variable annuity policies.
43
Financial Services
The Company’s exposure to the financial services sector is predominantly through banking and insurance institutions. The following table presents the Company’s exposure to the financial services sector included in the Securities by Type table above.
| December 31, 2011 | December 31, 2010 | |||||||||||||||||||||||
| Amortized Cost |
Fair Value |
Net Unrealized |
Amortized Cost |
Fair Value |
Net Unrealized |
|||||||||||||||||||
| AAA |
$ | 162 | $ | 165 | $ | 3 | $ | 157 | $ | 162 | $ | 5 | ||||||||||||
| AA |
1,259 | 1,244 | (15 | ) | 1,472 | 1,480 | 8 | |||||||||||||||||
| A |
2,557 | 2,583 | 26 | 2,496 | 2,381 | (115 | ) | |||||||||||||||||
| BBB |
1,377 | 1,197 | (180 | ) | 885 | 809 | (76 | ) | ||||||||||||||||
| BB & below |
159 | 141 | (18 | ) | 140 | 122 | (18 | ) | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Total |
$ | 5,514 | $ | 5,330 | $ | (184 | ) | $ | 5,150 | $ | 4,954 | $ | (196 | ) | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
Domestic financial companies continued to stabilize throughout 2011 due to improved earnings performance, strengthening of asset quality and capital retention. However, spread volatility remains high due to concerns around European sovereign risks and potential contagion, regulatory pressures and a weaker U.S. macroeconomic environment. Financial institutions remain vulnerable to these concerns, as well as ongoing stress in the real estate markets which could adversely impact the Company’s net unrealized position. Included in the table above as of December 31, 2011, is an amortized cost and fair value of $848 and $777, respectively, related to European investment exposure, of which only $20 and $19, respectively, relates to GIIPS. As of December 31, 2010, amortized cost and fair value includes $989 and $977, respectively, of European exposure, of which only $26 and $24, respectively, relates to GIIPS.
Commercial Real Estate
The commercial real estate market continued to show signs of improving fundamentals, such as increases in transaction activities, more readily available financing and new issuances. While delinquencies still remain at historically high levels, they are expected to move lower in 2012.
The following table presents the Company’s exposure to commercial mortgage backed-securities (“CMBS”) bonds by current credit quality and vintage year, included in the Securities by Type table above. Credit protection represents the current weighted average percentage of the outstanding capital structure subordinated to the Company’s investment holding that is available to absorb losses before the security incurs the first dollar loss of principal and excludes any equity interest or property value in excess of outstanding debt.
CMBS – Bonds [1]
| December 31, 2011 |
||||||||||||||||||||||||||||||||||||||||||||||||
| AAA | AA | A | BBB | BB and Below | Total | |||||||||||||||||||||||||||||||||||||||||||
| Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value |
|||||||||||||||||||||||||||||||||||||
| 2003 & Prior |
$ | 225 | $ | 229 | $ | 54 | $ | 53 | $ | 36 | $ | 35 | $ | 10 | $ | 9 | $ | 22 | $ | 20 | $ | 347 | $ | 346 | ||||||||||||||||||||||||
| 2004 |
191 | 200 | 59 | 67 | 30 | 27 | 30 | 28 | 6 | 4 | 316 | 326 | ||||||||||||||||||||||||||||||||||||
| 2005 |
287 | 311 | 43 | 41 | 93 | 80 | 120 | 92 | 30 | 23 | 573 | 547 | ||||||||||||||||||||||||||||||||||||
| 2006 |
541 | 579 | 410 | 389 | 173 | 153 | 187 | 153 | 299 | 214 | 1,610 | 1,488 | ||||||||||||||||||||||||||||||||||||
| 2007 |
160 | 173 | 184 | 162 | 45 | 36 | 116 | 91 | 97 | 79 | 602 | 541 | ||||||||||||||||||||||||||||||||||||
| 2008 |
30 | 32 | — | — | — | — | — | — | — | — | 30 | 32 | ||||||||||||||||||||||||||||||||||||
| 2009 |
28 | 29 | — | — | — | — | — | — | — | — | 28 | 29 | ||||||||||||||||||||||||||||||||||||
| 2010 |
6 | 7 | — | — | — | — | — | — | — | — | 6 | 7 | ||||||||||||||||||||||||||||||||||||
| 2011 |
235 | 246 | — | — | — | — | — | — | — | — | 235 | 246 | ||||||||||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||
| Total |
$ | 1,703 | $ | 1,806 | $ | 750 | $ | 712 | $ | 377 | $ | 331 | $ | 463 | $ | 373 | $ | 454 | $ | 340 | $ | 3,747 | $ | 3,562 | ||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||
| Credit protection |
27.5% | 24.0% | 20.4% | 13.6% | 6.8% | 21.9% | ||||||||||||||||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||||||||||||||
| December 31, 2010 |
||||||||||||||||||||||||||||||||||||||||||||||||
| AAA | AA | A | BBB | BB and Below | Total | |||||||||||||||||||||||||||||||||||||||||||
| Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value |
Amortized Cost |
Fair Value |
|||||||||||||||||||||||||||||||||||||
| 2003 & Prior |
$ | 545 | $ | 558 | $ | 65 | $ | 64 | $ | 33 | $ | 32 | $ | 14 | $ | 13 | $ | 18 | $ | 16 | $ | 675 | $ | 683 | ||||||||||||||||||||||||
| 2004 |
287 | 302 | 25 | 24 | 39 | 35 | 27 | 22 | 6 | 5 | 384 | 388 | ||||||||||||||||||||||||||||||||||||
| 2005 |
335 | 347 | 48 | 43 | 138 | 115 | 112 | 94 | 74 | 59 | 707 | 658 | ||||||||||||||||||||||||||||||||||||
| 2006 |
703 | 728 | 509 | 481 | 183 | 159 | 322 | 266 | 335 | 262 | 2,052 | 1,896 | ||||||||||||||||||||||||||||||||||||
| 2007 |
187 | 196 | 116 | 93 | 45 | 35 | 137 | 104 | 186 | 143 | 671 | 571 | ||||||||||||||||||||||||||||||||||||
| 2008 |
30 | 31 | — | — | — | — | — | — | — | — | 30 | 31 | ||||||||||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||
| Total |
$ | 2,087 | $ | 2,162 | $ | 763 | $ | 705 | $ | 438 | $ | 376 | $ | 612 | $ | 499 | $ | 619 | $ | 485 | $ | 4,519 | $ | 4,227 | ||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||
| Credit protection |
29.7% | 22.9% | 12.3% | 14.1% | 7.6% | 21.8% | ||||||||||||||||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||||||||||||||||||
| [1] | The vintage year represents the year the pool of loans was originated. |
44
The Company also has AFS exposure to commercial real estate (“CRE”) collateralized debt obligations (“CDOs”) with an amortized cost and fair value of $425 and $296, respectively, as of December 31, 2011 and $562 and $334, respectively, as of December 31, 2010. These securities are comprised of diversified pools of commercial mortgage loans or equity positions of other CMBS securitizations. Although the Company does not plan to invest in this asset class going forward, we continue to monitor these investments as economic and market uncertainties regarding future performance impacts market liquidity and results in higher risk premiums.
In addition to CMBS bonds and CRE CDOs, the Company has exposure to commercial mortgage loans as presented in the following table. These loans are collateralized by a variety of commercial properties and are diversified both geographically throughout the United States and by property type. These loans may be either in the form of a whole loan, where the Company is the sole lender, or a loan participation. Loan participations are loans where the Company has purchased or retained a portion of an outstanding loan or package of loans and participates on a pro-rata basis in collecting interest and principal pursuant to the terms of the participation agreement. In general, A-Note participations have senior payment priority, followed by B-Note participations and then mezzanine loan participations. As of December 31, 2011, loans within the Company’s mortgage loan portfolio that have had extensions or restructurings other than what is allowable under the original terms of the contract are immaterial.
Commercial Mortgage Loans
| December 31, 2011 | December 31, 2010 | |||||||||||||||||||||||
| Amortized Cost [1] |
Valuation Allowance |
Carrying Value |
Amortized Cost [1] |
Valuation Allowance |
Carrying Value |
|||||||||||||||||||
| Agricultural |
$ | 132 | $ | (5 | ) | $ | 127 | $ | 182 | $ | (5 | ) | $ | 177 | ||||||||||
| Whole loans |
3,575 | (13 | ) | 3,562 | 2,479 | (16 | ) | 2,463 | ||||||||||||||||
| A-Note participations |
236 | — | 236 | 288 | — | 288 | ||||||||||||||||||
| B-Note participations |
173 | (5 | ) | 168 | 195 | (5 | ) | 190 | ||||||||||||||||
| Mezzanine loans |
89 | — | 89 | 162 | (36 | ) | 126 | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Total |
$ | 4,205 | $ | (23 | ) | $ | 4,182 | $ | 3,306 | $ | (62 | ) | $ | 3,244 | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| [1] | Amortized cost represents carrying value prior to valuation allowances, if any. |
Since December 31, 2010, the Company funded $1.4 billion of commercial whole loans with a weighted average loan-to-value (“LTV”) ratio of 62% and a weighted average yield of 4.5%. The Company continues to originate commercial whole loans in primary markets, such as multi-family and retail, focusing on loans with strong LTV ratios and high quality property collateral. As of December 31, 2011, the Company had mortgage loans held-for-sale with a carrying value and valuation allowance of $57 and $4, respectively, and $64 and $4, respectively, as of December 31, 2010.
Limited Partnerships and Other Alternative Investments
The following table presents the Company’s investments in limited partnerships and other alternative investments which include hedge funds, mortgage and real estate funds, mezzanine debt funds, and private equity and other funds. Hedge funds include investments in funds of funds and direct funds. These hedge funds invest in a variety of strategies including global macro and long/short credit and equity. Mortgage and real estate funds consist of investments in funds whose assets consist of mortgage loans, mortgage loan participations, mezzanine loans or other notes which may be below investment grade, as well as equity real estate and real estate joint ventures. Mezzanine debt funds include investments in funds whose assets consist of subordinated debt that often incorporates equity-based options such as warrants and a limited amount of direct equity investments. Private equity and other funds primarily consist of investments in funds whose assets typically consist of a diversified pool of investments in small to mid-sized non-public businesses with high growth potential.
| December 31, 2011 | December 31, 2010 | |||||||||||||||
| Amount | Percent | Amount | Percent | |||||||||||||
| Hedge funds |
$ | 514 | 37.4 | % | $ | 33 | 4.0 | % | ||||||||
| Mortgage and real estate funds |
189 | 13.7 | % | 161 | 19.2 | % | ||||||||||
| Mezzanine debt funds |
60 | 4.4 | % | 68 | 8.1 | % | ||||||||||
| Private equity and other funds |
613 | 44.5 | % | 576 | 68.7 | % | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total |
$ | 1,376 | 100.0 | % | $ | 838 | 100.0 | % | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
Since December 31, 2010, the increase in hedge funds relate to additional investments in the type of fund strategies that the Company expects to generate superior risk-adjusted returns over time.
45
Available-for-Sale Securities — Unrealized Loss Aging
The total gross unrealized losses were $2.0 billion as of December 31, 2011, which have improved $397, or 17%, from December 31, 2010 as interest rates declined, partially offset by credit spread widening. As of December 31, 2011, $520 of the gross unrealized losses were associated with securities depressed less than 20% of cost or amortized cost.
The remaining $1.5 billion of gross unrealized losses were associated with securities depressed greater than 20%, which includes $138 associated with securities depressed over 50% for twelve months or more. These securities are backed primarily by commercial and residential real estate that have market spreads that continue to be wider than the spreads at the security’s respective purchase date. The unrealized losses remain largely due to the continued market and economic uncertainties surrounding residential and certain commercial real estate and lack of liquidity. Based upon the Company’s cash flow modeling and current market and collateral performance assumptions, these securities have sufficient credit protection levels to receive contractually obligated principal and interest payments. Also included in the gross unrealized losses depressed greater than 20% are financial services securities that have a floating-rate coupon and/or long-dated maturities.
As part of the Company’s ongoing security monitoring process, the Company has reviewed its AFS securities in an unrealized loss position and concluded that there were no additional impairments as of December 31, 2011 and that these securities are temporarily depressed and are expected to recover in value as the securities approach maturity or as real estate related market spreads continue to improve. For these securities in an unrealized loss position where a credit impairment has not been recorded, the Company’s best estimate of expected future cash flows are sufficient to recover the amortized cost basis of the security. Furthermore, the Company neither has an intention to sell nor does it expect to be required to sell these securities. For further information regarding the Company’s impairment analysis, see Other-Than-Temporary Impairments in the Investment Portfolio Risks and Risk Management section of this MD&A.
The following table presents the Company’s unrealized loss aging for AFS securities by length of time the security was in a continuous unrealized loss position.
| December 31, 2011 | December 31, 2010 | |||||||||||||||||||||||||||||||
| Items | Cost or Amortized Cost |
Fair Value |
Unrealized Loss [1] |
Items | Cost or Amortized Cost |
Fair Value |
Unrealized Loss |
|||||||||||||||||||||||||
| Three months or less |
628 | $ | 2,815 | $ | 2,572 | $ | (243 | ) | 200 | $ | 6,892 | $ | 6,631 | $ | (257 | ) | ||||||||||||||||
| Greater than three to six months |
357 | 1,606 | 1,537 | (69 | ) | 219 | 353 | 335 | (17 | ) | ||||||||||||||||||||||
| Greater than six to nine months |
168 | 755 | 702 | (53 | ) | 60 | 293 | 269 | (24 | ) | ||||||||||||||||||||||
| Greater than nine to eleven months |
22 | 58 | 52 | (6 | ) | 82 | 127 | 115 | (12 | ) | ||||||||||||||||||||||
| Greater than twelve months |
747 | 8,166 | 6,521 | (1,601 | ) | 1,024 | 10,769 | 8,689 | (2,059 | ) | ||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Total |
1,922 | $ | 13,400 | $ | 11,384 | $ | (1,972 | ) | 1,585 | $ | 18,434 | $ | 16,039 | $ | (2,369 | ) | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| [1] | Unrealized losses exclude the fair value of bifurcated embedded derivative features of certain securities as changes in value are recorded in net realized capital gains (losses). |
The following tables present the Company’s unrealized loss aging for AFS securities continuously depressed over 20% by length of time (included in the table above).
| December 31, 2011 | December 31, 2010 | |||||||||||||||||||||||||||||||
| Consecutive Months |
Items | Cost or Amortized Cost |
Fair Value |
Unrealized Loss [1] |
Items | Cost or Amortized Cost |
Fair Value |
Unrealized Loss |
||||||||||||||||||||||||
| Three months or less |
174 | $ | 1,498 | $ | 1,045 | $ | (428 | ) | 47 | $ | 433 | $ | 322 | $ | (111 | ) | ||||||||||||||||
| Greater than three to six months |
106 | 955 | 674 | (281 | ) | 15 | 126 | 97 | (29 | ) | ||||||||||||||||||||||
| Greater than six to nine months |
36 | 348 | 232 | (116 | ) | 24 | 155 | 107 | (48 | ) | ||||||||||||||||||||||
| Greater than nine to eleven months |
— | — | — | — | 9 | 20 | 16 | (4 | ) | |||||||||||||||||||||||
| Greater than twelve months |
203 | 1,521 | 894 | (627 | ) | 342 | 3,547 | 2,244 | (1,303 | ) | ||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Total |
519 | $ | 4,322 | $ | 2,845 | $ | (1,452 | ) | 437 | $ | 4,281 | $ | 2,786 | $ | (1,495 | ) | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| [1] | Unrealized losses exclude the fair value of bifurcated embedded derivative features of certain securities as changes in value are recorded in net realized capital gains (losses). |
46
The following tables present the Company’s unrealized loss aging for AFS securities continuously depressed over 50% by length of time (included in the tables above).
| December 31, 2011 | December 31, 2010 | |||||||||||||||||||||||||||||||
| Consecutive Months |
Items | Cost or Amortized Cost |
Fair Value |
Unrealized Loss |
Items | Cost or Amortized Cost |
Fair Value |
Unrealized Loss |
||||||||||||||||||||||||
| Three months or less |
39 | $ | 139 | $ | 49 | $ | (90 | ) | 15 | $ | 25 | $ | 11 | $ | (14 | ) | ||||||||||||||||
| Greater than three to six months |
18 | 66 | 27 | (39 | ) | 4 | 2 | 1 | (1 | ) | ||||||||||||||||||||||
| Greater than six to nine months |
7 | 33 | 11 | (22 | ) | 11 | 64 | 28 | (36 | ) | ||||||||||||||||||||||
| Greater than nine to eleven months |
3 | 5 | 1 | (4 | ) | — | — | — | — | |||||||||||||||||||||||
| Greater than twelve months |
51 | 202 | 64 | (138 | ) | 88 | 635 | 233 | (402 | ) | ||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Total |
118 | $ | 445 | $ | 152 | $ | (293 | ) | 118 | $ | 726 | $ | 273 | $ | (453 | ) | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
Other-Than-Temporary Impairments
The following table presents the Company’s impairments recognized in earnings by security type.
| For the years ended December 31, | ||||||||
| 2011 | 2010 | |||||||
| ABS |
$ | 24 | $ | 11 | ||||
| CDOs |
30 | 135 | ||||||
| CMBS |
||||||||
| Bonds |
5 | 112 | ||||||
| IOs |
3 | 1 | ||||||
| Corporate |
33 | 23 | ||||||
| Equity |
13 | 9 | ||||||
| RMBS |
||||||||
| Non-agency |
— | 2 | ||||||
| Alt-A |
1 | 8 | ||||||
| Sub-prime |
15 | 35 | ||||||
| U.S. Treasuries |
1 | — | ||||||
|
|
|
|
|
|||||
| Total |
$ | 125 | $ | 336 | ||||
|
|
|
|
|
|||||
Year ended December 31, 2011
For the year ended December 31, 2011, impairments recognized in earnings were comprised of credit impairments of $88, securities that the Company intends to sell of $24 and impairments on equity securities of $13.
Credit impairments were primarily concentrated in structured securities associated with commercial real estate, as well as direct private investments. The structured securities were impaired primarily due to property-specific deterioration of the underlying collateral. The Company calculated these impairments utilizing both a top down modeling approach and a security-specific collateral review. The top down modeling approach used discounted cash flow models that considered losses under current and expected future economic conditions. Assumptions used over the current period included macroeconomic factors, such as a high unemployment rate, as well as sector specific factors such as property value declines, commercial real estate delinquency levels and changes in net operating income. The macroeconomic assumptions considered by the Company did not materially change during 2011 and, as such, the credit impairments recognized for the year ended December 31, 2011 were primarily driven by actual or expected collateral deterioration, largely as a result of the Company’s security-specific collateral review.
The security-specific collateral review is performed to estimate potential future losses. This review incorporates assumptions about expected future collateral cash flows, including projected rental rates and occupancy levels that varied based on property type and sub-market. The results of the security-specific collateral review allowed the Company to estimate the expected timing of a security’s first loss, if any, and the probability and severity of potential ultimate losses. The Company then discounted these anticipated future cash flows at the security’s book yield prior to impairment.
Included in corporate and equity security types were direct private investments that were impaired primarily due to the likelihood of a disruption in contractual principal and interest payments due to the restructuring of the debtor’s obligation. Impairments on equity securities were primarily related to preferred stock associated with these direct private investments.
Impairments on securities for which the Company has the intent to sell were primarily on corporate bonds, certain ABS aircrafts bonds and CMBS as market pricing continues to improve and the Company would like the ability to reduce certain exposures.
47
In addition to the credit impairments recognized in earnings, the Company recognized non-credit impairments in other comprehensive income of $71 for the year ended December 31, 2011, predominantly concentrated in CRE CDOs and RMBS. These non-credit impairments represent the difference between fair value and the Company’s best estimate of expected future cash flows discounted at the security’s effective yield prior to impairment, rather than at current market implied credit spreads. These non-credit impairments primarily represent increases in market liquidity premiums and credit spread widening that occurred after the securities were purchased, as well as a discount for variable-rate coupons which are paying less than at purchase date. In general, larger liquidity premiums and wider credit spreads are the result of deterioration of the underlying collateral performance of the securities, as well as the risk premium required to reflect future uncertainty in the real estate market.
Future impairments may develop as the result of changes in intent to sell of specific securities or if actual results underperform current modeling assumptions, which may be the result of, but are not limited to, macroeconomic factors and security-specific performance below current expectations. Ultimate loss formation will be a function of macroeconomic factors and idiosyncratic security-specific performance.
Year ended December 31, 2010
For the year ended December 31, 2010, impairments recognized in earnings were comprised of credit impairments of $303 primarily concentrated on structured securities associated with commercial and residential real estate. Also included were impairments on debt securities for which the Company intended to sel1 of $27, mainly comprised of CMBS bonds in order to take advantage of price appreciation, as well as impairments on equity securities of $6 primarily on below investment grade securities depressed 20% for more than six months.
Valuation Allowances on Mortgage Loans
The following table presents (additions)/reversals to valuation allowances on mortgage loans.
| For the years ended December 31, | ||||||||
| 2011 | 2010 | |||||||
| Credit-related concerns |
$ | 27 | $ | (40 | ) | |||
| Held for sale |
||||||||
| Agricultural loans |
(2 | ) | (7 | ) | ||||
| B-note participations |
— | (10 | ) | |||||
| Mezzanine loans |
— | (51 | ) | |||||
|
|
|
|
|
|||||
| Total |
$ | 25 | $ | (108 | ) | |||
|
|
|
|
|
|||||
Year ended December 31, 2011
For the year ended December 31, 2011, valuation allowances on mortgage loan reversals of $25 were largely driven by the release of a reserve associated with the sale of a previously reserved for mezzanine loan. Continued improvement in commercial real estate property valuations will positively impact future loss development, with future impairments driven by idiosyncratic loan-specific performance.
Years ended December 31, 2010
For the years ended December 31, 2010, valuation allowances on mortgage loan additions of ($108) primarily related to B-Note participant and mezzanine loan sales. Also included were additions for expected credit losses due to borrower financial difficulty and/or collateral deterioration.
Variable Product Guarantee Risks and Risk Management
The Company’s equity product risk is managed at the Life Operations level of The Hartford. The disclosures in the following equity product risk section are reflective of the risk management program, including reinsurance with third parties and the dynamic and macro derivative hedging programs which are structured at a parent company level. The following disclosures are also reflective of the Company’s reinsurance of the majority of variable annuities with living and death benefit riders to an affiliated captive reinsurer, effective October 1, 2009. See Note 16 of the Notes to the Consolidated Financial Statements for further information on the reinsurance transaction
48
The Company’s variable products are significantly influenced by the U.S., Japanese, and other equity markets. Increases or declines in equity markets impact certain assets and liabilities related to the Company’s variable products and the Company’s earnings derived from those products. These variable products include annuity, mutual funds, and variable life insurance.
Generally, declines in equity markets will:
| • | reduce the value of assets under management and the amount of fee income generated from those assets; |
| • | increase the liability for direct GMWB benefits, and reinsured GMWB and GMIB benefits, resulting in realized capital losses; |
| • | increase the value of derivative assets used to hedge product guarantees resulting in realized capital gains; |
| • | increase the costs of the hedging instruments we use in our hedging program; |
| • | increase the Company’s net amount at risk for GMDB benefits; |
| • | decrease the Company’s actual gross profits, resulting in increased DAC amortization; |
| • | increase the amount of required assets to be held for backing variable annuity guarantees to maintain required regulatory reserve levels and targeted risk based capital ratios; |
| • | adversely affect customer sentiment toward equity-linked products negative, causing a decline in sales; and |
| • | decrease the Company’s estimated future gross profits. See Estimated Gross Profits Used in the Valuation and Amortization of Assets and Liabilities Associated with Variable Annuity and Other Universal Life-Type Contracts within Critical Accounting Estimates section of the MD&A for further information. |
Generally, increases in equity markets will reduce the value of the dynamic hedge program and macro hedge derivative assets, resulting in realized capital losses, and will generally have the inverse impact of those listed above. See section on Variable Annuity Hedging Program for more information.
Variable Annuity Guaranteed Benefits
The majority of the Company’s U.S. and U.K. variable annuities include a GMWB rider. Declines in the equity markets will increase the Company’s liability for these benefits. The Company reinsures a majority of the GMWB benefits with an affiliated captive reinsurer. A GMWB contract is ‘in the money’ if the contract holder’s guaranteed remaining benefit (“GRB”) becomes greater than the account value.
The majority of the Company’s variable annuity contracts include a GMDB rider. A majority of the Company’s GMDB benefits, both direct and assumed, are reinsured with an affiliated captive reinsurer and an external reinsurer. The net amount at risk (“NAR”) is generally defined as the guaranteed minimum benefit amount in excess of the contractholder’s current account value. Global variable annuity account values with guarantee features were $39.7 billion and $45.2 billion as of December 31, 2011 and December 31, 2010, respectively.
The following table summarizes the account values of the Company’s U.S. and U.K. Direct variable annuities with guarantee features and Japan assumed guarantee features as well as the NAR split between various guarantee features:
| Total Variable Annuity Guarantees | ||||||||||||||||||||||
| As of December 31, 2011 | ||||||||||||||||||||||
| ($ in billions) |
Account Value | Gross Net Amount at Risk |
Retained Net Amount at Risk |
% of Contracts in the Money |
% In the Money[3] | |||||||||||||||||
| U. S. Variable Annuity |
||||||||||||||||||||||
| GMDB |
$ | 20.9 | 3.7 | $ | 1.6 | 78 | % | 15 | % | |||||||||||||
| GMWB |
10.4 | 0.5 | 0.4 | 53 | % | 11 | % | |||||||||||||||
| Japan Variable Annuity |
||||||||||||||||||||||
| GMDB |
17.0 | 5.2 | — | 99 | % | 24 | % | |||||||||||||||
| GMIB |
16.3 | 4.8 | — | 99 | % | 23 | % | |||||||||||||||
| U.K. Variable Annuity |
||||||||||||||||||||||
| GMDB |
1.8 | 0.08 | — | 100 | % | 4 | % | |||||||||||||||
| GMWB |
1.8 | 0.07 | — | 57 | % | 3 | % | |||||||||||||||
49
| Total Variable Annuity Guarantees |
||||||||||||||||||||||
| As of December 31, 2010 | ||||||||||||||||||||||
| ($ in billions) |
Account Value | Gross Net Amount at Risk |
Retained Net Amount at Risk |
% of Contracts in the Money |
% In the Money[3] | |||||||||||||||||
| U. S. Variable Annuity |
|
|||||||||||||||||||||
| GMDB |
$ | 25.3 | $ | 3.3 | $ | 1.3 | 56 | % | 12 | % | ||||||||||||
| GMWB |
12.8 | 0.4 | 0.3 | 44 | % | 43 | % | |||||||||||||||
| Japan Variable Annuity |
||||||||||||||||||||||
| GMDB |
17.9 | 4.2 | — | 98 | % | 19 | % | |||||||||||||||
| GMIB |
17.7 | 3.9 | — | 99 | % | 19 | % | |||||||||||||||
| U.K. Variable Annuity |
||||||||||||||||||||||
| GMDB |
2.1 | 0.04 | — | 100 | % | 1 | % | |||||||||||||||
| GMWB |
2.1 | 0.03 | — | 25 | % | 1 | % | |||||||||||||||
| [1] | Policies with a guaranteed living benefits (a GMWB in the US or a GMIB in Japan) also have a guaranteed death benefit. The net amount at risk (“NAR”) for each benefit is shown; however these benefits are not additive. When a policy terminates due to death, any NAR related to GMWB or GMIB is released. Similarly, when a policy goes into benefit status on a GMWB or, by contract, the GMDB NAR is reduced to $0. When a policy goes into benefit status on a GMIB, its GMDB NAR is released |
| [2] | Excludes group annuity contracts with GMDB benefits. |
| [3] | For all contracts that are “in the money”, this represents the percentage by which the average contract was in the money. |
The Company expects to incur these payments in the future only if the policyholder has an “in the money” GMWB at their death or their account value is reduced to a specified level, through contractually permitted withdrawals and/or market declines. If the account value is reduced to the specified level, the contract holder will receive an annuity equal to the guaranteed remaining benefit (“GRB”). For the Company’s “life-time” GMWB products, this annuity can continue beyond the GRB. As the account value fluctuates with equity market returns on a daily basis and the “life-time” GMWB payments can exceed the GRB, the ultimate amount to be paid by the Company, if any, is uncertain and could be significantly more or less than the Company’s current carried liability. For additional information on the Company’s GMWB liability, see Note 3 of the Notes to Consolidated Financial Statements.
For assumed GMIB contracts, in general, the policyholder has the right to elect to annuitize benefits, beginning (for certain products) on the tenth or fifteenth anniversary year of contract commencement, receive lump sum payment of the then current account value, or remain in the variable sub-account. For GMIB contracts, if the policyholder makes an election, the policyholder is entitled to receive the original investment value over a 10- to 15- year annuitization period. A small percentage of the contracts will first become eligible to elect annuitization beginning in 2013. The remainder of the contracts will first become eligible to elect annuitization from 2014 to 2022. Because policyholders have various contractual rights to defer their annuitization election, the period over which annuitization election can take place is subject to policyholder behavior and therefore indeterminate. In addition, upon annuitization the contractholder surrenders access to the account value and the account value is transferred to the Company’s general account where it is invested and the additional investment proceeds are used towards payment of the original investment value. If the original investment value exceeds the account value upon annuitization then the contract is “in the money”. As of December 31, 2011 and December 31, 2010, substantially all of the Japan GMIB contracts were “in the money”. For additional information on the Company’s GMIB liability, see Note 8 of the Notes to Consolidated Financial Statements.
The following table represents the timing of account values eligible for annuitization under the assumed Japan GMIB as of December 31, 2011, as well as the NAR. The account values reflect 100% annuitization at the earliest point allowed by the contract and no adjustments for future market returns and policyholder behaviors. Future market returns, changes in the value of the Japanese yen and policyholder behaviors will impact account values eligible for annuitization in the years presented.
| ($ in billions) |
GMIB [1] Account Value |
Net Amount at Risk[3] | ||||||
| 2013 |
$ | — | $ | — | ||||
| 2014 |
— | — | ||||||
| 2015 |
5.2 | 1.4 | ||||||
| 2016 |
2.4 | 0.8 | ||||||
| 2017 |
2.8 | 0.9 | ||||||
| 2018 & beyond [2] |
5.9 | 1.7 | ||||||
|
|
|
|
|
|||||
| Total |
$ | 16.3 | $ | 4.8 | ||||
|
|
|
|
|
|||||
| [1] | Excludes certain non-GMIB living benefits of $0.5 billion of account value and $0.05 billion of NAR. |
| [2] | In 2018 & beyond, $2.6 billion of the $5.9 billion is primarily associated with account value that is eligible in 2021. |
| [3] | The NAR is 100% reinsured to a captive affiliate. See Note 16 of the Notes to Consolidated Financial Statements for additional information. |
50
Many policyholders with a GMDB also have a GMWB in the U.S. or GMIB in Japan. Policyholders that have a product that offer both guarantees can only receive the GMDB or the GMIB benefit in Japan or the GMDB or GMWB in the U.S. For additional information on the Company’s GMDB liability, see Note 8 of the Notes to Consolidated Financial Statements.
The Company enters into various reinsurance agreements to reinsure GMDB, GMWB and GMIB benefits issued by HLIKK, a Japan affiliate of the Company. In the second quarter of 2009, the Company suspended new product sales in the Company’s Japan affiliate and in the fourth quarter of 2009 the company reinsured 100% of the assumed benefits to an affiliated captive reinsurer. See Note 16 of the Notes to the Consolidated Financial Statements for further discussion.
Variable Annuity Market Risk Exposures
The following table summarizes the broad Variable Annuity Guarantees offered by the Company and the market risks to which the guarantee is most exposed from a U.S. GAAP accounting perspective.
| Variable Annuity Guarantees [1] | U.S. GAAP Treatment [1] |
Primary Market Risk Exposures [1] | ||
| U. S. GMDB |
Accumulation of the portion of fees required to cover expected claims, less accumulation of actual claims paid | Equity Market Levels | ||
| Japan GMDB (Assumed) |
Accumulation of the portion of fees required to cover expected claims, less accumulation of actual claims paid | Equity Market Levels/Interest Rates/Foreign Currency | ||
| GMWB |
Fair Value | Equity Market Levels / Implied Volatility / Interest Rates | ||
| For Life Component of GMWB |
Accumulation of the portion of fees required to cover expected claims, less accumulation of actual claims paid | Equity Market Levels | ||
| Japan GMIB (Assumed) |
Fair Value | Equity Market Levels / Interest Rates / Foreign Currency | ||
| Japan GMAB (Assumed) |
Fair Value | Equity Market Levels / Implied Volatility / Interest Rates | ||
| [1] | Each of these guarantees and the related U.S. GAAP accounting volatility will also be influenced by actual and estimated policyholder behavior. |
Risk Hedging
Variable Annuity Hedging Program
The Company’s variable annuity hedging is primarily focused on reducing the economic exposure to market risks associated with guaranteed benefits that are embedded in our global VA contracts through the use of reinsurance and capital market derivative instruments. The variable annuity hedging also considers the potential impacts on Statutory accounting results.
Reinsurance
The Company uses third-party reinsurance for a portion of U.S. contracts issued with GMWB riders prior to the third quarter of 2003 and GMWB risks associated with a block of business sold between the third quarter of 2003 and the second quarter of 2006. The Company also uses third party reinsurance for a majority of the GMDB issued in the U.S.
Capital Market Derivatives
GMWB Hedge Program
The Company enters into derivative contracts to hedge market risk exposures associated with the GMWB liabilities that are not reinsured. These derivative contracts include customized swaps, interest rate swaps and futures, and equity swaps, options, and futures, on certain indices including the S&P 500 index, EAFE index, and NASDAQ index.
Additionally, the Company holds customized derivative contracts to provide protection from certain capital market risks for the remaining term of specified blocks of non-reinsured GMWB riders. These customized derivative contracts are based on policyholder behavior assumptions specified at the inception of the derivative contracts. The Company retains the risk for differences between assumed and actual policyholder behavior and between the performance of the actively managed funds underlying the separate accounts and their respective indices.
While the Company actively manages this dynamic hedging program, increased U.S. GAAP earnings volatility may result from factors including, but not limited to: policyholder behavior, capital markets, divergence between the performance of the underlying funds and the hedging indices, changes in hedging positions and the relative emphasis placed on various risk management objectives.
51
Macro Hedge Program
The Company’s macro hedging program uses derivative instruments such as options, futures, swaps, and forwards on equities and interest rates to provide protection against the statutory tail scenario risk arising from U.S., GMWB and GMDB liabilities, on the Company’s statutory surplus. These macro hedges cover some of the residual risks not otherwise covered by specific dynamic hedging programs. Management assesses this residual risk under various scenarios in designing and executing the macro hedge program. The macro hedge program will result in additional U.S. GAAP earnings volatility as changes in the value of the macro hedge derivatives, which are designed to reduce statutory reserve and capital volatility, may not be closely aligned to changes in U.S. GAAP liabilities.
U.K Macro Hedge
The Company uses derivative instruments such as futures on equities and interest rates to provide protection against the statutory tail scenario risk arising from U.K. GMWB and GMDB liabilities on the Company’s statutory surplus. These macro hedges cover some of the residual risks not otherwise covered by specific dynamic hedging program. Management assesses this residual risk under various scenarios in designing and executing the macro hedge program. The use of derivatives will result in additional U.S. GAAP earnings volatility as changes in the value of the macro hedge derivatives, which are designed to reduce statutory reserve and capital volatility, may not be closely aligned to changes in U.S. GAAP liabilities. The following table summarizes the financial results by hedge program.
Japan Hedge Program
The Company holds derivative instruments that support The Hartford’s Japan hedging strategy. The derivatives are only a portion of the overall Japan hedge program and are held in concert with additional derivative positions held in other Hartford legal entities.
Equity Risk Impact on Statutory Capital and Risked Based Capital
In any particular year, statutory surplus amounts and RBC ratios may increase or decrease depending upon a variety of factors. The amount of change in the statutory surplus or RBC ratios can vary based on individual factors and may be compounded in extreme scenarios or if multiple factors occur at the same time. At times the impact of changes in certain market factors or a combination of multiple factors on RBC ratios can be varied and in some instances counterintuitive. Factors include:
| • | In general, as equity market levels decline, our reserves for death and living benefit guarantees associated with variable annuity contracts increases, sometimes at a greater than linear rate, reducing statutory surplus levels. In addition, as equity market levels increase, generally surplus levels will increase. RBC ratios will also tend to increase when equity markets increase. However, as a result of a number of factors and market conditions, including the level of hedging costs and other risk transfer activities, reserve requirements for death and living benefit guarantees and RBC requirements could increase resulting in lower RBC ratios. |
| • | As the value of certain fixed-income and equity securities in our investment portfolio decreases, due in part to credit spread widening, statutory surplus and RBC ratios may decrease. |
| • | As the value of certain derivative instruments that do not get hedge accounting decreases, statutory surplus and RBC ratios may decrease. |
| • | Our statutory surplus is also impacted by widening credit spreads as a result of the accounting for the assets and liabilities in our fixed market value adjusted (“MVA”) annuities. Statutory separate account assets supporting the fixed MVA annuities are recorded at fair value. In determining the statutory reserve for the fixed MVA annuities, we are required to use current crediting rates. In many capital market scenarios, current crediting rates are highly correlated with market rates implicit in the fair value of statutory separate account assets. As a result, the change in statutory reserve from period to period will likely substantially offset the change in the fair value of the statutory separate account assets. However, in periods of volatile credit markets, such as we have experienced, actual credit spreads on investment assets may increase sharply for certain sub-sectors of the overall credit market, resulting in statutory separate account asset market value losses. As actual credit spreads are not fully reflected in the current crediting rates, the calculation of statutory reserves will not substantially offset the change in fair value of the statutory separate account assets resulting in reductions in statutory surplus and can create funding obligations to the statutory separate account. |
Most of these factors are outside of the Company’s control. The Company’s financial strength and credit ratings are significantly influenced by the statutory surplus amounts and RBC ratios of our insurance company subsidiaries. Due to all of these factors, projecting statutory capital and the related projected RBC ratios is complex. In addition, rating agencies may implement changes to their internal models that have the effect of increasing or decreasing the amount of statutory capital we must hold in order to maintain our current ratings.
The Company has reinsured approximately 19% of its risk associated with GMWB with a third party and 15% of its risk associated with GMWB with an affiliated captive reinsurer. The Company has also reinsured 58% of its risk associated with the aggregate GMDB exposure. These reinsurance agreements serve to reduce the Company’s exposure to changes in the statutory reserves and the related capital and RBC ratios associated with changes in the equity markets. The Company also continues to explore other solutions for mitigating the capital market risk effect on surplus, such as internal and external reinsurance solutions, migrating towards a more statutory based hedging program, changes in product design, increasing pricing and expense management.
52
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 over the next twelve months.
Derivative Commitments
Certain of the Company’s derivative agreements contain provisions that are tied to the financial strength ratings of the individual legal entity that entered into the derivative agreement as set by nationally recognized statistical rating agencies. If the legal entity’s financial strength were to fall below certain ratings, the counterparties to the derivative agreements could demand immediate and ongoing full collateralization and in certain instances demand immediate settlement of all outstanding derivative positions traded under each impacted bilateral agreement. The settlement amount is determined by netting the derivative positions transacted under each agreement. If the termination rights were to be exercised by the counterparties, it could impact the legal entity’s ability to conduct hedging activities by increasing the associated costs and decreasing the willingness of counterparties to transact with the legal entity. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that are in a net liability position as of December 31, 2011, is $403. Of this $403, the legal entities have posted collateral of $425 in the normal course of business. Based on derivative market values as of December 31, 2011, a downgrade of one level below the current financial strength ratings by either Moody’s or S&P could require an additional $15 to be posted as collateral. Based on derivative market values as of December 31, 2011, a downgrade by either Moody’s or S&P of two levels below the legal entities’ current financial strength ratings would not require additional collateral to be posted. These collateral amounts could change as derivative market values change, as a result of changes in our hedging activities or to the extent changes in contractual terms are negotiated. The nature of the collateral that we would post, if required, would be primarily in the form of U.S. Treasury bills and U.S. Treasury notes.
The aggregate notional amount of derivative relationships that could be subject to immediate termination in the event of rating agency downgrades to either BBB+ or Baa1 as of December 30, 2011 was $12.7 billion with a corresponding fair value of $408. The notional and fair value amounts include a customized GMWB derivative with a notional amount of $4.2 billion and a fair value of $207, for which the Company has a contractual right to make a collateral payment in the amount of approximately $45 to prevent its termination. This customized GMWB derivative contains an early termination trigger such that if the unsecured, unsubordinated debt of the counterparty’s related party guarantor is downgraded two levels or more below the current ratings by Moody’s and one or more levels by S&P, the counterparty could terminate all transactions under the applicable International Swaps and Derivatives Association Master Agreement. As of December 31, 2011, the gross fair value of the affected derivative contracts is $223, which would approximate the settlement value.
Insurance Operations
In the event customers elect to surrender separate account assets, international statutory separate accounts or retail mutual funds, the Company will use the proceeds from the sale of the assets to fund the surrender and the Company’s liquidity position will not be impacted. In many instances the Company will receive a percentage of the surrender amount as compensation for early surrender (“surrender charge”), increasing the Company’s liquidity position. In addition, a surrender of variable annuity separate account or general account assets will decrease the Company’s obligation for payments on guaranteed living and death benefits.
As of December 31, 2011, the Company’s cash and short-term investments of $5 billion, included $1.9 billion of collateral received from, and held on behalf of, derivative counterparties and $336 of collateral pledged to derivative counterparties. The Company also held $2.8 billion of treasury securities, of which $425 had been pledged to derivative counterparties.
Total general account contractholder obligations are supported by $64 billion of cash and total general account invested assets, excluding equity securities, trading, which includes a significant short-term investment position, as depicted below, to meet liquidity needs.
The following table summarizes the Company’s fixed maturities, short-term investments, and cash, as of December 31, 2011:
| Fixed maturities |
$ | 49,095 | ||
| Short-term investments |
3,882 | |||
| Cash |
1,183 | |||
| Less: Derivative collateral |
(2,646 | ) | ||
|
|
|
|||
| Total |
$ | 51,514 | ||
|
|
|
Capital resources available to fund liquidity, upon contract holder surrender, are a function of the legal entity in which the liquidity requirement resides. Obligations of Individual Annuity, Individual Life and private placement life insurance products will be generally funded by both Hartford Life Insurance Company and Hartford Life and Annuity Insurance Company; obligations of Retirement Plans and institutional investment products will be generally funded by Hartford Life Insurance Company; and obligations of the Company’s international annuity subsidiary and affiliate will be generally funded by the legal entity in the country in which the obligation was generated.
53
Federal Home Loan Bank of Boston
The Company became a member of the Federal Home Loan Bank of Boston (“FHLBB”) in May 2011. Membership allows the Company access to collateralized advances, which may be used to support various spread-based business and enhance liquidity management. The Connecticut Department of Insurance (“CTDOI”) will permit the Company to pledge up to $1.48 billion in qualifying assets to secure FHLBB advances for 2012. The amount of advances that can be taken are dependent on the asset types pledged to secure the advances. The pledge limit is recalculated annually based on statutory admitted assets and capital and surplus. The Company would need to seek the prior approval of the CTDOI if there were a desire to exceed these limits. As of December 31, 2011, the Company had no advances outstanding under the FHLBB facility.
| Contractholder Obligations |
As
of December 31, 2011 |
|||
| Total Contractholder obligations |
$ | 202,949 | ||
| Less: Separate account assets [1] |
(143,859 | ) | ||
| International statutory separate accounts [1] |
(1,929 | ) | ||
|
|
|
|||
| General account contractholder obligations |
$ | 57,161 | ||
|
|
|
|||
| Composition of General Account Contractholder Obligations |
||||
| Contracts without a surrender provision and/or fixed payout dates [2] |
$ | 28,909 | ||
| Fixed MVA annuities [3] |
9,727 | |||
| International fixed MVA annuities |
2,642 | |||
| Guaranteed investment contracts (“GIC”) [4] |
567 | |||
| Other [5] |
15,316 | |||
|
|
|
|||
| General account contractholder obligations |
$ | 57,161 | ||
|
|
|
|||
| [1] | In the event customers elect to surrender separate account assets or international statutory separate accounts, the Company will use the proceeds from the sale of the assets to fund the surrender, and the Company’s liquidity position will not be impacted. In many instances the Company will receive a percentage of the surrender charge, increasing the Company’s liquidity position. In addition, a surrender of variable annuity separate account or general account assets will decrease the Company’s obligation for payments on guaranteed living and death benefits. |
| [2] | Relates to contracts such as payout annuities or institutional notes, other than guaranteed investment products with an MVA feature (discussed below) or surrenders of term life, group benefit contracts or death and living benefit reserves for which surrenders will have no current effect on the Company’s liquidity requirements. |
| [3] | Relates to annuities that are held in a statutory separate account, but under U.S. GAAP are recorded in the general account as Fixed MVA annuity contract holders are subject to the Company’s credit risk. In the statutory separate account, the Company is required to maintain invested assets with a fair value equal to the MVA surrender value of the Fixed MVA contract. In the event assets decline in value at a greater rate than the MVA surrender value of the Fixed MVA contract, the Company is required to contribute additional capital to the statutory separate account. The Company will fund these required contributions with operating cash flows or short-term investments. In the event that operating cash flows or short-term investments are not sufficient to fund required contributions, the Company may have to sell other invested assets at a loss, potentially resulting in a decrease in statutory surplus. As the fair value of invested assets in the statutory separate account are generally equal to the MVA surrender value of the Fixed MVA contract, surrender of Fixed MVA annuities will have an insignificant impact on the liquidity requirements of the Company. |
| [4] | GICs are subject to discontinuance provisions which allow the policyholders to terminate their contracts prior to scheduled maturity at the lesser of the book value or market value. Generally, the market value adjustment reflects changes in interest rates and credit spreads. As a result, the market value adjustment feature in the GIC serves to protect the Company from interest rate risks and limit the Company’s liquidity requirements in the event of a surrender. |
| [5] | Surrenders of, or policy loans taken from, as applicable, these general account liabilities, which include the general account option for Individual Annuity individual variable annuities and Life Insurance’s variable life contracts, the general account option for Retirement Plans’ annuities and universal life contracts sold by Life Insurance may be funded through operating cash flows of the Company, available short-term investments, or the Company may be required to sell fixed maturity investments to fund the surrender payment. Sales of fixed maturity investments could result in the recognition of significant realized losses and insufficient proceeds to fully fund the surrender amount. In this circumstance, the Company may need to take other actions, including enforcing certain contract provisions which could restrict surrenders and/or slow or defer payouts. |
54
Consumer Notes
The Company issued consumer notes through its Retail Investor Notes Program prior to 2009. A consumer note is an investment product distributed through broker-dealers directly to retail investors as medium-term, publicly traded fixed or floating rate, or a combination of fixed and floating rate, notes. Consumer notes are part of the Company’s spread-based business and proceeds are used to purchase investment products, primarily fixed rate bonds. Proceeds are not used for general operating purposes. Consumer notes maturities may extend up to 30 years and have contractual coupons based upon varying interest rates or indexes (e.g. consumer price index) and may include a call provision that allows the Company to extinguish the notes prior to its scheduled maturity date. Certain Consumer notes may be redeemed by the holder in the event of death. Redemptions are subject to certain limitations, including calendar year aggregate and individual limits. The aggregate limit is equal to the greater of $1 or 1% of the aggregate principal amount of the notes as of the end of the prior year. The individual limit is $250 thousand per individual. Derivative instruments are utilized to hedge the Company’s exposure to market risks in accordance with Company policy.
As of December 31, 2011, these consumer notes have interest rates ranging from 4% to 5% for fixed notes and, for variable notes, based on December 31, 2011 rates, either consumer price index plus 100 to 260 basis points, or indexed to the S&P 500, Dow Jones Industrials, foreign currency, or the Nikkei 225. The aggregate maturities of Consumer Notes are as follows: $155 in 2012, $78 in 2013, $13 in 2014, $30 in 2015, $18 in 2016 and $20 thereafter. For 2011, 2010 and 2009, interest credited to holders of consumer notes was $15, $25 and $51, respectively.
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
The following table identifies the Company’s contractual obligations as of December 31, 2011:
| Payments due by period | ||||||||||||||||||||
| Total | Less than 1 year |
1-3 years |
3-5 years |
More than 5 years |
||||||||||||||||
| Life and annuity obligations [1] |
$ | 287,842 | $ | 19,275 | $ | 25,158 | $ | 22,097 | $ | 221,312 | ||||||||||
| Operating lease obligations [2] |
52 | 15 | 20 | 10 | 7 | |||||||||||||||
| Consumer notes [3] |
348 | 168 | 104 | 55 | 21 | |||||||||||||||
| Purchase obligations [4] |
1,504 | 1,170 | 242 | 85 | 7 | |||||||||||||||
| Other long-term liabilities |
2,358 | 1,884 | 331 | 143 | — | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Total |
$ | 292,104 | $ | 22,512 | $ | 25,855 | $ | 22,390 | $ | 221,347 | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| [1] | Estimated life and annuity obligations include death claims, other charges associated with policyholder reserves, policy surrenders and policyholder dividends, offset by expected future deposits on in-force contracts. Estimated life and annuity obligations are based on mortality, morbidity and lapse assumptions comparable with the Company’s historical experience, modified for recent observed trends. The Company has also assumed market growth and interest crediting consistent with other assumptions. In contrast to this table, the majority of the Company’s obligations are recorded on the balance sheet at the current account values and do not incorporate an expectation of future market growth, interest crediting, or future deposits. Therefore, the estimated obligations presented in this table significantly exceed the liabilities recorded in reserve for future policy benefits and unpaid loss and loss adjustment expenses, other policyholder funds and benefits payable and separate account liabilities. Due to the significance of the assumptions used, the amounts presented could materially differ from actual results. |
| [2] | Includes future minimum lease payments on operating lease agreements. See Note 10 of the Notes to Consolidated Financial Statements for additional discussion on lease commitments. |
| [3] | Consumer notes include principal payments, contractual interest for fixed rate notes and, interest based on current rates for floating rate notes. See Note 12 of the Notes to Consolidated Financial Statements for additional discussion of consumer notes. |
| [4] | Included in purchase obligations is $310 relating to contractual commitments to purchase various goods and services such as maintenance, human resources, information technology, and transportation in the normal course of business. Purchase obligations exclude contracts that are cancelable without penalty or contracts that do not specify minimum levels of goods or services to be purchased. |
55
Dividends
Dividends to the Company from its insurance subsidiaries are restricted, as is the ability of the Company to pay dividends to its parent company. Future dividend decisions will be based on, and affected by, a number of factors, including the operating results and financial requirements of the Company on a stand-alone basis and the impact of regulatory restrictions.
The payment of dividends by Connecticut-domiciled insurers is limited under the insurance holding company laws of Connecticut. These laws require notice to and approval by the state insurance commissioner for the declaration or payment of any dividend, which, together with other dividends or distributions made within the preceding twelve months, exceeds the greater of (i) 10% of the insurer’s policyholder surplus as of December 31 of the preceding year or (ii) net income (or net gain from operations, if such company is a life insurance company) for the twelve-month period ending on the thirty-first day of December last preceding, in each case determined under statutory insurance accounting principles. In addition, if any dividend of a Connecticut-domiciled insurer exceeds the insurer’s earned surplus, it requires the prior approval of the Connecticut Insurance Commissioner. The insurance holding company laws of the other jurisdictions in which the Company’s insurance subsidiaries are incorporated (or deemed commercially domiciled) generally contain similar (although in certain instances somewhat more restrictive) limitations on the payment of dividends.
The Company’s subsidiaries are permitted to pay up to a maximum of approximately $399 in dividends in 2012 without prior approval from the applicable insurance commissioner. In 2011, the Company received dividends of $7 from its subsidiaries. With respect to dividends to its parent, the Company’s dividend limitation under the holding company laws of Connecticut is $592 in 2012. However, because the Company’s earned surplus is negative as of December 31, 2011, the Company will not be permitted to pay any dividends to its parent in 2012 without prior approval from the Connecticut Insurance Commissioner. In 2011, the Company did not pay dividends to its parent company.
Cash Flows
| 2011 | 2010 | |||||||
| Net cash provided by operating activities |
$ | 3,008 | $ | 1,882 | ||||
| Net cash provided by (used for) investing activities |
$ | (2,128 | ) | $ | 209 | |||
| Net cash used for financing activities |
$ | (225 | ) | $ | (2,363 | ) | ||
| Cash — End of Year |
$ | 1,183 | $ | 531 | ||||
Year ended December 31, 2011 compared to Year-ended December 31, 2010
Net cash provided by operating activities increased due to the settlement of a modified coinsurance agreement with an affiliated captive reinsurer.
Net cash used for investing activities in 2011 primarily relates to net payments of available-for-sale securities of $1.4 billion, net payments of mortgage loans of $914, partially offset by net receipts on derivatives of $938. Net cash provided by investing activities in 2010 primarily relates to net proceeds from sales of mortgage loans of $1.1 billion, partially offset by net purchases of available-for-sale securities of $241 and net payments on derivatives of $664.
Net cash used for financing activities in 2011 primarily relates to net outflows on investment and universal life-type contracts of $157 and repayments of consumer notes of $68. Net cash used for financing activities in 2010 primarily relates to net outflows on investment and universal life-type contracts of $1.4 billion and repayments of consumer notes of $754.
Operating cash flows in both periods have been more than adequate to meet liquidity requirements.
Equity Markets
For a discussion of the potential impact of the equity markets on capital and liquidity, see the Financial Risk on Statutory Capital and Liquidity Risk section in this MD&A.
Ratings
Ratings impact the Company’s cost of borrowing and its ability to access financing and are an important factor in establishing 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 Company’s cost of borrowing and ability to access financing, as well as the level of revenues or the persistency of its business may be adversely impacted.
56
The following table summarizes Hartford Life Insurance Company’s and it’s wholly-owned subsidiary Hartford Life and Annuity Insurance Company’s financial ratings from the major independent rating organizations as of February 17, 2012:
| Insurance Financial Strength Ratings: |
A.M. Best | Fitch | Standard & Poor’s | Moody’s | ||||||||||||
| Hartford Life Insurance Company |
A | A- | A | A3 | ||||||||||||
| Hartford Life and Annuity Insurance Company |
A | A- | A | A3 | ||||||||||||
These ratings are not a recommendation to buy or hold any of the Company’s securities and they may be revised or revoked at any time at the sole discretion of the rating organization.
The agencies consider many factors in determining the final rating of an insurance company. One consideration is the relative level of statutory surplus necessary to support the business written. Statutory surplus represents the capital of the insurance company reported in accordance with accounting practices prescribed by the applicable state insurance department. See Part I, Item 1A. Risk Factors — “Downgrades in our finanicial strength or credit ratings, which may make our products less attractive, could increase our cost of capital and inhibit out ability to refinance our debt, which would have a material adverse effect on our business, financial condition, results of operations and liquidity.”
Statutory Capital
The Company’s stockholder’s equity, as prepared using U.S. GAAP, was $9.7 billion as of December 31, 2011. The Company’s estimated aggregate statutory capital and surplus, as prepared in accordance with the National Association of Insurance Commissioners’ Accounting Practices and Procedures Manual (“U.S. STAT”), was $5.9 billion as of December 31, 2011.
Significant differences between U.S. GAAP stockholder’s equity and aggregate statutory capital and surplus prepared in accordance with U.S. STAT include the following:
| • | Costs incurred by the Company to acquire insurance policies are deferred under US GAAP while those costs are expensed immediately under US STAT. |
| • | Temporary differences between the book and tax basis of an asset or liability which are recorded as deferred tax assets are evaluated for recoverability under US GAAP while those amounts deferred are subject to limitations under US STAT. |
| • | The assumptions used in the determination of benefit reserves is prescribed under US STAT, while the assumptions used under US GAAP are generally the Company’s best estimates. The methodologies for determining life insurance reserve amounts may also be different. For example, reserving for living benefit reserves under US STAT is generally addressed by the Commissioners’ Annuity Reserving Valuation Methodology and the related Actuarial Guidelines, while under US GAAP, those same living benefits may be considered embedded derivatives and recorded at fair value or they may be considered SOP 03-1 reserves. The sensitivity of these life insurance reserves to changes in equity markets, as applicable, will be different between US GAAP and US STAT. |
| • | The difference between the amortized cost and fair value of fixed maturity and other investments, net of tax, is recorded as an increase or decrease to the carrying value of the related asset and to equity under US GAAP, while US STAT only records certain securities at fair value, such as equity securities and certain lower rated bonds required by the NAIC to be recorded at the lower of amortized cost or fair value. In the case of the Company’s market value adjusted (MVA) fixed annuity products, invested assets are marked to fair value (including the impact of audit spreads) and liabilities are marked to fair value (but generally excluding the impacts of credit spreads) for statutory purposes only. In the case of the Company’s market value adjusted (MVA) fixed annuity products, invested assets are marked to fair value (but generally actual credit spreads are not fully reflected) for statutory purposes only. |
| • | US STAT for life insurance companies establishes a formula reserve for realized and unrealized losses due to default and equity risks associated with certain invested assets (the Asset Valuation Reserve), while US GAAP does not. Also, for those realized gains and losses caused by changes in interest rates, US STAT for life insurance companies defers and amortizes the gains and losses, caused by changes in interest rates, into income over the original life to maturity of the asset sold (the Interest Maintenance Reserve) while US GAAP does not. |
| • | Goodwill arising from the acquisition of a business is tested for recoverability on an annual basis (or more frequently, as necessary) for US GAAP, while under US STAT goodwill is amortized over a period not to exceed 10 years and the amount of goodwill is limited. |
In addition, certain assets, including a portion of premiums receivable and fixed assets, are non-admitted (recorded at zero value and charged against surplus) under US STAT. US GAAP generally evaluates assets based on their recoverability.
In 2010 The Hartford entered into an intercompany liquidity agreement that allows for short-term advances of funds among the HFSG Holding Company and certain Connecticut domiciled insurers, including Hartford Life Insurance Company, of up to $2.0 billion for liquidity and other general corporate purposes. The Connecticut Insurance Department granted approval for these insurance companies to treat receivables from a parent as admitted assets for statutory accounting.
57
Risk-based Capital
State insurance regulators and the NAIC have adopted risk-based capital requirements for life insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks. The requirements provide a means of measuring the minimum amount of statutory surplus appropriate for an insurance company to support its overall business operations based on its size and risk profile. Under risk-based capital (“RBC”) requirements, a company’s RBC is calculated by applying factors and performing calculations relating to various asset, premium, claim, expense and reserve items. The adequacy of a company’s actual capital is determined by the ratio of a company’s total adjusted capital, as defined by the insurance regulators, to its company action level of RBC (known as the RBC ratio), also as defined by insurance regulators. RBC standards are used by regulators to set in motion appropriate regulatory actions related to insurers that show indications of inadequate conditions. In addition, the rating agencies view RBC ratios along with their proprietary models as factors in making ratings determinations.
Contingencies
Legal Proceedings — For a discussion regarding contingencies related to the Company’s legal proceedings, please see Item 3, “Legal Proceedings”.
For further information on other contingencies, see Note 10 of Notes to Consolidated Financial Statements.
Legislative Initiatives
On February 13, 2012, the Obama Administration released its “FY 2013, Budget of the United States Government” (the “Budget”). Although the Administration has not released proposed statutory language, the Budget includes proposals which if enacted, would affect the taxation of life insurance companies and certain life insurance products. In particular, the proposals would affect the treatment of corporate owned life insurance (“COLI”) policies by limiting the availability of certain interest deductions for companies that purchase those policies. The proposals would also change the method used to determine the amount of dividend income received by a life insurance company on assets held in separate accounts used to support products, including variable life insurance and variable annuity contracts, that are eligible for the dividends received deduction (“DRD”). The DRD reduces the amount of dividend income subject to tax and is a significant component of the difference between the Company’s actual tax expense and expected amount determined using the federal statutory tax rate of 35%. If proposals of this type were enacted, the Company’s sale of variable annuities and variable life products and its profits on COLI policies could be adversely affected and the Company’s actual tax expense could increase, reducing earnings.
Guaranty Fund and Other Insurance-related Assessments
For a discussion regarding Guaranty Fund and Other Insurance-related Assessments, see Note 10 of the Notes to Consolidated Financial Statements.
IMPACT OF NEW ACCOUNTING STANDARDS
For a discussion of accounting standards, see Note 1 of Notes to Consolidated Financial Statements.
| Item 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK |
The information required by this item is set forth in the Capital Markets Risk Management section of Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and is incorporated herein by reference.
| Item 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
See Index to Consolidated Financial Statements and Schedules elsewhere herein.
| Item 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
None.
| Item 9A. | CONTROLS AND PROCEDURES |
Evaluation of disclosure controls and procedures
The Company’s principal executive officer and its principal financial officer, based on their evaluation of the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) have concluded that the Company’s disclosure controls and procedures are effective for the purposes set forth in the definition thereof in Exchange Act Rule 13a-15(e) as of December 31, 2011.
58
Management’s annual report on internal control over financial reporting
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting for the Company as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. A company’s internal control over financial reporting includes policies and procedures that (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company’s management assessed its internal controls over financial reporting as of December 31, 2011 in relation to criteria for effective internal control over financial reporting described in “Internal Control — Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment under those criteria, The Company’s management concluded that its internal control over financial reporting was effective as of December 31, 2011.
This annual report does not include an attestation report of the company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
Changes in internal control over financial reporting
There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s fourth fiscal quarter of 2011 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
| Item 9B. | OTHER INFORMATION |
None.
| Item 10. | DIRECTORS, AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE OF HARTFORD LIFE INSURANCE COMPANY |
Omitted pursuant to General Instruction I(2)(c) of Form 10-K.
| Item 11. | EXECUTIVE COMPENSATION |
Omitted pursuant to General Instruction I(2)(c) of Form 10-K.
| Item 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS |
Omitted pursuant to General Instruction I(2)(c) of Form 10-K.
| Item 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE |
Omitted pursuant to General Instruction I(2)(c) of Form 10-K.
59
| Item 14. | PRINCIPAL ACCOUNTING FEES AND SERVICES |
The following table presents fees for professional services rendered by Deloitte & Touche LLP, the member firms of Deloitte Touche Tohmatsu, and their respective affiliates (collectively, the “Deloitte Entities”) for the audit of the Company’s annual financial statements, audit-related services, tax services and all other services for the years ended December 31, 2011 and 2010.
| Year
Ended December 31, 2011 |
Year
Ended December 31, 2010 |
|||||||
| (1) Audit fees |
$ | 10,384,856 | $ | 9,766,032 | ||||
| (2) Audit-related fees(a) |
424,198 | 707,026 | ||||||
| (3) Tax fees(b) |
— | 12,200 | ||||||
| (4) All other fees(c) |
270,000 | 267,081 | ||||||
|
|
|
|
|
|||||
| Total |
$ | 11,079,054 | $ | 10,752,339 | ||||
|
|
|
|
|
|||||
| (a) | Fees for the years ended December 31, 2011 and 2010 principally consisted of internal control reviews. |
| (b) | Fees for the year ended December 31, 2010 principally consisted of international tax compliance services and tax examination assistance. |
| (c) | Fees for the year ended December 31, 2011 principally consisted of an enterprise risk management project and an investment related controls project. Fees for the year ended December 31, 2010 consisted of an enterprise risk management project. |
The Hartford’s Audit Committee (the “Committee”) concluded that the provision of the non-audit services provided to The Hartford by the Deloitte Entities during 2011 and 2010 was compatible with maintaining the Deloitte Entities’ independence.
The Committee has established policies requiring pre-approval of audit and non-audit services provided by the independent registered public accounting firm. The policies require that the Committee pre-approve specifically described audit, and audit-related services, annually. For the annual pre-approval, the Committee approves categories of audit services, audit-related services and related fee budgets. For all pre-approvals, the Committee considers whether such services are consistent with the rules of the SEC and the Public Company Accounting Oversight Board on auditor independence. The independent registered public accounting firm and management report to the Committee on a timely basis regarding the services rendered by and actual fees paid to the independent registered public accounting firm to ensure that such services are within the limits approved by the Committee. The Committee’s policies require specific pre-approval of all tax services, internal control-related services and all other permitted services on an individual project basis. As provided by the Committee’s policies, the Committee has delegated to its Chairman the authority to address any requests for pre-approval of services between Committee meetings, up to a maximum of $100,000 for non-tax services and up to a maximum of $5,000 for tax services. The Chairman must report any pre-approvals to the full Committee at its next scheduled meeting.
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) Documents filed as a part of this report:
| (1) | Consolidated Financial Statements. See Index to Consolidated Financial Statements and Schedules elsewhere herein. |
| (2) | Consolidated Financial Statement Schedules. See Index to Consolidated Financial Statement and Schedules elsewhere herein. |
| (3) | Exhibits. See Exhibit Index elsewhere herein. |
60
HARTFORD LIFE INSURANCE COMPANY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholder of
Hartford Life Insurance Company
Hartford, Connecticut
We have audited the accompanying consolidated balance sheets of Hartford Life Insurance Company and subsidiaries (the “Company”) as of December 31, 2011 and 2010, and the related consolidated statements of operations, changes in equity, and cash flows for each of the three years in the period ended December 31, 2011. Our audits also included the consolidated financial statement schedules listed in the Index at Item 15. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Hartford Life Insurance Company and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
As discussed in Note 1 of the consolidated financial statements, the Company changed its method of accounting and reporting for variable interest entities and embedded credit derivatives as required by accounting guidance adopted in 2010 and for other-than-temporary impairments as required by accounting guidance adopted in 2009.
DELOITTE & TOUCHE LLP
Hartford, Connecticut
February 24, 2012
F-2
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
Consolidated Statements of Operations
| For the years ended December 31, | ||||||||||||
| (In millions) |
2011 | 2010 | 2009 | |||||||||
| Revenues |
||||||||||||
| Fee income and other |
$ | 3,802 | $ | 3,806 | $ | 3,723 | ||||||
| Earned premiums |
234 | 260 | 377 | |||||||||
| Net investment income (loss) |
||||||||||||
| Securities available-for-sale and other |
2,580 | 2,621 | 2,505 | |||||||||
| Equity securities, trading |
(14 | ) | 238 | 343 | ||||||||
|
|
|
|
|
|
|
|||||||
| Total net investment income |
2,566 | 2,859 | 2,848 | |||||||||
| Net realized capital gains (losses): |
||||||||||||
| Total other-than-temporary impairment (“OTTI”) losses |
(196 | ) | (712 | ) | (1,722 | ) | ||||||
| OTTI losses recognized in other comprehensive income |
71 | 376 | 530 | |||||||||
|
|
|
|
|
|
|
|||||||
| Net OTTI losses recognized in earnings |
(125 | ) | (336 | ) | (1,192 | ) | ||||||
| Net realized capital gains (losses), excluding net OTTI losses recognized in earnings |
126 | (608 | ) | 316 | ||||||||
|
|
|
|
|
|
|
|||||||
| Total net realized capital gains (losses) |
1 | (944 | ) | (876 | ) | |||||||
|
|
|
|
|
|
|
|||||||
| Total revenues |
6,603 | 5,981 | 6,072 | |||||||||
|
|
|
|
|
|
|
|||||||
| Benefits, losses and expenses |
||||||||||||
| Benefits, loss and loss adjustment expenses |
3,107 | 2,948 | 3,716 | |||||||||
| Benefits, loss and loss adjustment expenses – returns credited on international unit-linked bonds and pension products |
(14 | ) | 238 | 343 | ||||||||
| Amortization of deferred policy acquisition costs and present value of future profits |
616 | 215 | 3,716 | |||||||||
| Insurance operating costs and other expenses |
2,896 | 1,610 | 1,826 | |||||||||
| Dividends to policyholders |
17 | 21 | 12 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total benefits, losses and expenses |
6,622 | 5,032 | 9,613 | |||||||||
|
|
|
|
|
|
|
|||||||
| Income (loss) from continuing operations before income taxes |
(19 | ) | 949 | (3,541 | ) | |||||||
| Income tax expense (benefit) |
(263 | ) | 228 | (1,399 | ) | |||||||
|
|
|
|
|
|
|
|||||||
| Income (loss) from continuing operations, net of tax |
244 | 721 | (2,142 | ) | ||||||||
| Income (loss) from discontinued operations, net of tax |
— | 31 | (5 | ) | ||||||||
|
|
|
|
|
|
|
|||||||
| Net income (loss) |
244 | 752 | (2,147 | ) | ||||||||
| Net income attributable to the noncontrolling interest |
— | 8 | 10 | |||||||||
|
|
|
|
|
|
|
|||||||
| Net income (loss) attributable to Hartford Life Insurance Company |
$ | 244 | $ | 744 | $ | (2,157 | ) | |||||
|
|
|
|
|
|
|
|||||||
See Notes to Consolidated Financial Statements.
F-3
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Loss)
| For the years ended December 31, | ||||||||||||
| (In millions) |
2011 | 2010 | 2009 | |||||||||
| Comprehensive Income (Loss) |
||||||||||||
| Net income (loss) |
$ | 244 | $ | 744 | $ | (2,157 | ) | |||||
|
|
|
|
|
|
|
|||||||
| Other comprehensive income (loss) [1] |
||||||||||||
| Change in net unrealized gain/loss on securities [2] |
1,100 | 1,298 | 3,229 | |||||||||
| Change in net gain/loss on cash-flow hedging instruments |
103 | 117 | (292 | ) | ||||||||
| Change in foreign currency translation adjustments |
(2 | ) | (18 | ) | 115 | |||||||
|
|
|
|
|
|
|
|||||||
| Total other comprehensive income |
1,201 | 1,397 | 3,052 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total comprehensive income |
$ | 1,445 | $ | 2,141 | $ | 895 | ||||||
|
|
|
|
|
|
|
|||||||
| [1] | Net change in unrealized capital gain on securities is reflected net of tax benefit and other items of $713, $(699) and $(1,739) for the years ended December 31, 2011, 2010 and 2009, respectively. Net gain (loss) on cash flow hedging instruments is net of tax provision (benefit) of $(55), $(63) and $157 for the years ended December 31, 2011, 2010 and 2009, respectively. There is no tax effect on cumulative translation adjustments. |
| [2] | There were reclassification adjustments for after-tax gains (losses) realized in net income of $52, $(121) and $(1,076) for the years ended December 31, 2011, 2010 and 2009, respectively. |
See Notes to Consolidated Financial Statements.
F-4
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
| As of December 31, | ||||||||
| (In millions, except for share data) |
2011 | 2010 | ||||||
| Assets |
||||||||
| Investments: |
||||||||
| Fixed maturities, available-for-sale, at fair value (amortized cost of $46,236 and $45,323) (includes variable interest entity assets, at fair value, of $153 and $406) |
$ | 47,778 | $ | 44,834 | ||||
| Fixed maturities, at fair value using the fair value option (includes variable interest entity assets, at fair value, of $338 and $323) |
1,317 | 639 | ||||||
| Equity securities, trading, at fair value (cost of $1,860 and $2,061) |
1,967 | 2,279 | ||||||
| Equity securities, available for sale, at fair value (cost of $443 and $320) |
398 | 340 | ||||||
| Mortgage loans (net of allowances for loan losses of $23 and $62) |
4,182 | 3,244 | ||||||
| Policy loans, at outstanding balance |
1,952 | 2,128 | ||||||
| Limited partnership and other alternative investments (includes variable interest entity assets of $7 and $14) |
1,376 | 838 | ||||||
| Other investments |
1,974 | 1,461 | ||||||
| Short-term investments |
3,882 | 3,489 | ||||||
|
|
|
|
|
|||||
| Total investments |
64,826 | 59,252 | ||||||
| Cash |
1,183 | 531 | ||||||
| Premiums receivable and agents’ balances |
64 | 67 | ||||||
| Reinsurance recoverables |
5,006 | 3,924 | ||||||
| Deferred policy acquisition costs and present value of future profits |
4,598 | 4,949 | ||||||
| Deferred income taxes, net |
1,606 | 2,138 | ||||||
| Goodwill |
470 | 470 | ||||||
| Other assets |
925 | 692 | ||||||
| Separate account assets |
143,859 | 159,729 | ||||||
|
|
|
|
|
|||||
| Total assets |
$ | 222,537 | $ | 231,752 | ||||
|
|
|
|
|
|||||
| Liabilities |
||||||||
| Reserve for future policy benefits and unpaid losses and loss adjustment expenses |
11,831 | $ | 11, 385 | |||||
| Other policyholder funds and benefits payable |
45,016 | 43,395 | ||||||
| Other policyholder funds and benefits payable – international unit-linked bonds and pension products |
1,929 | 2,252 | ||||||
| Consumer notes |
314 | 382 | ||||||
| Other liabilities (includes variable interest entity liabilities of $477 and $422) |
9,927 | 6,398 | ||||||
| Separate account liabilities |
143,859 | 159,729 | ||||||
|
|
|
|
|
|||||
| Total liabilities |
$ | 212,876 | $ | 223,541 | ||||
| Commitments and Contingencies (Note 10) |
||||||||
| Stockholder’s Equity |
||||||||
| Common stock — 1,000 shares authorized, issued and outstanding, par value $5,690 |
6 | 6 | ||||||
| Additional paid-in capital |
8,271 | 8,265 | ||||||
| Accumulated other comprehensive income (loss), net of tax |
829 | (372 | ) | |||||
| Retained earnings |
555 | 312 | ||||||
|
|
|
|
|
|||||
| Total stockholder’s equity |
9,661 | 8,211 | ||||||
|
|
|
|
|
|||||
| Total liabilities and stockholder’s equity |
$ | 222,537 | $ | 231,752 | ||||
|
|
|
|
|
|||||
See Notes to Consolidated Financial Statements.
F-5
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
Consolidated Statements of Changes in Equity
| (In millions) |
Common Stock |
Additional Paid-In Capital |
Accumulated Other Comprehensive Income (Loss) |
Retained Earnings (Deficit) |
Non- Controlling Interest |
Total Stockholder’s Equity |
||||||||||||||||||
| Balance, December 31, 2010 |
$ | 6 | $ | 8,265 | $ | (372 | ) | $ | 312 | $ | — | $ | 8,211 | |||||||||||
| Capital contributions from parent |
— | 6 | — | — | — | 6 | ||||||||||||||||||
| Dividends declared |
— | — | — | (1 | ) | — | (1 | ) | ||||||||||||||||
| Net income |
— | — | — | 244 | — | 244 | ||||||||||||||||||
| Total other comprehensive income |
— | — | 1,201 | — | — | 1,201 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Balance December 31, 2011 |
$ | 6 | $ | 8,271 | $ | 829 | $ | 555 | $ | — | $ | 9,661 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Balance, December 31, 2009 |
$ | 6 | $ | 8,457 | $ | (1,941 | ) | $ | (287 | ) | $ | 61 | $ | 6,296 | ||||||||||
| Cumulative effect of accounting changes, net of DAC and tax |
— | — | 172 | (146 | ) | — | 26 | |||||||||||||||||
| Capital contributions from parent |
— | (192 | ) | — | — | — | (192 | ) | ||||||||||||||||
| Dividends declared |
— | — | — | 1 | — | 1 | ||||||||||||||||||
| Change in noncontrolling interest ownership |
— | — | — | — | (69 | ) | (69 | ) | ||||||||||||||||
| Net income |
— | — | — | 744 | 8 | 752 | ||||||||||||||||||
| Total other comprehensive income |
— | — | 1,397 | — | — | 1,397 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Balance December 31, 2010 |
$ | 6 | $ | 8,265 | $ | (372 | ) | $ | 312 | $ | — | $ | 8,211 | |||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Balance, December 31, 2008 |
$ | 6 | $ | 6,157 | $ | (4,531 | ) | $ | 1,446 | $ | 165 | $ | 3,243 | |||||||||||
| Cumulative effect of accounting changes, net of DAC and tax |
— | — | (462 | ) | 462 | — | — | |||||||||||||||||
| Capital contributions from parent (1) |
— | 2,300 | — | — | — | 2,300 | ||||||||||||||||||
| Dividends declared |
— | — | — | (38 | ) | — | (38 | ) | ||||||||||||||||
| Change in noncontrolling interest ownership |
— | — | — | — | (114 | ) | (114 | ) | ||||||||||||||||
| Net loss |
— | — | — | (2,157 | ) | 10 | (2,147 | ) | ||||||||||||||||
| Total other comprehensive income |
— | — | 3,052 | — | — | 3,052 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Balance December 31, 2009 |
$ | 6 | $ | 8,457 | $ | (1,941 | ) | $ | (287 | ) | $ | 61 | $ | 6,296 | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| (1) | For the year ended December 31, 2009, the Company received $2.1 billion in capital contributions from its parent and returned capital of $700 to its parent. The Company received noncash capital contributions of $887 as a result of valuations associated with the October 1, 2009 reinsurance transaction with an affiliated captive reinsurer. Refer to Note 16 of the Notes to Consolidated Financial Statements. |
See Notes to Consolidated Financial Statements
F-6
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
Consolidated Statements of Cash Flows
| For the years ended December 31, | ||||||||||||
| (In millions) |
2011 | 2010 | 2009 | |||||||||
| Operating Activities |
||||||||||||
| Net income (loss) |
$ | 244 | $ | 752 | $ | (2,147 | ) | |||||
| Adjustments to reconcile net income(loss) to net cash provided by operating activities |
||||||||||||
| Amortization of deferred policy acquisition costs and present value of future profits |
616 | 232 | 3,727 | |||||||||
| Additions to deferred policy acquisition costs and present value of future profits |
(533 | ) | (521 | ) | (674 | ) | ||||||
| Change in: |
||||||||||||
| Reserve for future policy benefits and unpaid losses and loss adjustment expenses |
252 | 13 | 574 | |||||||||
| Reinsurance recoverables |
57 | 26 | 66 | |||||||||
| Receivables and other assets |
9 | (112 | ) | (20 | ) | |||||||
| Payables and accruals |
2,402 | 295 | 420 | |||||||||
| Accrued and deferred income taxes |
(115 | ) | (90 | ) | (797 | ) | ||||||
| Net realized capital losses |
1 | 882 | 877 | |||||||||
| Net receipts (disbursements) from investment contracts related to policyholder funds – international unit-linked bonds and pension products |
(323 | ) | (167 | ) | 804 | |||||||
| Net (increase) decrease in equity securities, trading |
312 | 164 | (809 | ) | ||||||||
| Depreciation and amortization |
194 | 207 | 173 | |||||||||
| Other, net |
(108 | ) | 201 | 328 | ||||||||
|
|
|
|
|
|
|
|||||||
| Net cash provided by operating activities |
$ | 3,008 | $ | 1,882 | $ | 2,522 | ||||||
| Investing Activities |
||||||||||||
| Proceeds from the sale/maturity/prepayment of: |
||||||||||||
| Fixed maturities and short-term investments, available-for-sale |
$ | 19,203 | $ | 28,581 | $ | 37,224 | ||||||
| Fixed maturities, fair value option |
37 | 20 | — | |||||||||
| Equity securities, available-for-sale |
147 | 171 | 162 | |||||||||
| Mortgage loans |
332 | 1,288 | 413 | |||||||||
| Partnerships |
128 | 151 | 173 | |||||||||
| Payments for the purchase of: |
||||||||||||
| Fixed maturities and short-term investments, available-for-sale |
(20,517 | ) | (28,871 | ) | (35,519 | ) | ||||||
| Fixed maturities, fair value option |
(661 | ) | (74 | ) | — | |||||||
| Equity securities, available-for-sale |
(230 | ) | (122 | ) | (61 | ) | ||||||
| Mortgage loans |
(1,246 | ) | (189 | ) | (197 | ) | ||||||
| Partnerships |
(436 | ) | (172 | ) | (121 | ) | ||||||
| Proceeds from business sold |
— | 241 | — | |||||||||
| Derivatives payments (sales), net |
938 | (644 | ) | (520 | ) | |||||||
| Change in policy loans, net |
176 | (8 | ) | 34 | ||||||||
| Change in payables for collateral under securities lending, net |
— | (46 | ) | (1,805 | ) | |||||||
| Change in all other, net |
1 | (117 | ) | 25 | ||||||||
|
|
|
|
|
|
|
|||||||
| Net cash provided by (used for) investing activities |
$ | (2,128 | ) | $ | 209 | $ | (192 | ) | ||||
| Financing Activities |
||||||||||||
| Deposits and other additions to investment and universal life-type contracts |
$ | 12,124 | $ | 15,405 | $ | 13,398 | ||||||
| Withdrawals and other deductions from investment and universal life-type contracts |
(22,720 | ) | (25,030 | ) | (23,487 | ) | ||||||
| Net transfers from (to) separate accounts related to investment and universal life-type contracts |
10,439 | 8,211 | 6,805 | |||||||||
| Net repayments at maturity or settlement of consumer notes |
(68 | ) | (754 | ) | (74 | ) | ||||||
| Issuance of structured financing |
— | — | (189 | ) | ||||||||
| Capital contributions (1) (2) |
— | (195 | ) | 1,397 | ||||||||
| Dividends paid (1) |
— | — | (33 | ) | ||||||||
|
|
|
|
|
|
|
|||||||
| Net cash used for financing activities |
$ | (225 | ) | $ | (2,363 | ) | $ | (2,183 | ) | |||
| Foreign exchange rate effect on cash |
(3 | ) | 10 | (15 | ) | |||||||
| Net increase (decrease) in cash |
652 | (262 | ) | 132 | ||||||||
| Cash — beginning of year |
531 | 793 | 661 | |||||||||
|
|
|
|
|
|
|
|||||||
| Cash — end of year |
$ | 1,183 | $ | 531 | $ | 793 | ||||||
|
|
|
|
|
|
|
|||||||
| Supplemental Disclosure of Cash Flow Information: |
||||||||||||
| Net cash paid (received) during the year for income taxes |
$ | (105 | ) | $ | 354 | $ | (282 | ) | ||||
| Supplemental | schedule of noncash operating and financing activities: |
| (1) | The Company made noncash dividends of $5 in 2009 related to the assumed reinsurance agreements with Hartford Life Insurance K.K. |
| (2) | The Company received noncash capital contributions of $887 as a result of valuations associated with an October 1, 2009 reinsurance transaction with an affiliated captive reinsurer. Refer to Note 16 of the Notes to Consolidated Financial Statements for further discussion of this transaction. |
See Notes to Consolidated Financial Statements.
F-7
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in millions, unless otherwise stated)
1. Basis of Presentation and Accounting Policies
Basis of Presentation
Hartford Life Insurance Company (together with its subsidiaries, “HLIC”, “Company”, “we” or “our”) is a provider of insurance and investment products in the United States (“U.S.”) and is a wholly-owned subsidiary of Hartford Life and Accident Insurance Company (“HLA”). The Hartford Financial Services Group, Inc. (“The Hartford”) is the ultimate parent of the Company.
The Consolidated Financial Statements have been prepared on the basis of accounting principles generally accepted in the United States of America (“U.S. GAAP”), which differ materially from the accounting practices prescribed by various insurance regulatory authorities.
Consolidation
The Consolidated Financial Statements include the accounts of HLIC, companies in which the Company directly or indirectly has a controlling financial interest and those variable interest entities (“VIEs”) in which the Company is required to consolidate. Entities in which HLIC has significant influence over the operating and financing decisions but are not required to consolidate are reported using the equity method. For further discussions on VIEs, see Note 4 of the Notes to Consolidated Financial Statements. Material intercompany transactions and balances between HLIC and its subsidiaries have been eliminated.
Discontinued Operations
The results of operations of a component of the Company that either has been disposed of or is classified as held-for-sale are reported in discontinued operations if the operations and cash flows of the component have been or will be eliminated from the ongoing operations of the Company as a result of the disposal transaction and the Company will not have any significant continuing involvement in the operations of the component after the disposal transaction.
The Company is presenting the operations of certain businesses that meet the criteria for reporting as discontinued operations. Amounts for prior periods have been retrospectively reclassified. See Note 19 of the Notes to Consolidated Financial Statements for information on the specific subsidiaries and related impacts.
Use of Estimates
The preparation of financial statements, in conformity with U.S. GAAP, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The most significant estimates include those used in determining estimated gross profits used in the valuation and amortization of assets and liabilities associated with variable annuity and other universal life-type contracts; evaluation of other-than-temporary impairments on available-for-sale securities and valuation allowances on investments; living benefits required to be fair valued; goodwill impairment; valuation of investments and derivative instruments; valuation allowance on deferred tax assets; and contingencies relating to corporate litigation and regulatory matters. Certain of these estimates are particularly sensitive to market conditions, and deterioration and/or volatility in the worldwide debt or equity markets could have a material impact on the Consolidated Financial Statements.
Mutual Funds
The Company maintains a retail mutual fund operation whereby the Company, through wholly-owned subsidiaries, provides investment management and administrative services to The Hartford Mutual Funds, Inc. and The Hartford Mutual Funds II, Inc. (collectively, “mutual funds”), consisting of 57 non-proprietary mutual funds, as of December 31, 2011. The Company charges fees to these mutual funds, which are recorded as revenue by the Company. These mutual funds are registered with the Securities and Exchange Commission (“SEC”) under the Investment Company Act of 1940. The mutual funds are owned by the shareholders of those funds and not by the Company. In the fourth quarter of 2011, the Company entered into a preferred partnership agreement with Wellington Management Company, LLP (“Wellington Management”) and announced that Wellington Management will serve as the sole sub-advisor for The Hartford’s non-proprietary mutual funds, including equity and fixed income funds, pending a fund-by-fund review by The Hartford’s mutual funds board of directors. As of December 31, 2011, Wellington Management served as the sub-advisor for 29 of The Hartford’s non-proprietary mutual funds and has been the primary manager for the Company’s equity funds.
The mutual funds are owned by the shareholders of those funds and not by the Company. As such, the mutual fund assets and liabilities and related investment returns are not reflected in the Company’s Consolidated Financial Statements since they are not assets, liabilities and operations of the Company.
Reclassifications
Certain reclassifications have been made to prior year financial information to conform to the current year presentation.
F-8
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
1. Basis of Presentation and Accounting Policies (continued)
Future Adoption of New Accounting Standards
Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts
In October 2010, the FASB issued a standard clarifying the definition of acquisition costs that are eligible for deferral. Acquisition costs are to include only those costs that are directly related to the successful acquisition or renewal of insurance contracts; incremental direct costs of contract acquisition that are incurred in transactions with either independent third parties or employees; and advertising costs meeting the capitalization criteria for direct-response advertising.
This standard will be effective for fiscal years beginning after December 15, 2011, and interim periods within those years. This standard may be applied prospectively upon the date of adoption, with retrospective application permitted, but not required. Early adoption as of the beginning of a fiscal year is permitted.
The Company elected to adopt this standard retrospectively on January 1, 2012, resulting in a write down of the Company’s deferred acquisition costs relating to those costs which no longer meet the revised standard as summarized above. The Company estimates the cumulative effect of the retrospective adoption of this standard, when reflected in future financial statements, will reduce stockholders’ equity as of December 31, 2011 by approximately $750, after-tax and decrease 2011 net income by approximately $15. Excluding the effects of DAC Unlock and amortization related to realized gains and losses, the estimated effect would be a decrease to 2011 net income of approximately $50. Future income statement impacts will reflect higher non-deferrable expenses and lower amortization due to the lower DAC balance, before the effect of any DAC Unlock and amortization related to realized gains and losses.
Significant Accounting Policies
The Company’s significant accounting policies are described below or are referenced below to the applicable Note where the description is included.
| Accounting Policy |
Note | |||
| Fair Value Measurements |
3 | |||
| Investments and Derivative Instruments |
4 | |||
| Reinsurance |
5 | |||
| Deferred Policy Acquisition Costs and Present Value of Future Profits |
6 | |||
| Goodwill and Other Intangible Assets |
7 | |||
| Separate Accounts, Death Benefits and Other Insurance Benefit Features |
8 | |||
| Sales Inducements |
9 | |||
| Commitments and Contingencies |
10 | |||
| Income Taxes |
11 | |||
Revenue Recognition
For investment and universal life-type contracts, the amounts collected from policyholders are considered deposits and are not included in revenue. Fee income for universal life-type contracts consists of policy charges for policy administration, cost of insurance charges and surrender charges assessed against policyholders’ account balances and are recognized in the period in which services are provided. For the Company’s traditional life and group disability products premiums are recognized as revenue when due from policyholders.
Dividends to Policyholders
Policyholder dividends are paid to certain life insurance policyholders. Policies that receive dividends are referred to as participating policies. Such dividends are accrued using an estimate of the amount to be paid based on underlying contractual obligations under policies and applicable state laws.
Participating policies were 2%, 3% and 3% of the total life insurance policies as of December 31, 2011, 2010, and 2009, respectively. Dividends to policyholders were $17, $21 and $12 for the years ended December 31, 2011, 2010, and 2009, respectively. There were no additional amounts of income allocated to participating policyholders. If limitations exist on the amount of net income from participating life insurance contracts that may be distributed to stockholder’s, the policyholder’s share of net income on those contracts that cannot be distributed is excluded from stockholder’s equity by a charge to operations and a credit to a liability.
Cash
Cash represents cash on hand and demand deposits with banks or other financial institutions.
F-9
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
1. Basis of Presentation and Accounting Policies (continued)
Other Policyholder Funds and Benefits Payable
The Company has classified its fixed and variable annuities, 401(k), certain governmental annuities, private placement life insurance (“PPLI”), variable universal life insurance, universal life insurance and interest sensitive whole life insurance as universal life-type contracts. The liability for universal life-type contracts is equal to the balance that accrues to the benefit of the policyholders as of the financial statement date (commonly referred to as the account value), 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.
The Company has classified its institutional and governmental products, without life contingencies, including funding agreements, certain structured settlements and guaranteed investment contracts, as investment contracts. The liability for investment contracts is equal to the balance that accrues to the benefit of the contract holder as of the financial statement date, which includes the accumulation of deposits plus credited interest, less withdrawals and amounts assessed through the financial statement date. Contract holder funds include funding agreements held by Variable Interest Entities issuing medium-term notes.
Reserve for Future Policy Benefits and Unpaid Losses and Loss Adjustment
Liabilities for the Company’s group life and disability contracts as well its individual term life insurance policies include amounts for unpaid losses and future policy benefits. Liabilities for unpaid losses include estimates of amounts to fully settle known reported claims as well as claims related to insured events that the Company estimates have been incurred but have not yet been reported. Liabilities for future policy benefits are calculated by the net level premium method using interest, withdrawal and mortality assumptions appropriate at the time the policies were issued. The methods used in determining the liability for unpaid losses and future policy benefits are standard actuarial methods recognized by the American Academy of Actuaries. For the tabular reserves, discount rates are based on the Company’s earned investment yield and the morbidity/mortality tables used are standard industry tables modified to reflect the Company’s actual experience when appropriate. In particular, for the Company’s group disability known claim reserves, the morbidity table for the early durations of claim is based exclusively on the Company’s experience, incorporating factors such as gender, elimination period and diagnosis. These reserves are computed such that they are expected to meet the Company’s future policy obligations. Future policy benefits 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 and, as such, provisions for adverse deviation are built into the long-tailed liability assumptions.
Certain contracts classified as universal life-type may also include additional death or other insurance benefit features, such as guaranteed minimum death benefits offered with variable annuity contracts and no lapse guarantees offered with universal life insurance contracts. An additional liability is established for these benefits by estimating the expected present value of the benefits in excess of the projected account value in proportion to the present value of total expected assessments. Excess benefits are accrued as a liability as actual assessments are recorded. Determination of the expected value of excess benefits and assessments are based on a range of scenarios and assumptions including those related to market rates of return and volatility, contract surrender rates and mortality experience. Revisions to assumptions are made consistent with the Company’s process for a DAC unlock. For further information, see MD&A, Critical Accounting Estimates, Life Deferred Policy Acquisition Costs and Present Value of Future Benefits.
Foreign Currency Translation
Foreign currency translation gains and losses are reflected in stockholders’ equity as a component of accumulated other comprehensive income. The Company’s foreign subsidiaries’ balance sheet accounts are translated at the exchange rates in effect at each year end and income statement accounts are translated at the average rates of exchange prevailing during the year. The national currencies of the international operations are generally their functional currencies.
F-10
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
2. Segment Information
The Company has five reporting segments: Individual Annuity, Individual Life, Retirement Plans, Mutual Funds and Runoff Operations, as well as an Other category, as follows:
Individual Annuity
Individual Annuity offers variable, fixed market value adjusted (“MVA”), fixed index and single premium immediate annuities and longevity assurance to individuals.
Individual Life
Individual Life sells a variety of life insurance products, including variable universal life, universal life, and term life.
Retirement Plans
Retirement Plans provides products and services to corporations pursuant to Section 401(k) of the Internal Revenue Service Code of 1986 as amended (“the Code”) and products and services to municipalities and not-for-profit organizations under Sections 457 and 403(b) of the Code, collectively referred to as government plans.
Mutual Funds
Mutual Funds offers retail mutual funds, investment-only mutual funds and college savings plans under Section 529 of the Code (collectively referred to as non-proprietary) and proprietary mutual funds supporting the insurance products issued by The Hartford.
Runoff Operations
Runoff Operations consists of the international annuity business of the former Global Annuity reporting segment as well as certain product offerings previously included in the former Global Annuity and Life Insurance reporting segments. Runoff Operations encompasses the administration of investment retirement savings and other insurance and savings products to individuals and groups outside of the U.S., primarily in Japan and Europe, as well institutional investment products and private placement life insurance. In addition, Runoff Operations includes direct and assumed guaranteed minimum income benefit (“GMIB”), guaranteed minimum death benefit (“GMDB”), guaranteed minimum accumulation benefit (“GMAB”) and guaranteed minimum withdrawal benefit (“GMWB”) which is subsequently ceded to an affiliated captive reinsurer.
Other
The Company includes in an Other category corporate items not directly allocated to any of its reporting segments, intersegment eliminations, and certain group benefit products, including group life and group disability insurance that is directly written by the Company and for which nearly half is ceded to its parent, Hartford Life and Accident Insurance Company (“HLA”).
The accounting policies of the reporting segments are the same as those described in the summary of significant accounting policies in Note 1. The Company evaluates performance of its segments based on revenues, net income and the segment’s return on allocated capital. Each operating segment is allocated corporate surplus as needed to support its business.
The Company charges direct operating expenses to the appropriate segment and allocates the majority of indirect expenses to the segments based on an intercompany expense arrangement. Inter-segment revenues primarily occur between the Company’s Other category and the reporting segments. These amounts primarily include interest income on allocated surplus and interest charges on excess separate account surplus. Consolidated net investment income is unaffected by such transactions.
The following tables represent summarized financial information concerning the Company’s reporting segments.
| As of December 31, | ||||||||
| Assets |
2011 | 2010 | ||||||
| Individual Annuity |
$ | 87,245 | $ | 99,482 | ||||
| Individual Life |
17,456 | 15,911 | ||||||
| Retirement Plans |
35,410 | 34,153 | ||||||
| Mutual Funds |
182 | 153 | ||||||
| Runoff Operations |
79,658 | 78,905 | ||||||
| Other |
2,586 | 3,148 | ||||||
|
|
|
|
|
|||||
| Total assets |
$ | 222,537 | $ | 231,752 | ||||
|
|
|
|
|
|||||
F-11
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
2. Segment Information (continued)
| For the years ended December 31, | ||||||||||||
| Revenues by Product Line |
2011 | 2010 | 2009 | |||||||||
| Earned premiums, fees, and other considerations |
||||||||||||
| Individual Annuity |
||||||||||||
| Individual variable annuity |
$ | 1,595 | $ | 1,707 | $ | 1,551 | ||||||
| Fixed / MVA and other annuity |
56 | 14 | (2 | ) | ||||||||
|
|
|
|
|
|
|
|||||||
| Total Individual Annuity |
1,651 | 1,721 | 1,549 | |||||||||
| Individual Life |
||||||||||||
| Variable life |
396 | 416 | 503 | |||||||||
| Universal life |
429 | 367 | 362 | |||||||||
| Term life |
33 | 36 | 37 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total Individual Life |
858 | 819 | 902 | |||||||||
| Retirement Plans |
||||||||||||
| 401(k) |
332 | 318 | 286 | |||||||||
| Government plans |
48 | 41 | 38 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total Retirement Plans |
380 | 359 | 324 | |||||||||
| Mutual Funds |
||||||||||||
| Non-Proprietary |
511 | 519 | 437 | |||||||||
| Proprietary |
58 | 61 | — | |||||||||
|
|
|
|
|
|
|
|||||||
| Total Mutual Funds |
569 | 580 | 437 | |||||||||
|
|
|
|
|
|
|
|||||||
| Runoff Operations |
221 | 254 | 549 | |||||||||
|
|
|
|
|
|
|
|||||||
| Other |
357 | 333 | 339 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total premiums, fees, and other considerations |
4,036 | 4,066 | 4,100 | |||||||||
|
|
|
|
|
|
|
|||||||
| Net investment income |
2,566 | 2,859 | 2,848 | |||||||||
| Net realized capital losses |
1 | (944 | ) | (876 | ) | |||||||
|
|
|
|
|
|
|
|||||||
| Total Revenues |
$ | 6,603 | $ | 5,981 | $ | 6,072 | ||||||
|
|
|
|
|
|
|
|||||||
| Net income (loss) attributable to Hartford Life Insurance Company |
||||||||||||
| Individual Annuity |
$ | 87 | $ | 371 | $ | (1,962 | ) | |||||
| Individual Life |
104 | 195 | 8 | |||||||||
| Retirement Plans |
15 | 47 | (222 | ) | ||||||||
| Mutual Funds |
98 | 129 | 32 | |||||||||
| Runoff Operations |
(20 | ) | (78 | ) | 77 | |||||||
| Other |
(40 | ) | 80 | (90 | ) | |||||||
|
|
|
|
|
|
|
|||||||
| Total net income (loss) |
$ | 244 | $ | 744 | $ | (2,157 | ) | |||||
|
|
|
|
|
|
|
|||||||
| Net investment income (loss) |
||||||||||||
| Individual Annuity |
$ | 769 | $ | 813 | $ | 770 | ||||||
| Individual Life |
420 | 362 | 304 | |||||||||
| Retirement Plans |
396 | 364 | 315 | |||||||||
| Mutual Funds |
1 | (1 | ) | (16 | ) | |||||||
| Runoff Operations |
941 | 1,221 | 1,279 | |||||||||
| Other |
39 | 100 | 196 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total net investment income |
$ | 2,566 | $ | 2,859 | $ | 2,848 | ||||||
|
|
|
|
|
|
|
|||||||
| Amortization of deferred policy acquisition and present value of future profits |
||||||||||||
| Individual Annuity |
$ | 186 | $ | (39 | ) | $ | 3,189 | |||||
| Individual Life |
219 | 120 | 312 | |||||||||
| Retirement Plans |
134 | 27 | 56 | |||||||||
| Mutual Funds |
47 | 51 | 50 | |||||||||
| Runoff Operations |
30 | 56 | 111 | |||||||||
| Other |
— | — | (2 | ) | ||||||||
|
|
|
|
|
|
|
|||||||
| Total amortization of DAC |
$ | 616 | $ | 215 | $ | 3,716 | ||||||
|
|
|
|
|
|
|
|||||||
F-12
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
2. Segment Information (continued)
| For the years ended December 31, | ||||||||||||
| Income tax expense (benefit) |
2011 | 2010 | 2009 | |||||||||
| Individual Annuity |
$ | (220 | ) | $ | 41 | $ | (1,299 | ) | ||||
| Individual Life |
22 | 93 | (27 | ) | ||||||||
| Retirement Plans |
(45 | ) | 13 | (143 | ) | |||||||
| Mutual Funds |
52 | 51 | 20 | |||||||||
| Runoff Operations |
(48 | ) | 10 | 80 | ||||||||
| Other |
(24 | ) | 20 | (30 | ) | |||||||
|
|
|
|
|
|
|
|||||||
| Total income tax expense (benefit) |
$ | (263 | ) | $ | 228 | $ | (1,399 | ) | ||||
|
|
|
|
|
|
|
|||||||
3. Fair Value Measurements
The following financial instruments are carried at fair value in the Company’s Consolidated Financial Statements: fixed maturity and equity securities, available-for-sale (“AFS”), fixed maturities at fair value using fair value option (“FVO”); equity securities, trading; short-term investments; freestanding and embedded derivatives; separate account assets; and certain other liabilities. The following section applies the fair value hierarchy and disclosure requirements for the Company’s financial instruments that are carried at fair value. The fair value hierarchy prioritizes the inputs in the valuation techniques used to measure fair value into three broad Levels (Level 1, 2 and 3).
| Level 1 | Observable inputs that reflect quoted prices for identical assets or liabilities in active markets that the Company has the ability to access at the measurement date. Level 1 securities include highly liquid U.S. Treasuries, money market funds, and exchange traded equity and derivative securities. |
| Level 2 | Observable inputs, other than quoted prices included in Level 1, for the asset or liability or prices for similar assets and liabilities. Most fixed maturities and preferred stocks are model priced by vendors using observable inputs and are classified within Level 2. |
| Level 3 | Valuations that are derived from techniques in which one or more of the significant inputs are unobservable (including assumptions about risk). Level 3 securities include less liquid securities, guaranteed product embedded and reinsurance derivatives and other complex derivatives securities. Because Level 3 fair values, by their nature, contain unobservable inputs as there is little or no observable market for these assets and liabilities, considerable judgment is used to determine the Level 3 fair values. Level 3 fair values represent the Company’s best estimate of an amount that could be realized in a current market exchange absent actual market exchanges. |
In many situations, inputs used to measure the fair value of an asset or liability position may fall into different levels of the fair value hierarchy. In these situations, the Company will determine the level in which the fair value falls based upon the lowest level input that is significant to the determination of the fair value. Transfers of securities among the levels occur at the beginning of the reporting period. Transfers between Level 1 and Level 2 were not material for the year ended December 31, 2011. In most cases, both observable (e.g., changes in interest rates) and unobservable (e.g., changes in risk assumptions) inputs are used in the determination of fair values that the Company has classified within Level 3. Consequently, these values and the related gains and losses are based upon both observable and unobservable inputs. The Company’s fixed maturities included in Level 3 are classified as such because these securities are primarily priced by independent brokers and/or within illiquid markets.
F-13
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Fair Value Measurements (continued)
| December 31, 2011 | ||||||||||||||||
| Total | Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
|||||||||||||
| Assets accounted for at fair value on a recurring basis |
||||||||||||||||
| Fixed maturities, AFS |
||||||||||||||||
| ABS |
$ | 2,093 | $ | — | $ | 1,776 | $ | 317 | ||||||||
| CDOs |
1,798 | — | 1,470 | 328 | ||||||||||||
| CMBS |
4,269 | — | 3,921 | 348 | ||||||||||||
| Corporate |
30,229 | — | 28,732 | 1,497 | ||||||||||||
| Foreign government/government agencies |
1,224 | — | 1,187 | 37 | ||||||||||||
| States, municipalities and political subdivisions (“Municipal”) |
1,557 | — | 1,175 | 382 | ||||||||||||
| RMBS |
3,823 | — | 2,890 | 933 | ||||||||||||
| U.S. Treasuries |
2,785 | 487 | 2,298 | — | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total fixed maturities |
47,778 | 487 | 43,449 | 3,842 | ||||||||||||
| Fixed maturities, FVO |
1,317 | — | 833 | 484 | ||||||||||||
| Equity securities, trading |
1,967 | 1,967 | — | — | ||||||||||||
| Equity securities, AFS |
398 | 227 | 115 | 56 | ||||||||||||
| Derivative assets Credit derivatives |
(27 | ) | — | (6 | ) | (21 | ) | |||||||||
| Equity derivatives |
31 | — | — | 31 | ||||||||||||
| Foreign exchange derivatives |
505 | — | 505 | — | ||||||||||||
| Interest rate derivatives |
78 | — | 38 | 40 | ||||||||||||
| U.S. GMWB hedging instruments |
494 | — | 11 | 483 | ||||||||||||
| U.S. macro hedge program |
357 | — | — | 357 | ||||||||||||
| International program hedging instruments |
533 | — | 567 | (34 | ) | |||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total derivative assets [1] |
1,971 | — | 1,115 | 856 | ||||||||||||
| Short-term investments |
3,882 | 520 | 3,362 | — | ||||||||||||
| Reinsurance recoverable for U.S. GMWB and Japan GMWB, GMIB, and GMAB |
3,073 | — | — | 3,073 | ||||||||||||
| Separate account assets [2] |
139,421 | 101,633 | 36,757 | 1,031 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total assets accounted for at fair value on a recurring basis |
$ | 199,807 | 104,834 | 85,631 | 9,342 | |||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Liabilities accounted for at fair value on a recurring basis |
||||||||||||||||
| Other policyholder funds and benefits payable |
||||||||||||||||
| Guaranteed living benefits |
$ | (5,776 | ) | $ | — | $ | — | $ | (5,776 | ) | ||||||
| Equity linked notes |
(9 | ) | — | — | (9 | ) | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total other policyholder funds and benefits payable |
(5,785 | ) | — | — | (5,785 | ) | ||||||||||
| Derivative liabilities Credit derivatives |
(493 | ) | — | (25 | ) | (468 | ) | |||||||||
| Equity derivatives |
5 | — | — | 5 | ||||||||||||
| Foreign exchange derivatives |
140 | — | 140 | — | ||||||||||||
| Interest rate derivatives |
(315 | ) | — | (184 | ) | (131 | ) | |||||||||
| U.S. GMWB hedging instruments |
400 | — | — | 400 | ||||||||||||
| International program hedging instruments |
9 | — | 10 | (1 | ) | |||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total derivative liabilities [3] |
(254 | ) | — | (59 | ) | (195 | ) | |||||||||
| Other liabilities |
(9 | ) | — | — | (9 | ) | ||||||||||
| Consumer notes [4] |
(4 | ) | — | — | (4 | ) | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total liabilities accounted for at fair value on a recurring basis |
$ | (6,052 | ) | $ | — | $ | (59 | ) | $ | (5,993 | ) | |||||
|
|
|
|
|
|
|
|
|
|||||||||
F-14
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Fair Value Measurements (continued)
| December 31, 2010 | ||||||||||||||||
| Total | Quoted Prices in Active Markets for Identical Assets (Level 1) |
Significant Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
|||||||||||||
| Assets accounted for at fair value on a recurring basis |
||||||||||||||||
| Fixed maturities, AFS |
||||||||||||||||
| ABS |
$ | 2,068 | $ | — | $ | 1,660 | $ | 408 | ||||||||
| CDOs |
1,899 | — | 30 | 1,869 | ||||||||||||
| CMBS |
5,028 | — | 4,536 | 492 | ||||||||||||
| Corporate |
26,915 | — | 25,429 | 1,486 | ||||||||||||
| Foreign government/government agencies |
1,002 | — | 962 | 40 | ||||||||||||
| Municipal |
1,032 | — | 774 | 258 | ||||||||||||
| RMBS |
4,118 | — | 3,013 | 1,105 | ||||||||||||
| U.S. Treasuries |
2,772 | 248 | 2,524 | — | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total fixed maturities |
44,834 | 248 | 38,928 | 5,658 | ||||||||||||
| Fixed maturities, FVO |
639 | — | 128 | 511 | ||||||||||||
| Equity securities, trading |
2,279 | 2,279 | — | — | ||||||||||||
| Equity securities, AFS |
340 | 174 | 119 | 47 | ||||||||||||
| Derivative assets Credit derivatives |
(11 | ) | — | (19 | ) | 8 | ||||||||||
| Equity derivatives |
2 | — | — | 2 | ||||||||||||
| Foreign exchange derivatives |
784 | — | 784 | — | ||||||||||||
| Interest rate derivatives |
(99 | ) | — | (63 | ) | (36 | ) | |||||||||
| U.S. GMWB hedging instruments |
339 | — | (122 | ) | 461 | |||||||||||
| U.S. macro hedge program |
203 | — | — | 203 | ||||||||||||
| International program hedging instruments |
235 | 2 | 228 | 5 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total derivative assets [1] |
1,453 | 2 | 808 | 643 | ||||||||||||
| Short-term investments |
3,489 | 204 | 3,285 | — | ||||||||||||
| Reinsurance recoverable for U.S. GMWB and Japan GMWB, GMIB, and GMAB |
2,002 | — | — | 2,002 | ||||||||||||
| Separate account assets [2] |
153,713 | 116,703 | 35,763 | 1,247 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total assets accounted for at fair value on a recurring basis |
$ | 208,749 | 119,610 | 79,031 | 10,108 | |||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Liabilities accounted for at fair value on a recurring basis |
||||||||||||||||
| Other policyholder funds and benefits payable |
||||||||||||||||
| Guaranteed living benefits |
$ | (4,258 | ) | $ | — | $ | — | $ | (4,258 | ) | ||||||
| Equity linked notes |
(9 | ) | — | — | (9 | ) | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total other policyholder funds and benefits payable |
(4,267 | ) | — | — | (4,267 | ) | ||||||||||
| Derivative liabilities |
||||||||||||||||
| Credit derivatives |
(401 | ) | — | (49 | ) | (352 | ) | |||||||||
| Equity derivatives |
2 | — | — | 2 | ||||||||||||
| Foreign exchange derivatives |
(25 | ) | — | (25 | ) | — | ||||||||||
| Interest rate derivatives |
(59 | ) | — | (42 | ) | (17 | ) | |||||||||
| U.S. GMWB hedging instruments |
128 | — | (11 | ) | 139 | |||||||||||
| International program hedging instruments |
(2 | ) | (2 | ) | — | — | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total derivative liabilities [3] |
(357 | ) | (2 | ) | (127 | ) | (228 | ) | ||||||||
| Other liabilities |
(37 | ) | — | — | (37 | ) | ||||||||||
| Consumer notes [4] |
(5 | ) | — | — | (5 | ) | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total liabilities accounted for at fair value on a recurring basis |
$ | (4,666 | ) | $ | (2 | ) | $ | (127 | ) | $ | (4,537 | ) | ||||
|
|
|
|
|
|
|
|
|
|||||||||
| [1] | Includes over-the-counter derivative instruments in a net asset value position which may require the counterparty to pledge collateral to the Company. At December 31, 2011 and 2010, $1.4 billion and $962, respectively was the amount of cash collateral liability that was netted against the derivative asset value on the Consolidated Balance Sheet, and is excluded from the table above. For further information on derivative liabilities, see below in this Note 3. |
| [2] | As of December 31, 2011 and 2010 excludes approximately $4 and $6 billion of investment sales receivable that are not subject to fair value accounting, respectively. |
| [3] | Includes over-the-counter derivative instruments in a net negative market value position (derivative liability). In the Level 3 roll forward table included below in this Note, the derivative asset and liability are referred to as “freestanding derivatives” and are presented on a net basis. |
| [4] | Represents embedded derivatives associated with non-funding agreement-backed consumer equity-linked notes. |
F-15
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Fair Value Measurements (continued)
Determination of Fair Values
The valuation methodologies used to determine the fair values of assets and liabilities under the “exit price” notion, reflect market-participant objectives and are based on the application of the fair value hierarchy that prioritizes relevant observable market inputs over unobservable inputs. The Company determines the fair values of certain financial assets and financial liabilities based on quoted market prices where available and where prices represent a reasonable estimate of fair value. The Company also determines fair value based on future cash flows discounted at the appropriate current market rate. Fair values reflect adjustments for counterparty credit quality, the Company’s default spreads, liquidity and, where appropriate, risk margins on unobservable parameters. The following is a discussion of the methodologies used to determine fair values for the financial instruments listed in the above tables.
The fair valuation process is monitored by the Valuation Committee, which is a cross-functional group of senior management within HIMCO that meets at least quarterly. The Valuation Committee is co-chaired by the Heads of Investment Operations and Accounting, and has representation from various investment sector professionals, accounting, operations, legal, compliance and risk management. The purpose of the committee is to oversee the pricing policy and procedures by ensuring objective and reliable valuation practices and pricing of financial instruments, as well as addressing fair valuation issues and approving changes to valuation methodologies and pricing sources. There is also a Fair Value Working Group (“Working Group”) which includes the Heads of Investment Operations and Accounting, as well as other investment, operations, accounting and risk management professionals that meet monthly to review market data trends, pricing and trading statistics and results, and any proposed pricing methodology changes described in more detail in the following paragraphs.
Available-for-Sale Securities, Fixed Maturities, FVO, Equity Securities, Trading, and Short-term Investments
The fair value of AFS securities, fixed maturities, FVO, equity securities, trading, and short-term investments in an active and orderly market (e.g. not distressed or forced liquidation) are determined by management after considering one of three primary sources of information: third-party pricing services, independent broker quotations or pricing matrices. Security pricing is applied using a “waterfall” approach whereby publicly available prices are first sought from third-party pricing services, the remaining unpriced securities are submitted to independent brokers for prices, or lastly, securities are priced using a pricing matrix. Based on the typical trading volumes and the lack of quoted market prices for fixed maturities, third-party pricing services will normally derive the security prices from recent reported trades for identical or similar securities making adjustments through the reporting date based upon available market observable information as outlined above. If there are no recently reported trades, the third-party pricing services and independent brokers may use matrix or model processes to develop a security price where future cash flow expectations are developed based upon collateral performance and discounted at an estimated market rate. Included in the pricing of ABS and RMBS are estimates of the rate of future prepayments of principal over the remaining life of the securities. Such estimates are derived based on the characteristics of the underlying structure and prepayment speeds previously experienced at the interest rate levels projected for the underlying collateral. Actual prepayment experience may vary from these estimates.
Prices from third-party pricing services are often unavailable for securities that are rarely traded or are traded only in privately negotiated transactions. As a result, certain securities are priced via independent broker quotations which utilize inputs that may be difficult to corroborate with observable market based data. Additionally, the majority of these independent broker quotations are non-binding.
A pricing matrix is used to price private placement securities for which the Company is unable to obtain a price from a third-party pricing service by discounting the expected future cash flows from the security by a developed market discount rate utilizing current credit spreads. Credit spreads are developed each month using market based data for public securities adjusted for credit spread differentials between public and private securities which are obtained from a survey of multiple private placement brokers. The appropriate credit spreads determined through this survey approach are based upon the issuer’s financial strength and term to maturity, utilizing an independent public security index and trade information and adjusting for the non-public nature of the securities.
The Working Group performs a ongoing analysis of the prices and credit spreads received from third parties to ensure that the prices represent a reasonable estimate of the fair value. This process involves quantitative and qualitative analysis and is overseen by investment and accounting professionals. As a part of this analysis, the Company considers trading volume, new issuance activity and other factors to determine whether the market activity is significantly different than normal activity in an active market, and if so, whether transactions may not be orderly considering the weight of available evidence. If the available evidence indicates that pricing is based upon transactions that are stale or not orderly, the Company places little, if any, weight on the transaction price and will estimate fair value utilizing an internal pricing model. In addition, the Company ensures that prices received from independent brokers represent a reasonable estimate of fair value through the use of internal and external cash flow models developed based on spreads, and when available, market indices. As a result of this analysis, if the Company determines that there is a more appropriate fair value based upon the available market data, the price received from the third party is adjusted accordingly and approved by the Valuation Committee. The Company’s internal pricing model utilizes the Company’s best estimate of expected future cash flows discounted at a rate of return that a market participant would require. The significant inputs to the model include, but are not limited to, current market inputs, such as credit loss assumptions, estimated prepayment speeds and market risk premiums.
F-16
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Fair Value Measurements (continued)
The Company conducts other specific activities to monitor controls around pricing. Daily analyses identify price changes over 3-5%, sale trade prices that differ over 3% from the prior day’s price and purchase trade prices that differ more than 3% from the current day’s price. Weekly analyses identify prices that differ more than 5% from published bond prices of a corporate bond index. Monthly analyses identify price changes over 3%, prices that haven’t changed, missing prices and second source validation on most sectors. Analyses are conducted by a dedicated pricing unit who follows up with trading and investment sector professionals and challenges prices with vendors when the estimated assumptions used differ from what the Company feels a market participant would use. Any changes from the identified pricing source are verified by further confirmation of assumptions used. Examples of other procedures performed include, but are not limited to, initial and on-going review of third-party pricing services’ methodologies, review of pricing statistics and trends and back testing recent trades. For a sample of structured securities, a comparison of the vendor’s assumptions to our internal econometric models is also performed; any differences are challenged in accordance with the process described above.
The Company has analyzed the third-party pricing services’ valuation methodologies and related inputs, and has also evaluated the various types of securities in its investment portfolio to determine an appropriate fair value hierarchy level based upon trading activity and the observability of market inputs. Most prices provided by third-party pricing services are classified into Level 2 because the inputs used in pricing the securities are market observable. Due to a general lack of transparency in the process that brokers use to develop prices, most valuations that are based on brokers’ prices are classified as Level 3. Some valuations may be classified as Level 2 if the price can be corroborated with observable market data.
Derivative Instruments, including embedded derivatives within investments
Derivative instruments are fair valued using pricing valuation models; that utilize independent market data inputs, quoted market prices for exchange-traded derivatives, or independent broker quotations. Excluding embedded and reinsurance related derivatives, as of December 31, 2011 and 2010, 98% and 97%, respectively, of derivatives, based upon notional values, were priced by valuation models or quoted market prices. The remaining derivatives were priced by broker quotations. The Company performs a monthly analysis on derivative valuations which includes both quantitative and qualitative analysis. Examples of procedures performed include, but are not limited to, review of pricing statistics and trends, back testing recent trades, analyzing the impacts of changes in the market environment, and review of changes in market value for each derivative including those derivatives priced by brokers.
The Company performs various controls on derivative valuations which includes both quantitative and qualitative analysis. Analyses are conducted by a dedicated derivative pricing team that works directly with investment sector professionals to analyze impacts of changes in the market environment and investigate variances. There is a monthly analysis to identify market value changes greater than pre-defined thresholds, stale prices, missing prices and zero prices. Also on a monthly basis, a second source validation, typically to broker quotations, is performed for certain of the more complex derivatives, as well as for all new deals during the month. A model validation review is performed on any new models, which typically includes detailed documentation and validation to a second source. The model validation documentation and results of validation are presented to the Valuation Committee for approval. There is a monthly control to review changes in pricing sources to ensure that new models are not moved to production until formally approved.
The Company utilizes derivative instruments to manage the risk associated with certain assets and liabilities. However, the derivative instrument may not be classified with the same fair value hierarchy level as the associated assets and liabilities. Therefore the realized and unrealized gains and losses on derivatives reported in Level 3 may not reflect the offsetting impact of the realized and unrealized gains and losses of the associated assets and liabilities.
Valuation Techniques and Inputs for Investments
Generally, the Company determines the estimated fair value of its AFS securities, fixed maturities, FVO, equity securities, trading, and short-term investments using the market approach. The income approach is used for securities priced using a pricing matrix, as well as for derivative instruments. For Level 1 investments, which are comprised of on-the-run U.S. Treasuries, exchange-traded equity securities, short-term investments, and exchange traded futures and option contracts, valuations are based on observable inputs that reflect quoted prices for identical assets in active markets that the Company has the ability to access at the measurement date.
For most of the Company’s debt securities, the following inputs are typically used in the Company’s pricing methods: reported trades, benchmark yields, bids and/or estimated cash flows. For securities except U.S. Treasuries, inputs also include issuer spreads, which may consider credit default swaps. Derivative instruments are valued using mid-market inputs that are predominantly observable in the market.
F-17
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Fair Value Measurements (continued)
A description of additional inputs used in the Company’s Level 2 and Level 3 measurements is listed below:
| Level 2 | The fair values of most of the Company’s Level 2 investments are determined by management after considering prices received from third party pricing services. These investments include most fixed maturities and preferred stocks, including those reported in separate account assets. |
| • | ABS, CDOs, CMBS and RMBS – Primary inputs also include monthly payment information, collateral performance, which varies by vintage year and includes delinquency rates, collateral valuation loss severity rates, collateral refinancing assumptions, credit default swap indices and, for ABS and RMBS, estimated prepayment rates. |
| • | Corporates, including investment grade private placements – Primary inputs also include observations of credit default swap curves related to the issuer. |
| • | Foreign government/government agencies—Primary inputs also include observations of credit default swap curves related to the issuer and political events in emerging markets. |
| • | Municipals – Primary inputs also include Municipal Securities Rulemaking Board reported trades and material event notices, and issuer financial statements. |
| • | Short-term investments – Primary inputs also include material event notices and new issue money market rates. |
| • | Equity securities, trading – Consist of investments in mutual funds. Primary inputs include net asset values obtained from third party pricing services. |
| • | Credit derivatives – Significant inputs primarily include the swap yield curve and credit curves. |
| • | Foreign exchange derivatives – Significant inputs primarily include the swap yield curve, currency spot and forward rates, and cross currency basis curves. |
| • | Interest rate derivatives – Significant input is primarily the swap yield curve. |
| Level 3 | Most of the Company’s securities classified as Level 3 are valued based on brokers’ prices. This includes less liquid securities such as lower quality asset-backed securities (“ABS”), commercial mortgage-backed securities (“CMBS”), commercial real estate (“CRE”) CDOs and residential mortgage-backed securities (“RMBS”) primarily backed by below-prime loans. Primary inputs for these structured securities are consistent with the typical inputs used in Level 2 measurements noted above, but are Level 3 due to their illiquid markets. Additionally, certain long-dated securities are priced based on third party pricing services, including municipal securities, foreign government/government agencies, bank loans and below investment grade private placement securities. Primary inputs for these long-dated securities are consistent with the typical inputs used in Level 1 and Level 2 measurements noted above, but include benchmark interest rate or credit spread assumptions that are not observable in the marketplace. Also included in Level 3 are certain derivative instruments that either have significant unobservable inputs or are valued based on broker quotations. Significant inputs for these derivative contracts primarily include the typical inputs used in the Level 1 and Level 2 measurements noted above, but also may include the following: |
| • | Credit derivatives- Significant unobservable inputs may include credit correlation and swap yield curve and credit curve extrapolation beyond observable limits. |
| • | Equity derivatives – Significant unobservable inputs may include equity volatility. |
| • | Interest rate contracts – Significant unobservable inputs may include swap yield curve extrapolation beyond observable limits and interest rate volatility. |
Product Derivatives
The Company currently offers certain variable annuity products with GMWB rider in the U.S., and formerly offered GMWBs in the U.K. The Company has also assumed, through reinsurance from Hartford Life Insurance KK (“HLIKK”), a Japanese affiliate of the Company, GMIB, GMWB and GMAB. The Company has subsequently ceded certain GMWB rider liabilities and the assumed reinsurance from HLIKK to an affiliated captive reinsurer. The GMWB represents an embedded derivative in the variable annuity contract. When it is determined that (1) the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, and (2) a separate instrument with the same terms would qualify as a derivative instrument, the embedded derivative is bifurcated from the host for measurement purposes. The embedded derivative, which is reported with the host instrument in the Consolidated Balance Sheets, is carried at fair value with changes in fair value reported in net realized capital gains and losses. The Company’s GMWB liability is carried at fair value and reported in other policyholder funds.
F-18
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Fair Value Measurements (continued)
In valuing the embedded derivative, the Company attributes to the derivative a portion of the fees collected from the contract holder equal to the present value of future GMWB claims (the “Attributed Fees”). All changes in the fair value of the embedded derivative are recorded in net realized capital gains and losses. The excess of fees collected from the contract holder over the Attributed Fees are associated with the host variable annuity contract reported in fee income.
The reinsurance assumed on the HLIKK GMIB, GMWB, and GMAB and ceded to an affiliated captive reinsurer meets the characteristics of a free-standing derivative instrument. As a result, the derivative asset or liability is recorded at fair value with changes in the fair value reported in net realized capital gains and losses.
U.S. GMWB Ceded Reinsurance Derivative
The fair value of the U.S. GMWB reinsurance derivative is calculated as an aggregation of the components described in the Living Benefits Required to be Fair Valued discussion below and is modeled using significant unobservable policyholder behavior inputs, identical to those used in calculating the underlying liability, such as lapses, fund selection, resets and withdrawal utilization and risk margins.
During 2009, the Company entered into a reinsurance arrangement with an affiliated captive reinsurer to transfer a portion of its risk of loss associated with direct US GMWB and assumed HLIKK GMIB, GMWB, and GMAB. In addition, in 2010 the Company entered into reinsurance arrangements with the affiliated captive reinsurer to transfer its risk of loss associated with direct UK GMWB. These arrangements are recognized as a derivative and carried at fair value in reinsurance recoverables. Changes in the fair value of the reinsurance agreements are reported in net realized capital gains and losses. Please see Note 16 for more information on this transaction.
Separate Account Assets
Separate account assets are primarily invested in mutual funds but also have investments in fixed maturity and equity securities. The separate account investments are valued in the same manner, and using the same pricing sources and inputs, as the fixed maturity, equity security, and short-term investments of the Company.
Living Benefits Required to be Fair Valued (in Other Policyholder Funds and Benefits Payable)
Fair values for GMWB and guaranteed minimum accumulation benefit (“GMAB”) contracts are calculated using the income approach based upon internally developed models because active, observable markets do not exist for those items. The fair value of the Company’s guaranteed benefit liabilities, classified as embedded derivatives, and the related reinsurance and customized freestanding derivatives is calculated as an aggregation of the following components: Best Estimate Claims Costs calculated based on actuarial and capital market assumptions related to projected cash flows over the lives of the contracts; Credit Standing Adjustment; and Margins representing an amount that market participants would require for the risk that the Company’s assumptions about policyholder behavior could differ from actual experience. The resulting aggregation is reconciled or calibrated, if necessary, to market information that is, or may be, available to the Company, but may not be observable by other market participants, including reinsurance discussions and transactions. The Company believes the aggregation of these components, as necessary and as reconciled or calibrated to the market information available to the Company, results in an amount that the Company would be required to transfer or receive, for an asset, to or from market participants in an active liquid market, if one existed, for those market participants to assume the risks associated with the guaranteed minimum benefits and the related reinsurance and customized derivatives. The fair value is likely to materially diverge from the ultimate settlement of the liability as the Company believes settlement will be based on our best estimate assumptions rather than those best estimate assumptions plus risk margins. In the absence of any transfer of the guaranteed benefit liability to a third party, the release of risk margins is likely to be reflected as realized gains in future periods’ net income. Each component described below is unobservable in the marketplace and requires subjectivity by the Company in determining their value.
Best Estimate Claims Costs
The Best Estimate Claims Costs is calculated based on actuarial and capital market assumptions related to projected cash flows, including the present value of benefits and related contract charges, over the lives of the contracts, incorporating expectations concerning policyholder behavior such as lapses, fund selection, resets and withdrawal utilization (for the customized derivatives, policyholder behavior is prescribed in the derivative contract). Because of the dynamic and complex nature of these cash flows, best estimate assumptions and a Monte Carlo stochastic process involving the generation of thousands of scenarios that assume risk neutral returns consistent with swap rates and a blend of observable implied index volatility levels were used. Estimating these cash flows involves numerous estimates and subjective judgments including those regarding expected markets rates of return, market volatility, correlations of market index returns to funds, fund performance, discount rates and various actuarial assumptions for policyholder behavior which emerge over time.
F-19
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Fair Value Measurements (continued)
At each valuation date, the Company assumes expected returns based on:
| • | risk-free rates as represented by the Eurodollar futures, LIBOR deposits and swap rates to derive forward curve rates; |
| • | market implied volatility assumptions for each underlying index based primarily on a blend of observed market “implied volatility” data; |
| • | correlations of historical returns across underlying well known market indices based on actual observed returns over the ten years preceding the valuation date; and |
| • | three years of history for fund regression. |
As many guaranteed benefit obligations are relatively new in the marketplace, actual policyholder behavior experience is limited. As a result, estimates of future policyholder behavior are subjective and based on analogous internal and external data. As markets change, mature and evolve and actual policyholder behavior emerges, management continually evaluates the appropriateness of its assumptions for this component of the fair value model.
On a daily basis, the Company updates capital market assumptions used in the GMWB liability model such as interest rates, equity indices and the blend of implied equity index volatilities. The Company monitors various aspects of policyholder behavior and may modify certain of its assumptions, including living benefit lapses and withdrawal rates, if credible emerging data indicates that changes are warranted. At a minimum, all policyholder behavior assumptions are reviewed and updated, as appropriate, in conjunction with the completion of the Company’s comprehensive study to refine its estimate of future gross profits during the third quarter of each year.
Credit Standing Adjustment
This assumption makes an adjustment that market participants would make, in determining fair value, to reflect the risk that guaranteed benefit obligations or the GMWB reinsurance recoverables will not be fulfilled (“nonperformance risk”). As a result of sustained volatility in the Company’s credit default spreads, during 2009 the Company changed its estimate of the Credit Standing Adjustment to incorporate a blend of observable Company and reinsurer credit default spreads from capital markets, adjusted for market recoverability. Prior to the first quarter of 2009, the Company calculated the Credit Standing Adjustment by using default rates published by rating agencies, adjusted for market recoverability. For the year ended December 30, 2011, 2010 and 2009, the credit standing adjustment assumption, net of reinsurance and exclusive of the impact of the credit standing adjustment on other market sensitivities, resulted in pre-tax realized losses of $(156), $(8) and $(263), respectively.
Margins
The behavior risk margin adds a margin that market participants would require for the risk that the Company’s assumptions about policyholder behavior could differ from actual experience. The behavior risk margin is calculated by taking the difference between adverse policyholder behavior assumptions and best estimate assumptions.
Assumption updates, including policyholder behavior assumptions, affected best estimates and margins for a total pre-tax realized gains of approximately $13, $45 and $231 for the year ended December, 31, 2011, 2010 and 2009, respectively.
In addition to the non-market-based updates described above, the Company recognized non-market-based updates driven by the relative outperformance (underperformance) of the underlying actively managed funds as compared to their respective indices resulting in before-tax realized gains/(losses) of approximately $(18), $31 and $481 for the year ended December 31, 2011, 2010 and 2009, respectively.
F-20
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Fair Value Measurements (continued)
Assets and Liabilities Measured at Fair Value on a Recurring Basis Using Significant Unobservable Inputs (Level 3)
The tables below provide a fair value roll forward for the years ending December 31, 2011 and 2010, for the financial instruments classified as Level 3.
Roll-forward of Financial Instruments Measured at Fair Value on a Recurring Basis Using Significant Unobservable Inputs (Level 3) for twelve months from January 1, 2011 to December 31, 2011
| Fixed Maturities, AFS | ||||||||||||||||||||||||||||||||||||
| Assets |
ABS | CDOs | CMBS | Corporate | Foreign govt./govt. agencies |
Municipal | RMBS | Total Fixed Maturities, AFS |
Fixed Maturities, FVO |
|||||||||||||||||||||||||||
| Fair value as of January 1, 2011 |
$ | 408 | $ | 1,869 | $ | 492 | $ | 1,486 | $ | 40 | $ | 258 | $ | 1,105 | $ | 5,658 | $ | 511 | ||||||||||||||||||
| Total realized/unrealized gains (losses) |
||||||||||||||||||||||||||||||||||||
| Included in net income [2] |
(26 | ) | (30 | ) | 13 | (27 | ) | — | — | (21 | ) | (91 | ) | 23 | ||||||||||||||||||||||
| Included in OCI [3] |
18 | 112 | 41 | (14 | ) | — | 46 | (3 | ) | 200 | — | |||||||||||||||||||||||||
| Purchases |
35 | — | 18 | 83 | — | 87 | 25 | 248 | — | |||||||||||||||||||||||||||
| Settlements |
(32 | ) | (129 | ) | (72 | ) | (92 | ) | (3 | ) | — | (111 | ) | (439 | ) | (2 | ) | |||||||||||||||||||
| Sales |
(9 | ) | (54 | ) | (225 | ) | (122 | ) | — | — | (16 | ) | (426 | ) | (43 | ) | ||||||||||||||||||||
| Transfers into Level 3 [4] |
79 | 30 | 131 | 498 | 29 | — | 69 | 836 | — | |||||||||||||||||||||||||||
| Transfers out of Level 3 [4] |
(156 | ) | (1,470 | ) | (50 | ) | (315 | ) | (29 | ) | (9 | ) | (115 | ) | (2,144 | ) | (5 | ) | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
| Fair Value as of December 31, 2011 |
$ | 317 | $ | 328 | $ | 348 | $ | 1,497 | $ | 37 | $ | 382 | $ | 933 | $ | 3,842 | $ | 484 | ||||||||||||||||||
| Changes in unrealized gains (losses) included in net income related to financial instruments still held at December 31, 2011 [2] |
$ | (14 | ) | $ | (29 | ) | $ | (5 | ) | $ | (11 | ) | $ | — | $ | — | $ | (15 | ) | $ | (74 | ) | $ | 19 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
| Freestanding Derivatives [5] | ||||||||||||||||||||||||||||||||
| Assets (Liabilities) |
Equity Securities, AFS |
Credit | Equity | Interest Rate |
U.S. GMWB Hedging |
U.S. Macro Hedge Program |
Intl. Program Hedging Instr. |
Total Free- Standing Derivatives [5] |
||||||||||||||||||||||||
| Fair value as of January 1, 2011 |
$ | 47 | $ | (344 | ) | $ | 4 | $ | (53 | ) | $ | 600 | $ | 203 | $ | 5 | $ | 415 | ||||||||||||||
| Total realized/unrealized gains (losses) |
||||||||||||||||||||||||||||||||
| Included in net income [2] |
(11 | ) | (144 | ) | (8 | ) | 9 | 279 | (128 | ) | 3 | 11 | ||||||||||||||||||||
| Included in OCI [3] |
(3 | ) | — | — | — | — | — | — | — | |||||||||||||||||||||||
| Purchases |
31 | 20 | 40 | — | 23 | 347 | (43 | ) | 387 | |||||||||||||||||||||||
| Settlements |
— | (21 | ) | — | (47 | ) | (19 | ) | (65 | ) | — | (152 | ) | |||||||||||||||||||
| Sales |
(4 | ) | — | — | — | — | — | — | — | |||||||||||||||||||||||
| Transfers out of Level 3 [4] |
(4 | ) | — | — | — | — | — | — | — | |||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Fair value as of December 31, 2011 |
$ | 56 | $ | (489 | ) | $ | 36 | $ | (91 | ) | $ | 883 | $ | 357 | $ | (35 | ) | $ | 661 | |||||||||||||
| Changes in unrealized gains (losses) included in net income related to financial instruments still held at December 31, 2011 [2] |
$ | (9 | ) | $ | (137 | ) | $ | (8 | ) | $ | 10 | $ | 278 | $ | (107 | ) | $ | (4 | ) | $ | 32 | |||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Assets |
Reinsurance Recoverable
for U.S. GMWB and Japan GMWB, GMIB, and GMAB [6] |
Separate Accounts |
||||||
| Fair value as of January 1, 2011 |
$ | 2,002 | $ | 1,247 | ||||
| Total realized/unrealized gains (losses) |
||||||||
| Included in net income [1], [2] |
504 | 25 | ||||||
| Included in OCI [3] |
111 | — | ||||||
| Purchases |
— | 292 | ||||||
| Settlements |
456 | — | ||||||
| Sales |
— | (171 | ) | |||||
| Transfers into Level 3 [4] |
— | 14 | ||||||
| Transfers out of Level 3 [4] |
— | (376 | ) | |||||
|
|
|
|
|
|||||
| Fair value as of December 31, 2011 |
$ | 3,073 | $ | 1,031 | ||||
|
|
|
|
|
|||||
| Changes in unrealized gains (losses) included in net income related to financial instruments still held at December 31, 2011 [2] |
$ | 504 | $ | (1 | ) | |||
|
|
|
|
|
|||||
F-21
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Fair Value Measurements (continued)
| Other Policyholder Funds and Benefits Payable | ||||||||||||||||||||
| Liabilities |
Guaranteed Living Benefits [7] |
Equity Linked Notes |
Total Other Policyholder Funds and Benefits Payable |
Other Liabilities |
Consumer Notes |
|||||||||||||||
| Fair value as of January 1, 2011 |
$ | (4,258 | ) | $ | (9 | ) | $ | (4,267 | ) | $ | (37 | ) | $ | (5 | ) | |||||
| Total realized/unrealized gains (losses) |
||||||||||||||||||||
| Included in net income [1], [2] |
(1,118 | ) | — | (1,118 | ) | 28 | 1 | |||||||||||||
| Included in OCI [3] |
(126 | ) | — | (126 | ) | — | — | |||||||||||||
| Settlements |
(274 | ) | — | (274 | ) | — | — | |||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Fair value as of December 31, 2011 |
$ | (5,776 | ) | $ | (9 | ) | $ | (5,785 | ) | $ | (9 | ) | $ | (4 | ) | |||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Changes in unrealized gains (losses) included in net income related to financial instruments still held at December 31, 2011 [2] |
$ | (1,118 | ) | $ | — | $ | (1,118 | ) | $ | 28 | $ | 1 | ||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
Roll-forward of Financial Instruments Measured at Fair Value on a Recurring Basis Using Significant Unobservable Inputs (Level 3) for the twelve months from January 1, 2010 to December 31, 2010
| Fixed Maturities, AFS | ||||||||||||||||||||||||||||||||||||
| Assets |
ABS | CDOs | CMBS | Corporate | Foreign govt./govt. agencies |
Municipal | RMBS | Total Fixed Maturities, AFS |
Fixed Maturities, FVO |
|||||||||||||||||||||||||||
| Fair value as of January 1, 2010 |
$ | 497 | $ | 2,109 | $ | 269 | $ | 5,239 | $ | 80 | $ | 218 | $ | 995 | $ | 9,407 | $ | — | ||||||||||||||||||
| Total realized/unrealized gains (losses) |
||||||||||||||||||||||||||||||||||||
| Included in net income [2] |
(16 | ) | (124 | ) | (98 | ) | (10 | ) | — | 1 | (38 | ) | (285 | ) | 74 | |||||||||||||||||||||
| Included in OCI [3] |
71 | 467 | 327 | 193 | 1 | 24 | 228 | 1,311 | — | |||||||||||||||||||||||||||
| Purchases, issuances, and settlements |
(59 | ) | (187 | ) | (157 | ) | (66 | ) | (8 | ) | 19 | (129 | ) | (587 | ) | (10 | ) | |||||||||||||||||||
| Transfers into Level 3 [4] |
40 | 42 | 267 | 800 | — | — | 102 | 1,251 | 447 | |||||||||||||||||||||||||||
| Transfers out of Level 3 [4] |
(125 | ) | (438 | ) | (116 | ) | (4,670 | ) | (33 | ) | (4 | ) | (53 | ) | (5,439 | ) | — | |||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
| Fair Value as of December 31, 2010 |
$ | 408 | $ | 1,869 | $ | 492 | $ | 1,486 | $ | 40 | $ | 258 | $ | 1,105 | $ | 5,658 | $ | 511 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
| Changes in unrealized gains (losses) included in net income related to financial instruments still held at December 31, 2010 [2] |
$ | (6 | ) | $ | (130 | ) | $ | (58 | ) | $ | (20 | ) | $ | — | $ | — | $ | (35 | ) | $ | (249 | ) | $ | 71 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
| Freestanding Derivatives [5] | ||||||||||||||||||||||||||||||||
| Assets (Liabilities) |
Equity Securities, AFS |
Credit | Equity | Interest Rate |
U.S. GMWB Hedging |
U.S. Macro Hedge Program |
Intl. Program Hedging Instr. |
Total Free- Standing Derivatives [5] |
||||||||||||||||||||||||
| Fair value as of January 1, 2010 |
$ | 32 | $ | (161 | ) | $ | (2 | ) | $ | 5 | $ | 236 | $ | 278 | $ | 12 | $ | 368 | ||||||||||||||
| Total realized/unrealized gains (losses) |
||||||||||||||||||||||||||||||||
| Included in net income [2] |
(3 | ) | 104 | 6 | (3 | ) | (74 | ) | (312 | ) | (29 | ) | (308 | ) | ||||||||||||||||||
| Included in OCI [3] |
7 | — | — | — | — | — | — | — | ||||||||||||||||||||||||
| Purchases, issuances, and settlements |
11 | 3 | — | (44 | ) | 442 | 237 | 22 | 660 | |||||||||||||||||||||||
| Transfers into Level 3 [4] |
— | (290 | ) | — | — | — | — | — | (290 | ) | ||||||||||||||||||||||
| Transfers out of Level 3 [4] |
— | — | — | (11 | ) | (4 | ) | — | — | (15 | ) | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Fair value as of December 31, 2010 |
$ | 47 | $ | (344 | ) | $ | 4 | $ | (53 | ) | $ | 600 | $ | 203 | $ | 5 | $ | 415 | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Changes in unrealized gains (losses) included in net income related to financial instruments still held at December 31, 2010 [2] |
$ | (3 | ) | $ | 103 | $ | 6 | $ | (23 | ) | $ | (61 | ) | $ | (292 | ) | $ | (29 | ) | $ | (296 | ) | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Assets |
Reinsurance Recoverable for U.S. GMWB [6] |
Separate Accounts |
||||||
| Fair value as of January 1, 2010 |
$ | 1,108 | $ | 962 | ||||
| Total realized/unrealized gains (losses) |
||||||||
| Included in net income [1], [2] |
182 | 142 | ||||||
| Included in OCI [3] |
260 | — | ||||||
| Purchases, issuances, and settlements |
452 | 314 | ||||||
| Transfers into Level 3 [4] |
— | 14 | ||||||
| Transfers out of Level 3 [4] |
— | (185 | ) | |||||
|
|
|
|
|
|||||
| Fair value as of December 31, 2010 |
$ | 2,002 | $ | 1,247 | ||||
|
|
|
|
|
|||||
| Changes in unrealized gains (losses) included in net income related to financial instruments still held at December 31, 2010 [2] |
$ | 182 | $ | 20 | ||||
|
|
|
|
|
|||||
F-22
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Fair Value Measurements (continued)
| Other Policyholder Funds and Benefits Payable [1] | ||||||||||||||||||||||||
| Liabilities |
Guaranteed Living Benefits [7] |
Institutional Notes |
Equity Linked Notes |
Total Other Policyholder Funds and Benefits Payable |
Other Liabilities |
Consumer Notes |
||||||||||||||||||
| Fair value as of January 1, 2010 |
$ | (3,439 | ) | $ | (2 | ) | $ | (10 | ) | $ | (3,451 | ) | $ | — | $ | (5 | ) | |||||||
| Total realized/unrealized gains (losses) |
||||||||||||||||||||||||
| Included in net income [1], [2] |
(259 | ) | 2 | — | (257 | ) | (26 | ) | — | |||||||||||||||
| Included in OCI [3] |
(307 | ) | — | — | (307 | ) | — | — | ||||||||||||||||
| Purchases, issuances and settlements |
(253 | ) | — | 1 | (252 | ) | — | — | ||||||||||||||||
| Transfers into Level 3 [4] |
— | — | — | — | (11 | ) | — | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Fair value as of December 31, 2010 |
$ | (4,258 | ) | $ | — | $ | (9 | ) | $ | (4,267 | ) | $ | (37 | ) | $ | (5 | ) | |||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Changes in unrealized gains (losses) included in net income related to financial instruments still held at December 31, 2010 [2] |
$ | (259 | ) | $ | 2 | $ | — | $ | (257 | ) | $ | — | $ | — | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| [1] | The Company classifies gains and losses on GMWB reinsurance derivatives and Guaranteed Living Benefit embedded derivatives as unrealized gains (losses) for purposes of disclosure in this table because it is impracticable to track on a contract-by-contract basis the realized gains (losses) for these derivatives and embedded derivatives. |
| [2] | All amounts in these rows are reported in net realized capital gains (losses). The realized/unrealized gains (losses) included in net income for separate account assets are offset by an equal amount for separate account liabilities, which results in a net zero impact on net income for the Company. All amounts are before income taxes and amortization of DAC. |
| [3] | All amounts are before income taxes and amortization of DAC. |
| [4] | Transfers in and/or (out) of Level 3 are primarily attributable to the availability of market observable information and the re-evaluation of the observability of pricing inputs. |
| [5] | Derivative instruments are reported in this table on a net basis for asset/(liability) positions and reported in the Consolidated Balance Sheet in other investments and other liabilities. |
| [6] | Includes fair value of reinsurance recoverables of approximately $2.6 billion and $1.7 billion as of December 31, 2011 and December 31, 2010, respectively, related to a transaction entered into with an affiliated captive reinsurer. See Note 16 of the Notes to Consolidated Financial Statements for more information. |
| [7] | Includes both market and non-market impacts in deriving realized and unrealized gains (losses). |
Fair Value Option
The Company elected the fair value option for its investments containing an embedded credit derivative which were not bifurcated as a result of adoption of new accounting guidance effective July 1, 2010. The underlying credit risk of these securities is primarily corporate bonds and commercial real estate. The Company elected the fair value option given the complexity of bifurcating the economic components associated with the embedded credit derivative. Additionally, the Company elected the fair value option for purchases of foreign government securities to align with the accounting for yen-based fixed annuity liabilities, which are adjusted for changes in spot rates through realized gains and losses. Similar to other fixed maturities, income earned from these securities is recorded in net investment income. Changes in the fair value of these securities are recorded in net realized capital gains and losses.
The Company previously elected the fair value option for one of its consolidated VIEs in order to apply a consistent accounting model for the VIE’s assets and liabilities. The VIE is an investment vehicle that holds high quality investments, derivative instruments that references third-party corporate credit and issues notes to investors that reflect the credit characteristics of the high quality investments and derivative instruments. The risks and rewards associated with the assets of the VIE inure to the investors. The investors have no recourse against the Company. As a result, there has been no adjustment to the market value of the notes for the Company’s own credit risk.
The following table presents the changes in fair value of those assets and liabilities accounted for using the fair value option reported in net realized capital gains and losses in the Company’s Consolidated Statements of Operations.
| For the years ended December 31, | ||||||||
| 2011 | 2010 | |||||||
| Assets |
||||||||
| Fixed maturities, FVO |
||||||||
| ABS |
$ | — | $ | (5 | ) | |||
| Corporate |
10 | (7 | ) | |||||
| CRE CDOs |
(33 | ) | 79 | |||||
| Foreign government |
45 | — | ||||||
| Other liabilities |
||||||||
| Credit-linked notes |
28 | (26 | ) | |||||
|
|
|
|
|
|||||
| Total realized capital gains |
$ | 50 | $ | 41 | ||||
|
|
|
|
|
|||||
F-23
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Fair Value Measurements (continued)
The following table presents the fair value of assets and liabilities accounted for using the fair value option included in the Company’s Consolidated Balance Sheets.
| As of December 31, | ||||||||
| 2011 | 2010 | |||||||
| Assets |
||||||||
| Fixed maturities, FVO |
||||||||
| ABS |
$ | 65 | $ | 64 | ||||
| CRE CDOs |
214 | 260 | ||||||
| Corporate |
272 | 251 | ||||||
| Foreign government |
766 | 64 | ||||||
|
|
|
|
|
|||||
| Total fixed maturities, FVO |
$ | 1,317 | $ | 639 | ||||
| Other liabilities |
||||||||
| Credit-linked notes [1] |
$ | 9 | $ | 37 | ||||
|
|
|
|
|
|||||
| [1] | As of December 31, 2011 and 2010, the outstanding principal balance of the notes was $243. |
Financial Instruments Not Carried at Fair Value
The following presents carrying amounts and fair values of the Company’s financial instruments not carried at fair value, and not included in the above fair value discussion as of December 31, 2011 and 2010 were as follows:
| December 31, 2011 | December 31, 2010 | |||||||||||||||
| Carrying Amount |
Fair Value |
Carrying Amount |
Fair Value |
|||||||||||||
| Assets |
||||||||||||||||
| Policy loans |
$ | 1,952 | $ | 2,099 | $ | 2,128 | $ | 2,164 | ||||||||
| Mortgage loans |
4,182 | 4,382 | 3,244 | 3,272 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Liabilities |
||||||||||||||||
| Other policyholder funds and benefits payable [1] |
$ | 10,065 | $ | 10,959 | $ | 10,824 | $ | 11,050 | ||||||||
| Consumer notes [2] |
310 | 305 | 377 | 392 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| [1] | Excludes group accident and health and universal life insurance contracts, including corporate owned life insurance. |
| [2] | Excludes amounts carried at fair value and included in disclosures above. |
The Company has not made any changes in its valuation methodologies for the following assets and liabilities since December 31, 2010.
| • | Fair value for policy loans and consumer notes were estimated using discounted cash flow calculations using current interest rates. |
| • | Fair values for mortgage loans were estimated using discounted cash flow calculations based on current lending rates for similar type loans. Current lending rates reflect changes in credit spreads and the remaining terms of the loans. |
| • | Other policyholder funds and benefits payable, not carried at fair value, is determined by estimating future cash flows, discounted at the current market rate. |
F-24
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Investments and Derivative Instruments
Significant Investment Accounting Policies
Overview
The Company’s investments in fixed maturities include bonds, redeemable preferred stock and commercial paper. These investments, along with certain equity securities, which include common and non-redeemable preferred stocks, are classified as AFS and are carried at fair value. The after-tax difference from cost or amortized cost is reflected in stockholders’ equity as a component of Other Comprehensive Income (Loss) (“OCI”), after adjustments 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 and reserve adjustments. Fixed maturities for which the Company elected the fair value option are classified as FVO and are carried at fair value. The equity investments associated with the variable annuity products offered in Japan are recorded at fair value and are classified as trading with changes in fair value recorded in net investment income. Policy loans are carried at outstanding balance. Mortgage loans are recorded at the outstanding principal balance adjusted for amortization of premiums or discounts and net of valuation allowances. Short-term investments are carried at amortized cost, which approximates fair value. Limited partnerships and other alternative investments are reported at their carrying value with the change in carrying value accounted for under the equity method and accordingly the Company’s share of earnings are included in net investment income. Recognition of limited partnerships and other alternative investment income is delayed due to the availability of the related financial information, as private equity and other funds are generally on a three-month delay and hedge funds are on a one-month delay. Accordingly, income for the years ended December 31, 2011, 2010 and 2009 may not include the full impact of current year changes in valuation of the underlying assets and liabilities, which are generally obtained from the limited partnerships and other alternative investments’ general partners. Other investments primarily consist of derivatives instruments which are carried at fair value.
Recognition and Presentation of Other-Than-Temporary Impairments
The Company deems debt securities and certain equity securities with debt-like characteristics (collectively “debt securities”) to be other-than-temporarily impaired (“impaired”) if a security meets the following conditions: a) the Company intends to sell or it is more likely than not the Company will be required to sell the security before a recovery in value, or b) the Company does not expect to recover the entire amortized cost basis of the security. If the Company intends to sell or it is more likely than not the Company will be required to sell the security before a recovery in value, a charge is recorded in net realized capital losses equal to the difference between the fair value and amortized cost basis of the security. For those impaired debt securities which do not meet the first condition and for which the Company does not expect to recover the entire amortized cost basis, the difference between the security’s amortized cost basis and the fair value is separated into the portion representing a credit other-than-temporary impairment (“impairment”), which is recorded in net realized capital losses, and the remaining impairment, which is recorded in OCI. Generally, the Company determines a security’s credit impairment as the difference between its amortized cost basis and its best estimate of expected future cash flows discounted at the security’s effective yield prior to impairment. The remaining non-credit impairment, which is recorded in OCI, is the difference between the security’s fair value and the Company’s best estimate of expected future cash flows discounted at the security’s effective yield prior to the impairment, which typically represents current market liquidity and risk premiums. The previous amortized cost basis less the impairment recognized in net realized capital losses becomes the security’s new cost basis. The Company accretes the new cost basis to the estimated future cash flows over the expected remaining life of the security by prospectively adjusting the security’s yield, if necessary.
The Company’s evaluation of whether a credit impairment exists for debt securities includes but is not limited to, the following factors: (a) changes in the financial condition of the security’s underlying collateral, (b) whether the issuer is current on contractually obligated interest and principal payments, (c) changes in the financial condition, credit rating and near-term prospects of the issuer, (d) the extent to which the fair value has been less than the amortized cost of the security and (e) the payment structure of the security. The Company’s best estimate of expected future cash flows used to determine the credit loss amount is a quantitative and qualitative process that incorporates information received from third-party sources along with certain internal assumptions and judgments regarding the future performance of the security. The Company’s best estimate of future cash flows involves assumptions including, but not limited to, various performance indicators, such as historical and projected default and recovery rates, credit ratings, current and projected delinquency rates, and loan-to-value (“LTV”) ratios. In addition, for structured securities, the Company considers factors including, but not limited to, average cumulative collateral loss rates that vary by vintage year, commercial and residential property value declines that vary by property type and location and commercial real estate delinquency levels. These assumptions require the use of significant management judgment and include the probability of issuer default and estimates regarding timing and amount of expected recoveries which may include estimating the underlying collateral value. In addition, projections of expected future debt security cash flows may change based upon new information regarding the performance of the issuer and/or underlying collateral such as changes in the projections of the underlying property value estimates.
F-25
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Investments and Derivative Instruments (continued)
For equity securities where the decline in the fair value is deemed to be other-than-temporary, a charge is recorded in net realized capital losses equal to the difference between the fair value and cost basis of the security. The previous cost basis less the impairment becomes the security’s new cost basis. The Company asserts its intent and ability to retain those equity securities deemed to be temporarily impaired until the price recovers. Once identified, these securities are systematically restricted from trading unless approved by a committee of investment and accounting professionals (“Committee”). The Committee will only authorize the sale of these securities based on predefined criteria that relate to events that could not have been reasonably foreseen. Examples of the criteria include, but are not limited to, the deterioration in the issuer’s financial condition, security price declines, a change in regulatory requirements or a major business combination or major disposition.
The primary factors considered in evaluating whether an impairment exists for an equity security include, but are not limited to: (a) the length of time and extent to which the fair value has been less than the cost of the security, (b) changes in the financial condition, credit rating and near-term prospects of the issuer, (c) whether the issuer is current on preferred stock dividends and (d) the intent and ability of the Company to retain the investment for a period of time sufficient to allow for recovery.
Mortgage Loan Valuation Allowances
The Company’s security monitoring process reviews mortgage loans on a quarterly basis to identify potential credit losses. Commercial mortgage loans are considered to be impaired when management estimates that, based upon current information and events, it is probable that the Company will be unable to collect amounts due according to the contractual terms of the loan agreement. Criteria used to determine if an impairment exists include, but are not limited to: current and projected macroeconomic factors, such as unemployment rates, and property-specific factors such as rental rates, occupancy levels, LTV ratios and debt service coverage ratios (“DSCR”). In addition, the Company considers historic, current and projected delinquency rates and property values. These assumptions require the use of significant management judgment and include the probability and timing of borrower default and loss severity estimates. In addition, projections of expected future cash flows may change based upon new information regarding the performance of the borrower and/or underlying collateral such as changes in the projections of the underlying property value estimates.
For mortgage loans that are deemed impaired, a valuation allowance is established for the difference between the carrying amount and the Company’s share of either (a) the present value of the expected future cash flows discounted at the loan’s effective interest rate, (b) the loan’s observable market price or, most frequently, (c) the fair value of the collateral. A valuation allowance has been established for either individual loans or as a projected loss contingency for loans with an LTV ratio of 90% or greater and consideration of other credit quality factors, including DSCR. Changes in valuation allowances are recorded in net realized capital gains and losses. Interest income on impaired loans is accrued to the extent it is deemed collectible and the loans continue to perform under the original or restructured terms. Interest income ceases to accrue for loans when it is probable that the Company will not receive interest and principal payments according to the contractual terms of the loan agreement, or if a loan is more than 60 days past due. Loans may resume accrual status when it is determined that sufficient collateral exists to satisfy the full amount of the loan and interest payments, as well as when it is probable cash will be received in the foreseeable future. Interest income on defaulted loans is recognized when received.
Net Realized Capital Gains and Losses
Net realized capital gains and losses from investment sales, after deducting the life and pension policyholders’ share for certain products, are reported as a component of revenues and are determined on a specific identification basis, as well as changes in value associated with fixed maturities for which the fair value option was elected. Net realized capital gains and losses also result from fair value changes in derivatives contracts (both free-standing and embedded) that do not qualify, or are not designated, as a hedge for accounting purposes, and the change in value of derivatives in certain fair-value hedge relationships. Impairments and mortgage loan valuation allowances are recognized as net realized capital losses in accordance with the Company’s policies previously discussed. Foreign currency transaction remeasurements are also included in net realized capital gains and losses.
Net Investment Income
Interest income from fixed maturities and mortgage loans is recognized when earned on the constant effective yield method based on estimated timing of cash flows. The amortization of premium and accretion of discount for fixed maturities also takes into consideration call and maturity dates that produce the lowest yield. For securitized financial assets subject to prepayment risk, yields are recalculated and adjusted periodically to reflect historical and/or estimated future repayments using the retrospective method; however, if these investments are impaired, any yield adjustments are made using the prospective method. Prepayment fees on fixed maturities and mortgage loans are recorded in net investment income when earned. For limited partnerships and other alternative investments, the equity method of accounting is used to recognize the Company’s share of earnings. For impaired debt securities, the Company accretes the new cost basis to the estimated future cash flows over the expected remaining life of the security by prospectively adjusting the security’s yield, if necessary. The Company’s non-income producing investments were not material for the years ended December 31, 2011, 2010 and 2009.
F-26
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Investments and Derivative Instruments (continued)
Net investment income on equity securities, trading, includes dividend income and the changes in market value of the securities associated with the variable annuity products sold in Japan and the United Kingdom. The returns on these policyholder-directed investments inure to the benefit of the variable annuity policyholders but the underlying funds do not meet the criteria for separate account reporting. Accordingly, these assets are reflected in the Company’s general account and the returns credited to the policyholders are reflected in interest credited, a component of benefits, losses and loss adjustment expenses.
Significant Derivative Instruments Accounting Policies
Overview
The Company utilizes a variety of derivative instruments, including swaps, caps, floors, forwards, futures and options through one of four Company-approved objectives: to hedge risk arising from interest rate, equity market, credit spread and issuer default, price or currency exchange rate risk or volatility; to manage liquidity; to control transaction costs; or to enter into replication transactions.
Interest rate, volatility, dividend, credit default and index swaps involve the periodic exchange of cash flows with other parties, at specified intervals, calculated using agreed upon rates or other financial variables 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 interest rate or falls below the floor strike interest 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 that specify a rate of interest or currency exchange rate to be paid or received on an obligation beginning on a future start date and are typically settled in cash.
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 or cash, and changes in the futures’ contract values are settled daily in cash.
Option contracts grant the purchaser, for a premium payment, the right to either purchase from or sell to the issuer a financial instrument at a specified price, within a specified period or on a stated date.
Foreign currency swaps exchange an initial principal amount in two currencies, agreeing to re-exchange the currencies at a future date, at an agreed upon exchange rate. There may also be a periodic exchange of payments at specified intervals calculated using the agreed upon rates and exchanged principal amounts.
The Company’s derivative transactions are used in strategies permitted under the derivative use plans required by the State of Connecticut, the State of Illinois and the State of New York insurance departments.
Accounting and Financial Statement Presentation of Derivative Instruments and Hedging Activities
Derivative instruments are recognized on the Consolidated Balance Sheets at fair value. For balance sheet presentation purposes, the Company offsets the fair value amounts, income accruals, and cash collateral held, related to derivative instruments executed in a legal entity and with the same counterparty under a master netting agreement, which provides the Company with the legal right of offset.
On the date the derivative contract is entered into, the Company designates the derivative as (1) a hedge of the fair value of a recognized asset or liability (“fair value” hedge), (2) a hedge of the variability in cash flows of a forecasted transaction or of amounts to be received or paid related to a recognized asset or liability (“cash flow” hedge), (3) a hedge of a net investment in a foreign operation (“net investment” hedge) or (4) held for other investment and/or risk management purposes, which primarily involve managing asset or liability related risks which do not qualify for hedge accounting.
Fair Value Hedges
Changes in the fair value of a derivative that is designated and qualifies as a fair value hedge, including foreign-currency fair value hedges, along with the changes in the fair value of the hedged asset or liability that is attributable to the hedged risk, are recorded in current period earnings with any differences between the net change in fair value of the derivative and the hedged item representing the hedge ineffectiveness. Periodic cash flows and accruals of income/expense (“periodic derivative net coupon settlements”) are recorded in the line item of the consolidated statements of operations in which the cash flows of the hedged item are recorded.
F-27
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Investments and Derivative Instruments (continued)
Cash Flow Hedges
Changes in the fair value of a derivative that is designated and qualifies as a cash flow hedge, including foreign-currency cash flow hedges, are recorded in AOCI and are reclassified into earnings when the variability of the cash flow of the hedged item impacts earnings. Gains and losses on derivative contracts that are reclassified from AOCI to current period earnings are included in the line item in the consolidated statements of operations in which the cash flows of the hedged item are recorded. Any hedge ineffectiveness is recorded immediately in current period earnings as net realized capital gains and losses. Periodic derivative net coupon settlements are recorded in the line item of the consolidated statements of operations in which the cash flows of the hedged item are recorded.
Net Investment in a Foreign Operation Hedges
Changes in fair value of a derivative used as a hedge of a net investment in a foreign operation, to the extent effective as a hedge, are recorded in the foreign currency translation adjustments account within AOCI. Cumulative changes in fair value recorded in AOCI are reclassified into earnings upon the sale or complete, or substantially complete, liquidation of the foreign entity. Any hedge ineffectiveness is recorded immediately in current period earnings as net realized capital gains and losses. Periodic derivative net coupon settlements are recorded in the line item of the consolidated statements of operations in which the cash flows of the hedged item are recorded.
Other Investment and/or Risk Management Activities
The Company’s other investment and/or risk management activities primarily relate to strategies used to reduce economic risk or replicate permitted investments and do not receive hedge accounting treatment. Changes in the fair value, including periodic derivative net coupon settlements, of derivative instruments held for other investment and/or risk management purposes are reported in current period earnings as net realized capital gains and losses.
Hedge Documentation and Effectiveness Testing
To qualify for hedge accounting treatment, a derivative must be highly effective in mitigating the designated changes in fair value or cash flow of the hedged item. At hedge inception, the Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking each hedge transaction. The documentation process includes linking derivatives that are designated as fair value, cash flow, or net investment hedges to specific assets or liabilities on the balance sheet or to specific forecasted transactions and defining the effectiveness and ineffectiveness testing methods to be used. The Company also formally assesses both at the hedge’s inception and ongoing on a quarterly basis, whether the derivatives that are used in hedging transactions have been and are expected to continue to be highly effective in offsetting changes in fair values or cash flows of hedged items. Hedge effectiveness is assessed using qualitative and quantitative methods. Qualitative methods may include comparison of critical terms of the derivative to the hedged item. Quantitative methods include regression or other statistical analysis of changes in fair value or cash flows associated with the hedge relationship. Hedge ineffectiveness of the hedge relationships are measured each reporting period using the “Change in Variable Cash Flows Method”, the “Change in Fair Value Method”, the “Hypothetical Derivative Method”, or the “Dollar Offset Method”.
Discontinuance of Hedge Accounting
The Company discontinues hedge accounting prospectively when (1) it is determined that the derivative is no longer highly effective in offsetting changes in the fair value or cash flows of a hedged item; (2) the derivative is de-designated as a hedging instrument; or (3) the derivative expires or is sold, terminated or exercised.
When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair-value hedge, the derivative continues to be carried at fair value on the balance sheet with changes in its fair value recognized in current period earnings.
When hedge accounting is discontinued because the Company becomes aware that it is not probable that the forecasted transaction will occur, the derivative continues to be carried on the balance sheet at its fair value, and gains and losses that were accumulated in AOCI are recognized immediately in earnings.
In other situations in which hedge accounting is discontinued on a cash-flow hedge, including those where the derivative is sold, terminated or exercised, amounts previously deferred in AOCI are reclassified into earnings when earnings are impacted by the variability of the cash flow of the hedged item.
F-28
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Investments and Derivative Instruments (continued)
Embedded Derivatives
The Company purchases and issues financial instruments and products that contain embedded derivative instruments. When it is determined that (1) the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, and (2) a separate instrument with the same terms would qualify as a derivative instrument, the embedded derivative is bifurcated from the host for measurement purposes. The embedded derivative, which is reported with the host instrument in the consolidated balance sheets, is carried at fair value with changes in fair value reported in net realized capital gains and losses.
Credit Risk
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. For each legal entity of the Company, credit exposures are generally quantified daily based on the prior business day’s market value and collateral is pledged to and held by, or on behalf of, the Company to the extent the current value of derivatives exceeds the contractual thresholds for every counterparty. The maximum uncollateralized threshold for a derivative counterparty for a single level entity is $10. The Company also minimizes the credit risk of derivative instruments by entering into transactions with high quality counterparties primarily rated A or better, which are monitored and evaluated by the Company’s risk management team and reviewed by senior management. In addition, the Company monitors counterparty credit exposure on a monthly basis to ensure compliance with Company policies and statutory limitations. The Company generally requires that derivative contracts, other than exchange traded contracts, certain forward contracts, and certain embedded and reinsurance derivatives, 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.
Net Investment Income (Loss)
| For the years ended December 31, | ||||||||||||
| (Before-tax) |
2011 | 2010 | 2009 | |||||||||
| Fixed maturities |
$ | 1,941 | $ | 1,977 | $ | 2,094 | ||||||
| Equity securities, AFS |
10 | 14 | 43 | |||||||||
| Mortgage loans |
206 | 199 | 232 | |||||||||
| Policy loans |
128 | 129 | 136 | |||||||||
| Limited partnerships and other alternative investments |
143 | 121 | (171 | ) | ||||||||
| Other investments |
226 | 253 | 242 | |||||||||
| Investment expenses |
(74 | ) | (72 | ) | (71 | ) | ||||||
|
|
|
|
|
|
|
|||||||
| Total securities AFS and other |
2,580 | 2,621 | 2,505 | |||||||||
| Equity securities, trading |
(14 | ) | 238 | 343 | ||||||||
|
|
|
|
|
|
|
|||||||
| Total net investment income (loss) |
$ | 2,566 | $ | 2,859 | $ | 2,848 | ||||||
|
|
|
|
|
|
|
|||||||
The net unrealized gain (loss) on equity securities, trading, included in net investment income during the years ended December 31, 2011, 2010 and 2009, was ($111), $160 and $276, respectively, substantially all of which have corresponding amounts credited to policyholders. These amounts were not included in gross unrealized gains (losses).
F-29
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
Net Realized Capital Gains (Losses)
| For the years ended December 31, | ||||||||||||
| (Before-tax) |
2011 | 2010 | 2009 | |||||||||
| Gross gains on sales |
$ | 405 | $ | 486 | $ | 364 | ||||||
| Gross losses on sales |
(200 | ) | (336 | ) | (828 | ) | ||||||
| Net OTTI losses recognized in earnings |
(125 | ) | (336 | ) | (1,192 | ) | ||||||
| Valuation allowances on mortgage loans |
25 | (108 | ) | (292 | ) | |||||||
| Japanese fixed annuity contract hedges, net [1] |
3 | 27 | 47 | |||||||||
| Periodic net coupon settlements on credit derivatives/Japan |
— | (3 | ) | (33 | ) | |||||||
| Results of variable annuity hedge program |
||||||||||||
| U. S. GMWB derivatives, net |
(397 | ) | 89 | 1,464 | ||||||||
| U. S. Macro hedge program |
(216 | ) | (445 | ) | (733 | ) | ||||||
|
|
|
|
|
|
|
|||||||
| Total U.S. program |
(613 | ) | (356 | ) | 731 | |||||||
| International program |
723 | (13 | ) | (138 | ) | |||||||
|
|
|
|
|
|
|
|||||||
| Total results of variable annuity hedge program |
110 | (369 | ) | 593 | ||||||||
| GMIB/GMAB/GMWB reinsurance assumed |
(326 | ) | (769 | ) | 1,106 | |||||||
| Coinsurance and modified coinsurance ceded reinsurance contracts |
373 | 284 | (577 | ) | ||||||||
| Other, net [2] |
(264 | ) | 180 | (64 | ) | |||||||
|
|
|
|
|
|
|
|||||||
| Net realized capital gains (losses) |
$ | 1 | $ | (944 | ) | $ | (876 | ) | ||||
|
|
|
|
|
|
|
|||||||
| [1] | Relates to the Japanese fixed annuity product (adjustment of product liability for changes in spot currency exchange rates, related derivative hedging instruments, excluding net period coupon settlements, and Japan FVO securities). |
| [2] | Primarily consists of losses on non-qualifying derivatives and fixed maturities, FVO, Japan 3Win related foreign currency swaps and other investment gains and losses. |
F-30
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Investments and Derivative Instruments (continued)
Sales of Available-for-Sale Securities
| For the years ended December 31, | ||||||||||||
| 2011 | 2010 | 2009 | ||||||||||
| Fixed maturities, AFS |
||||||||||||
| Sale proceeds |
$ | 19,861 | $ | 27,739 | $ | 27,809 | ||||||
| Gross gains |
354 | 413 | 495 | |||||||||
| Gross losses |
(205 | ) | (299 | ) | (830 | ) | ||||||
| Equity securities, AFS |
||||||||||||
| Sale proceeds |
$ | 147 | $ | 171 | $ | 162 | ||||||
| Gross gains |
50 | 12 | 2 | |||||||||
| Gross losses |
— | (4 | ) | (27 | ) | |||||||
|
|
|
|
|
|
|
|||||||
Sales of AFS securities in 2011 were the result of the reinvestment into spread product well-positioned for modest economic growth, as well as the purposeful reduction of certain exposures.
Other-Than-Temporary Impairment Losses
The following table presents a roll-forward of the Company’s cumulative credit impairments on debt securities held as of December 31, 2011 and 2010.
| For the years ended December 31, | ||||||||||||
| 2011 | 2010 | 2009 | ||||||||||
| Balance as of beginning of period |
$ | (1,598 | ) | $ | (1,632 | ) | $ | — | ||||
| Credit impairments remaining in retained earnings related to adoption of new accounting guidance in April 2009 |
— | — | (941 | ) | ||||||||
| Additions for credit impairments recognized on [1]: |
||||||||||||
| Securities not previously impaired |
(41 | ) | (181 | ) | (690 | ) | ||||||
| Securities previously impaired |
(47 | ) | (122 | ) | (201 | ) | ||||||
| Reductions for credit impairments previously recognized on: |
||||||||||||
| Securities that matured or were sold during the period |
358 | 314 | 196 | |||||||||
| Securities that the Company intends to sell or more likely than not will be required to sell before recovery |
— | — | 1 | |||||||||
| Securities due to an increase in expected cash flows |
9 | 23 | 3 | |||||||||
|
|
|
|
|
|
|
|||||||
| Balance as of end of period |
$ | (1,319 | ) | $ | (1,598 | ) | $ | (1,632 | ) | |||
|
|
|
|
|
|
|
|||||||
| [1] | These additions are included in the net OTTI losses recognized in earnings in the Consolidated Statements of Operations. |
Available-for-Sale Securities
The following table presents the Company’s AFS securities by type.
| December 31, 2011 | December 31, 2010 | |||||||||||||||||||||||||||||||||||||||
| Cost or Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair Value |
Non-Credit OTTI [1] |
Cost or Amortized Cost |
Gross Unrealized Gains |
Gross Unrealized Losses |
Fair Value |
Non-Credit OTTI [1] |
|||||||||||||||||||||||||||||||
| ABS |
$ | 2,361 | $ | 38 | $ | (306 | ) | $ | 2,093 | $ | (3 | ) | $ | 2,395 | $ | 29 | $ | (356 | ) | $ | 2,068 | $ | (1 | ) | ||||||||||||||||
| CDOs |
2,055 | 15 | (272 | ) | 1,798 | (29 | ) | 2,278 | — | (379 | ) | 1,899 | (59 | ) | ||||||||||||||||||||||||||
| CMBS |
4,418 | 169 | (318 | ) | 4,269 | (19 | ) | 5,283 | 146 | (401 | ) | 5,028 | (15 | ) | ||||||||||||||||||||||||||
| Corporate [2] |
28,084 | 2,729 | (539 | ) | 30,229 | — | 25,934 | 1,545 | (538 | ) | 26,915 | 6 | ||||||||||||||||||||||||||||
| Foreign govt./govt. agencies |
1,121 | 106 | (3 | ) | 1,224 | — | 963 | 48 | (9 | ) | 1,002 | — | ||||||||||||||||||||||||||||
| Municipal |
1,504 | 104 | (51 | ) | 1,557 | — | 1,149 | 7 | (124 | ) | 1,032 | — | ||||||||||||||||||||||||||||
| RMBS |
4,069 | 170 | (416 | ) | 3,823 | (97 | ) | 4,450 | 79 | (411 | ) | 4,118 | (113 | ) | ||||||||||||||||||||||||||
| U.S. Treasuries |
2,624 | 162 | (1 | ) | 2,785 | — | 2,871 | 11 | (110 | ) | 2,772 | — | ||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
| Total fixed maturities, AFS |
46,236 | 3,493 | (1,906 | ) | 47,778 | (148 | ) | 45,323 | 1,865 | (2,328 | ) | 44,834 | (182 | ) | ||||||||||||||||||||||||||
| Equity securities, AFS |
443 | 21 | (66 | ) | 398 | — | 320 | 61 | (41 | ) | 340 | — | ||||||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
| Total AFS securities |
$ | 46,679 | $ | 3,514 | $ | (1,972 | ) | $ | 48,176 | $ | (148 | ) | $ | 45,643 | $ | 1,926 | $ | (2,369 | ) | $ | 45,174 | $ | (182 | ) | ||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
| [1] | Represents the amount of cumulative non-credit OTTI losses recognized in OCI on securities that also had credit impairments. These losses are included in gross unrealized losses as of December 31, 2011 and 2010. |
| [2] | Gross unrealized gains (losses) exclude the fair value of bifurcated embedded derivative features of certain securities. Subsequent changes in value will be recorded in net realized capital gains (losses). |
F-31
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Investments and Derivative Instruments (continued)
The following table presents the Company’s fixed maturities, AFS, by contractual maturity year.
| December 31, 2011 | ||||||||
| Maturity |
Amortized Cost | Fair Value | ||||||
| One year or less |
$ | 2,340 | $ | 2,359 | ||||
| Over one year through five years |
10,006 | 10,378 | ||||||
| Over five years through ten years |
8,133 | 8,728 | ||||||
| Over ten years |
12,854 | 14,330 | ||||||
|
|
|
|
|
|||||
| Subtotal |
33,333 | 35,795 | ||||||
| Mortgage-backed and asset-backed securities |
12,903 | 11,983 | ||||||
|
|
|
|
|
|||||
| Total |
$ | 46,236 | $ | 47,778 | ||||
|
|
|
|
|
|||||
Estimated maturities may differ from contractual maturities due to security call or prepayment provisions. Due to the potential for variability in payment spreads (i.e. prepayments or extensions), mortgage-backed and asset-backed securities are not categorized by contractual maturity.
Concentration of Credit Risk
The Company aims to maintain a diversified investment portfolio including issuer, sector and geographic stratification, where applicable, and has established certain exposure limits, diversification standards and review procedures to mitigate credit risk.
As of December 31, 2011 and 2010, the Company was not exposed to any concentration of credit risk of a single issuer greater than 10% of the Company’s stockholders’ equity other than U.S. government and certain U.S. government agencies. As of December 31, 2011, other than U.S. government and certain U.S. government agencies, the Company’s three largest exposures by issuer were the Government of Japan, the Government of the United Kingdom and AT&T Inc. which each comprised less than 1.2% of total invested assets. As of December 31, 2010, other than U.S. government and certain U.S. government agencies, the Company’s three largest exposures by issuer were JP Morgan Chase & Co., Berkshire Hathaway Inc. and Wells Fargo & Co. which each comprised less than 0.6% of total invested assets.
The Company’s three largest exposures by sector as of December 31, 2011 were commercial real estate, U.S. Treasuries and utilities which comprised approximately 14%, 9% and 9%, respectively, of total invested assets. The Company’s three largest exposures by sector as of December 31, 2010 were commercial real estate, U.S. Treasuries and financial services which comprised approximately 15%, 10% and 9%, respectively, of total invested assets.
Security Unrealized Loss Aging
The following tables present the Company’s unrealized loss aging for AFS securities by type and length of time the security was in a continuous unrealized loss position.
| December 31, 2011 | ||||||||||||||||||||||||||||||||||||
| Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||||||||||||||
| Amortized Cost |
Fair Value |
Unrealized Losses |
Amortized Cost |
Fair Value |
Unrealized Losses |
Amortized Cost |
Fair Value |
Unrealized Losses |
||||||||||||||||||||||||||||
| ABS |
$ | 420 | $ | 385 | $ | (35 | ) | $ | 1,002 | $ | 731 | $ | (271 | ) | $ | 1,422 | $ | 1,116 | $ | (306 | ) | |||||||||||||||
| CDOs |
80 | 58 | (22 | ) | 1,956 | 1,706 | (250 | ) | 2,036 | 1,764 | (272 | ) | ||||||||||||||||||||||||
| CMBS |
911 | 830 | (81 | ) | 1,303 | 1,066 | (237 | ) | 2,214 | 1,896 | (318 | ) | ||||||||||||||||||||||||
| Corporate [1] |
2,942 | 2,823 | (119 | ) | 2,353 | 1,889 | (420 | ) | 5,295 | 4,712 | (539 | ) | ||||||||||||||||||||||||
| Foreign govt./govt. agencies |
24 | 23 | (1 | ) | 40 | 38 | (2 | ) | 64 | 61 | (3 | ) | ||||||||||||||||||||||||
| Municipal |
202 | 199 | (3 | ) | 348 | 300 | (48 | ) | 550 | 499 | (51 | ) | ||||||||||||||||||||||||
| RMBS |
355 | 271 | (84 | ) | 1,060 | 728 | (332 | ) | 1,415 | 999 | (416 | ) | ||||||||||||||||||||||||
| U.S. Treasuries |
185 | 184 | (1 | ) | — | — | — | 185 | 184 | (1 | ) | |||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
| Total fixed maturities |
5,119 | 4,773 | (346 | ) | 8,062 | 6,458 | (1,560 | ) | 13,181 | 11,231 | (1,906 | ) | ||||||||||||||||||||||||
| Equity securities |
115 | 90 | (25 | ) | 104 | 63 | (41 | ) | 219 | 153 | (66 | ) | ||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
| Total securities in an unrealized loss |
$ | 5,234 | $ | 4,863 | $ | (371 | ) | $ | 8,166 | $ | 6,521 | $ | (1,601 | ) | $ | 13,400 | $ | 11,384 | $ | (1,972 | ) | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
| [1] | Unrealized losses exclude the fair value of bifurcated embedded derivative features of certain securities. Subsequent changes in value will be recorded in net realized capital gains (losses). |
F-32
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Investments and Derivative Instruments (continued)
| December 31, 2010 | ||||||||||||||||||||||||||||||||||||
| Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||||||||||||||
| Cost or Amortized Cost |
Fair Value |
Unrealized Losses |
Cost or Amortized Cost |
Fair Value |
Unrealized Losses |
Cost or Amortized Cost |
Fair Value |
Unrealized Losses |
||||||||||||||||||||||||||||
| ABS |
$ | 237 | $ | 226 | $ | (11 | ) | $ | 1,226 | $ | 881 | $ | (345 | ) | $ | 1,463 | $ | 1,107 | $ | (356 | ) | |||||||||||||||
| CDOs |
316 | 288 | (28 | ) | 1,934 | 1,583 | (351 | ) | 2,250 | 1,871 | (379 | ) | ||||||||||||||||||||||||
| CMBS |
374 | 355 | (19 | ) | 2,532 | 2,150 | (382 | ) | 2,906 | 2,505 | (401 | ) | ||||||||||||||||||||||||
| Corporate |
3,726 | 3,591 | (130 | ) | 2,777 | 2,348 | (408 | ) | 6,503 | 5,939 | (538 | ) | ||||||||||||||||||||||||
| Foreign govt./govt. agencies |
250 | 246 | (4 | ) | 40 | 35 | (5 | ) | 290 | 281 | (9 | ) | ||||||||||||||||||||||||
| Municipal |
415 | 399 | (16 | ) | 575 | 467 | (108 | ) | 990 | 866 | (124 | ) | ||||||||||||||||||||||||
| RMBS |
1,187 | 1,155 | (32 | ) | 1,379 | 1,000 | (379 | ) | 2,566 | 2,155 | (411 | ) | ||||||||||||||||||||||||
| U.S. Treasuries |
1,142 | 1,073 | (69 | ) | 158 | 117 | (41 | ) | 1,300 | 1,190 | (110 | ) | ||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
| Total fixed maturities, AFS |
7,647 | 7,333 | (309 | ) | 10,621 | 8,581 | (2,019 | ) | 18,268 | 15,914 | (2,328 | ) | ||||||||||||||||||||||||
| Equity securities. AFS |
18 | 17 | (1 | ) | 148 | 108 | (40 | ) | 166 | 125 | (41 | ) | ||||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
| Total AFS securities in an unrealized loss |
$ | 7,665 | $ | 7,350 | $ | (310 | ) | $ | 10,769 | $ | 8,689 | $ | (2,059 | ) | $ | 18,434 | $ | 16,039 | $ | (2,369 | ) | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||||
As of December 31, 2011, AFS securities in an unrealized loss position, comprised of 1,922 securities, primarily related to corporate securities primarily within the financial services sector, CMBS and RMBS which have experienced significant price deterioration. As of December 31, 2011, 73% of these securities were depressed less than 20% of cost or amortized cost. The decline in unrealized losses during 2011 was primarily attributable to a decline in interest rates, partially offset by credit spread widening.
Most of the securities depressed for twelve months or more relate to structured securities with exposure to commercial and residential real estate, as well as certain floating rate corporate securities or those securities with greater than 10 years to maturity, concentrated in the financial services sector. Current market spreads continue to be significantly wider for structured securities with exposure to commercial and residential real estate, as compared to spreads at the security’s respective purchase date, largely due to the economic and market uncertainties regarding future performance of commercial and residential real estate. In addition, the majority of securities have a floating-rate coupon referenced to a market index where rates have declined substantially. The Company neither has an intention to sell nor does it expect to be required to sell the securities outlined above.
Mortgage Loans
| December 31, 2011 | December 31, 2010 | |||||||||||||||||||||||
| Amortized Cost [1] |
Valuation Allowance |
Carrying Value |
Amortized Cost [1] |
Valuation Allowance |
Carrying Value |
|||||||||||||||||||
| Commercial |
$ | 4,205 | $ | (23 | ) | $ | 4,182 | $ | 3,306 | (62 | ) | 3,244 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Total mortgage loans |
$ | 4,205 | $ | (23 | ) | $ | 4,182 | $ | 3,306 | $ | (62 | ) | $ | 3,244 | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| [1] | Amortized cost represents carrying value prior to valuation allowances, if any. |
As of December 31, 2011, the carrying value of mortgage loans associated with the valuation allowance was $347. Included in the table above are mortgage loans held-for-sale with a carrying value and valuation allowance of $57 and $4, respectively, as of December 31, 2011, and $64 and $4, respectively, as of December 31, 2010. The carrying value of these loans is included in mortgage loans in the Company’s Consolidated Balance Sheets. As of December 31, 2011, loans within the Company’s mortgage loan portfolio that have had extensions or restructurings other than what is allowable under the original terms of the contract are immaterial.
The following table presents the activity within the Company’s valuation allowance for mortgage loans. These loans have been evaluated both individually and collectively for impairment. Loans evaluated collectively for impairment are immaterial.
| For the years ended December 31, | ||||||||||||
| 2011 | 2010 | 2009 | ||||||||||
| Balance as of January 1 |
$ | (62 | ) | $ | (260 | ) | $ | (13 | ) | |||
| Additions |
25 | (108 | ) | (292 | ) | |||||||
| Deductions |
14 | 306 | 45 | |||||||||
|
|
|
|
|
|
|
|||||||
| Balance as of December 31 |
$ | (23 | ) | $ | (62 | ) | $ | (260 | ) | |||
|
|
|
|
|
|
|
|||||||
F-33
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Investments and Derivative Instruments (continued)
The current weighted-average LTV ratio of the Company’s commercial mortgage loan portfolio was 66% as of December 31, 2011, while the weighted-average LTV ratio at origination of these loans was 63%. LTV ratios compare the loan amount to the value of the underlying property collateralizing the loan. The loan values are updated no less than annually through property level reviews of the portfolio. Factors considered in the property valuation include, but are not limited to, actual and expected property cash flows, geographic market data and capitalization rates. DSCRs compare a property’s net operating income to the borrower’s principal and interest payments. The current weighted average DSCR of the Company’s commercial mortgage loan portfolio was approximately 1.99x as of December 31, 2011. The Company did not hold any commercial mortgage loans greater than 60 days past due.
The following table presents the carrying value of the Company’s commercial mortgage loans by LTV and DSCR.
| Commercial Mortgage Loans Credit Quality |
||||||||||||||||
| December 31, 2011 | December 31, 2010 | |||||||||||||||
| Loan-to-value |
Carrying Value |
Avg. Debt-Service Coverage Ratio |
Carrying Value |
Avg. Debt-Service Coverage Ratio |
||||||||||||
| Greater than 80% |
$ | 422 | 1.67x | $ | 961 | 1.67x | ||||||||||
| 65% - 80% |
1,779 | 1.57x | 1,366 | 2.11x | ||||||||||||
| Less than 65% |
1,981 | 2.45x | 917 | 2.44x | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total commercial mortgage loans |
$ | 4,182 | 1.99x | $ | 3,244 | 2.07x | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
The following tables present the carrying value of the Company’s mortgage loans by region and property type.
| Mortgage Loans by Region |
||||||||||||||||
| December 31, 2011 | December 31, 2010 | |||||||||||||||
| Carrying Value |
Percent of Total |
Carrying Value |
Percent of Total |
|||||||||||||
| East North Central |
$ | 59 | 1.4 | % | $ | 51 | 1.6 | % | ||||||||
| Middle Atlantic |
401 | 9.6 | % | 344 | 10.6 | % | ||||||||||
| Mountain |
61 | 1.5 | % | 49 | 1.5 | % | ||||||||||
| New England |
202 | 4.8 | % | 188 | 5.8 | % | ||||||||||
| Pacific |
1,268 | 30.3 | % | 898 | 27.7 | % | ||||||||||
| South Atlantic |
810 | 19.4 | % | 679 | 20.9 | % | ||||||||||
| West North Central |
16 | 0.4 | % | 19 | 0.6 | % | ||||||||||
| West South Central |
115 | 2.7 | % | 117 | 3.6 | % | ||||||||||
| Other [1] |
1,250 | 29.9 | % | 899 | 27.7 | % | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total mortgage loans |
$ | 4,182 | 100.0 | % | $ | 3,244 | 100.0 | % | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| [1] | Primarily represents loans collateralized by multiple properties in various regions. |
| Mortgage Loans by Property Type |
||||||||||||||||
| December 31, 2011 | December 31, 2010 | |||||||||||||||
| Carrying Value |
Percent of Total |
Carrying Value |
Percent of Total |
|||||||||||||
| Commercial |
||||||||||||||||
| Agricultural |
$ | 127 | 3.0 | % | $ | 177 | 5.5 | % | ||||||||
| Industrial |
1,262 | 30.1 | % | 833 | 25.7 | % | ||||||||||
| Lodging |
84 | 2.0 | % | 123 | 3.8 | % | ||||||||||
| Multifamily |
734 | 17.6 | % | 479 | 14.8 | % | ||||||||||
| Office |
836 | 20.0 | % | 796 | 24.5 | % | ||||||||||
| Retail |
918 | 22.0 | % | 556 | 17.1 | % | ||||||||||
| Other |
221 | 5.3 | % | 280 | 8.6 | % | ||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total mortgage loans |
$ | 4,182 | 100.0 | % | $ | 3,244 | 100.0 | % | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
F-34
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Investments and Derivative Instruments (continued)
Variable Interest Entities
The Company is involved with various special purpose entities and other entities that are deemed to be VIEs primarily as a collateral manager and as an investor through normal investment activities, as well as a means of accessing capital. A VIE is an entity that either has investors that lack certain essential characteristics of a controlling financial interest or lacks sufficient funds to finance its own activities without financial support provided by other entities.
The Company performs ongoing qualitative assessments of its VIEs to determine whether the Company has a controlling financial interest in the VIE and therefore is the primary beneficiary. The Company is deemed to have a controlling financial interest when it has both the ability to direct the activities that most significantly impact the economic performance of the VIE and the obligation to absorb losses or right to receive benefits from the VIE that could potentially be significant to the VIE. Based on the Company’s assessment, if it determines it is the primary beneficiary, the Company consolidates the VIE in the Company’s Consolidated Financial Statements.
Consolidated VIEs
The following table presents the carrying value of assets and liabilities, and the maximum exposure to loss relating to the VIEs for which the Company is the primary beneficiary. Creditors have no recourse against the Company in the event of default by these VIEs nor does the Company have any implied or unfunded commitments to these VIEs. The Company’s financial or other support provided to these VIEs is limited to its investment management services and original investment.
| December 31, 2011 | December 31, 2010 | |||||||||||||||||||||||
| Total Assets |
Total Liabilities [1] |
Maximum Exposure to Loss [2] |
Total Assets |
Total Liabilities [1] |
Maximum Exposure to Loss [2] |
|||||||||||||||||||
| CDOs [3] |
$ | 491 | $ | 474 | $ | 25 | $ | 729 | $ | 416 | $ | 265 | ||||||||||||
| Limited partnerships |
7 | 3 | 4 | 14 | 6 | 8 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Total |
$ | 498 | $ | 477 | $ | 29 | $ | 743 | $ | 422 | $ | 273 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| [1] | Included in other liabilities in the Company’s Consolidated Balance Sheets. |
| [2] | The maximum exposure to loss represents the maximum loss amount that the Company could recognize as a reduction in net investment income or as a realized capital loss and is the cost basis of the Company’s investment. |
| [3] | Total assets included in fixed maturities, AFS, and fixed maturities, FVO, in the Company’s Consolidated Balance Sheets. |
CDOs represent structured investment vehicles for which the Company has a controlling financial interest as it provides collateral management services, earns a fee for those services and also holds investments in the securities issued by these vehicles. Limited partnerships represent one hedge fund for which the Company holds a majority interest in the fund as an investment.
Non-Consolidated VIEs
The Company does not hold any investments issued by VIEs for which the Company is not the primary beneficiary as of December 31, 2011 and 2010.
In addition, the Company, through normal investment activities, makes passive investments in structured securities issued by VIEs for which the Company is not the manager which are included in ABS, CDOs, CMBS and RMBS in the Available-for-Sale Securities table and fixed maturities, FVO, in the Company’s Consolidated Balance Sheets. The Company has not provided financial or other support with respect to these investments other than its original investment. For these investments, the Company determined it is not the primary beneficiary due to the relative size of the Company’s investment in comparison to the principal amount of the structured securities issued by the VIEs, the level of credit subordination which reduces the Company’s obligation to absorb losses or right to receive benefits and the Company’s inability to direct the activities that most significantly impact the economic performance of the VIEs. The Company’s maximum exposure to loss on these investments is limited to the amount of the Company’s investment.
F-35
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Investments and Derivative Instruments (continued)
Equity Method Investments
The Company has investments in limited partnerships and other alternative investments which include hedge funds, mortgage and real estate funds, mezzanine debt funds, and private equity and other funds (collectively, “limited partnerships”). These investments are accounted for under the equity method and the Company’s maximum exposure to loss as of December 31, 2011 is limited to the total carrying value of $1.4 billion. In addition, the Company has outstanding commitments totaling approximately $376, to fund limited partnership and other alternative investments as of December 31, 2011. The Company’s investments in limited partnerships are generally of a passive nature in that the Company does not take an active role in the management of the limited partnerships. In 2011, aggregate investment income (losses) from limited partnerships and other alternative investments exceeded 10% of the Company’s pre-tax consolidated net income. Accordingly, the Company is disclosing aggregated summarized financial data for the Company’s limited partnership investments. This aggregated summarized financial data does not represent the Company’s proportionate share of limited partnership assets or earnings. Aggregate total assets of the limited partnerships in which the Company invested totaled $75.7 billion and $81.6 billion as of December 31, 2011 and 2010, respectively. Aggregate total liabilities of the limited partnerships in which the Company invested totaled $13.8 billion and $15.6 billion as of December 31, 2011 and 2010, respectively. Aggregate net investment income (loss) of the limited partnerships in which the Company invested totaled $1.2 billion, $927 and ($437) for the periods ended December 31, 2011, 2010 and 2009, respectively. Aggregate net income (loss) of the limited partnerships in which the Company invested totaled $8.1 billion, $9.7 billion, and ($6.9) billion for the periods ended December 31, 2011, 2010 and 2009, respectively. As of, and for the period ended, December 31, 2011, the aggregated summarized financial data reflects the latest available financial information.
Derivative Instruments
The Company utilizes a variety of over-the-counter and exchange traded derivative instruments as a part of its overall risk management strategy, as well as to enter into replication transactions. Derivative instruments are used to manage risk associated with interest rate, equity market, credit spread, issuer default, price, and currency exchange rate risk or volatility. Replication transactions are used as an economical means to synthetically replicate the characteristics and performance of assets that would otherwise be permissible investments under the Company’s investment policies. The Company also purchases and issues financial instruments and products that either are accounted for as free-standing derivatives, such as certain reinsurance contracts, or may contain features that are deemed to be embedded derivative instruments, such as the GMWB rider included with certain variable annuity products.
Cash flow hedges
Interest rate swaps
Interest rate swaps are primarily used to convert interest receipts on floating-rate fixed maturity securities or interest payments on floating-rate guaranteed investment contracts to fixed rates. These derivatives are predominantly used to better match cash receipts from assets with cash disbursements required to fund liabilities.
The Company also enters into forward starting swap agreements to hedge the interest rate exposure related to the purchase of fixed-rate securities. These derivatives are primarily structured to hedge interest rate risk inherent in the assumptions used to price certain liabilities.
Foreign currency swaps
Foreign currency swaps are used to convert foreign currency-denominated cash flows related to certain investment receipts and liability payments to U.S. dollars in order to minimize cash flow fluctuations due to changes in currency rates.
Fair value hedges
Interest rate swaps
Interest rate swaps are used to hedge the changes in fair value of certain fixed rate liabilities and fixed maturity securities due to fluctuations in interest rates.
Foreign currency swaps
Foreign currency swaps are used to hedge the changes in fair value of certain foreign currency-denominated fixed rate liabilities due to changes in foreign currency rates by swapping the fixed foreign payments to floating rate U.S. dollar denominated payments.
F-36
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Investments and Derivative Instruments (continued)
Non-qualifying strategies
Interest rate swaps, swaptions, caps, floors, and futures
The Company uses interest rate swaps, swaptions, caps, floors, and futures to manage duration between assets and liabilities in certain investment portfolios. In addition, the Company enters into interest rate swaps to terminate existing swaps, thereby offsetting the changes in value of the original swap. As of December 31, 2011 and 2010, the notional amount of interest rate swaps in offsetting relationships was $5.1 billion and $4.7 billion, respectively.
Foreign currency swaps and forwards
The Company enters into foreign currency swaps and forwards to convert the foreign currency exposures of certain foreign currency-denominated fixed maturity investments to U.S. dollars.
Japan 3Win foreign currency swaps
Prior to the second quarter of 2009, The Company offered certain variable annuity products with a GMIB rider through an affiliate, HLIKK, in Japan. The GMIB rider is reinsured to a wholly-owned U.S. subsidiary, which invests in U.S. dollar denominated assets to support the liability. The U.S. subsidiary entered into pay U.S. dollar, receive yen forward contracts to hedge the currency and interest rate exposure between the U.S. dollar denominated assets and the yen denominated fixed liability reinsurance payments.
Japanese fixed annuity hedging instruments
Prior to the second quarter of 2009, The Company offered a yen denominated fixed annuity product through HLIKK and reinsured to a wholly-owned U.S. subsidiary. The U.S. subsidiary invests in U.S. dollar denominated securities to support the yen denominated fixed liability payments and entered into currency rate swaps to hedge the foreign currency exchange rate and yen interest rate exposures that exist as a result of U.S. dollar assets backing the yen denominated liability.
Credit derivatives that purchase credit protection
Credit default swaps are used to purchase credit protection on an individual entity or referenced index to economically hedge against default risk and credit-related changes in value on fixed maturity securities. These contracts require the Company to pay a periodic fee in exchange for compensation from the counterparty should the referenced security issuers experience a credit event, as defined in the contract.
Credit derivatives that assume credit risk
Credit default swaps are used to assume credit risk related to an individual entity, referenced index, or asset pool, as a part of replication transactions. These contracts entitle the Company to receive a periodic fee in exchange for an obligation to compensate the derivative counterparty should the referenced security issuers experience a credit event, as defined in the contract. The Company is also exposed to credit risk due to credit derivatives embedded within certain fixed maturity securities. These securities are primarily comprised of structured securities that contain credit derivatives that reference a standard index of corporate securities.
Credit derivatives in offsetting positions
The Company enters into credit default swaps to terminate existing credit default swaps, thereby offsetting the changes in value of the original swap going forward.
Equity index swaps, options and futures
The Company offers certain equity indexed products, which may contain an embedded derivative that requires bifurcation. The Company enters into S&P index swaps and options to economically hedge the equity volatility risk associated with these embedded derivatives. In addition, during third quarter of 2011 the Company entered into equity index options and futures with the purpose of hedging the impact of an adverse equity market environment on the investment portfolio.
F-37
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Investments and Derivative Instruments (continued)
U.S. GMWB product derivatives
The Company offers certain variable annuity products with a GMWB rider in the U.S. The GMWB is a bifurcated embedded derivative that 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. Certain contract provisions can increase the GRB at contractholder election or after the passage of time. The notional value of the embedded derivative is the GRB.
U.S. GMWB reinsurance contracts
The Company has entered into reinsurance arrangements to offset a portion of its risk exposure to the GMWB for the remaining lives of covered variable annuity contracts. Reinsurance contracts covering GMWB are accounted for as free-standing derivatives. The notional amount of the reinsurance contracts is the GRB amount.
U.S. GMWB hedging instruments
The Company enters into derivative contracts to partially hedge exposure associated with a portion of the GMWB liabilities that are not reinsured. These derivative contracts include customized swaps, interest rate swaps and futures, and equity swaps, options, and futures, on certain indices including the S&P 500 index, EAFE index, and NASDAQ index.
The following table represents notional and fair value for U.S. GMWB hedging instruments.
| Notional Amount | Fair Value | |||||||||||||||
| December 31, 2011 |
December 31, 2010 |
December 31, 2011 |
December 31, 2010 |
|||||||||||||
| Customized swaps |
$ | 8,389 | $ | 10,113 | $ | 385 | $ | 209 | ||||||||
| Equity swaps, options, and futures |
5,320 | 4,943 | 498 | 391 | ||||||||||||
| Interest rate swaps and futures |
2,697 | 2,800 | 11 | (133 | ) | |||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total |
$ | 16,406 | $ | 17,856 | $ | 894 | $ | 467 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
U.S. macro hedge program
The Company utilizes equity options and futures contracts to partially hedge against a decline in the equity markets and the resulting statutory surplus and capital impact primarily arising from GMDB, GMIB and GMWB obligations.
The following table represents notional and fair value for the U.S. macro hedge program.
| Notional Amount | Fair Value | |||||||||||||||
| December 31, 2011 |
December 31, 2010 |
December 31, 2011 |
December 31, 2010 |
|||||||||||||
| Equity futures |
59 | 166 | $ | — | $ | — | ||||||||||
| Equity options |
6,760 | 12,891 | 357 | 203 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total |
$ | 6,819 | $ | 13,057 | $ | 357 | $ | 203 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
International program product derivatives
The Company formerly offered certain variable annuity products with GMWB or GMAB riders in the U.K. and Japan. The GMWB and GMAB are bifurcated embedded derivatives. The GMWB provides the policyholder with a GRB if the account value is reduced to zero through a combination of market declines and withdrawals. The GRB is generally equal to premiums less withdrawals. Certain contract provisions can increase the GRB at contractholder election or after the passage of time. The GMAB provides the policyholder with their initial deposit in a lump sum after a specified waiting period. The notional amount of the embedded derivatives are the foreign currency denominated GRBs converted to U.S. dollars at the current foreign spot exchange rate as of the reporting period date.
International program hedging instruments
The Company utilizes equity futures, options and swaps, and currency forwards, and options to partially hedge against a decline in the debt and equity markets or changes in foreign currency exchange rates and the resulting statutory surplus and capital impact primarily arising from GMDB, GMIB and GMWB obligations issued in the U.K. and Japan. The Company also enters into foreign currency denominated interest rate swaps and swaptions to hedge the interest rate exposure related to the potential annuitization of certain benefit obligations.
F-38
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Investments and Derivative Instruments (continued)
The following table represents notional and fair value for the international program hedging instruments.
| Notional Amount | Fair Value | |||||||||||||||
| December 31, 2011 |
December 31, 2010 |
December 31, 2011 |
December 31, 2010 |
|||||||||||||
| Currency forwards |
$ | 8,622 | $ | 4,951 | $ | 446 | $ | 166 | ||||||||
| Currency options [1] |
7,038 | 5,296 | 72 | 62 | ||||||||||||
| Equity futures |
2,691 | 1,002 | — | — | ||||||||||||
| Equity options |
1,120 | 1,073 | (3 | ) | 4 | |||||||||||
| Equity swaps |
392 | 369 | (8 | ) | 1 | |||||||||||
| Interest rate futures |
739 | — | — | — | ||||||||||||
| Interest rate swaps and swaptions |
8,117 | — | 35 | — | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total |
$ | 28,719 | $ | 12,691 | $ | 542 | $ | 233 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| [1] | As of December 31, 2011 and 2010, notional amounts include $5.3 billion and $3.1 billion, respectively, related to long positions and $2.1 billion and $2.2 billion, respectively, related to short positions. |
GMAB, GMWB and GMIB reinsurance contracts
The Company reinsured the GMAB, GMWB, and GMIB embedded derivatives for host variable annuity contracts written by HLIKK. The reinsurance contracts are accounted for as free-standing derivative contracts. The notional amount of the reinsurance contracts is the yen denominated GRB balance value converted at the period-end yen to U.S. dollar foreign spot exchange rate. For further information on this transaction, refer to Note 16 of the Notes to Consolidated Financial Statements.
Coinsurance and modified coinsurance reinsurance contracts
During 2010, a subsidiary entered into a coinsurance with funds withheld and modified coinsurance reinsurance agreement with an affiliated captive reinsurer, which creates an embedded derivative. In addition, provisions of this agreement include reinsurance to cede a portion of direct written U.S. GMWB riders, which is accounted for as an embedded derivative. Additional provisions of this agreement cede variable annuity contract GMAB, GMWB and GMIB riders reinsured by the Company that have been assumed from HLIKK and is accounted for as a free-standing derivative. For further information on this transaction, refer to Note 16 of the Notes to Consolidated Financial Statements.
F-39
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Investments and Derivative Instruments (continued)
Derivative Balance Sheet Classification
The table below summarizes the balance sheet classification of the Company’s derivative related fair value amounts, as well as the gross asset and liability fair value amounts. The fair value amounts presented do not include income accruals or cash collateral held amounts, which are netted with derivative fair value amounts to determine balance sheet presentation. Derivatives in the Company’s separate accounts are not included because the associated gains and losses accrue directly to policyholders. The Company’s derivative instruments are held for risk management purposes, unless otherwise noted in the table below. The notional amount of derivative contracts represents the basis upon which pay or receive amounts are calculated and is presented in the table to quantify the volume of the Company’s derivative activity. Notional amounts are not necessarily reflective of credit risk.
| Net Derivatives | Asset Derivatives | Liability Derivatives | ||||||||||||||||||||||||||||||
| Notional Amount | Fair Value | Fair Value | Fair Value | |||||||||||||||||||||||||||||
| Hedge Designation/ Derivative Type |
Dec. 31, 2011 |
Dec. 31, 2010 |
Dec. 31, 2011 |
Dec. 31, 2010 |
Dec. 31, 2011 |
Dec. 31, 2010 |
Dec. 31, 2011 |
Dec. 31, 2010 |
||||||||||||||||||||||||
| Cash flow hedges |
||||||||||||||||||||||||||||||||
| Interest rate swaps |
$ | 6,339 | $ | 7,652 | $ | 276 | $ | 144 | $ | 276 | $ | 182 | $ | — | $ | (38 | ) | |||||||||||||||
| Foreign currency swaps |
229 | 255 | (5 | ) | — | 17 | 18 | (22 | ) | (18 | ) | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Total cash flow hedges |
6,568 | 7,907 | 271 | 144 | 293 | 200 | (22 | ) | (56 | ) | ||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Fair value hedges |
||||||||||||||||||||||||||||||||
| Interest rate swaps |
1,007 | 1,079 | (78 | ) | (47 | ) | — | 4 | (78 | ) | (51 | ) | ||||||||||||||||||||
| Foreign currency swaps |
677 | 677 | (39 | ) | (12 | ) | 64 | 71 | (103 | ) | (83 | ) | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Total fair value hedges |
1,684 | 1,756 | (117 | ) | (59 | ) | 64 | 75 | (181 | ) | (134 | ) | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Non-qualifying strategies |
||||||||||||||||||||||||||||||||
| Interest rate contracts |
||||||||||||||||||||||||||||||||
| Interest rate swaps, swaptions, caps, floors, and futures |
6,252 | 5,490 | (435 | ) | (255 | ) | 417 | 121 | (852 | ) | (376 | ) | ||||||||||||||||||||
| Foreign exchange contracts |
||||||||||||||||||||||||||||||||
| Foreign currency swaps and forwards |
208 | 196 | (10 | ) | (14 | ) | 3 | — | (13 | ) | (14 | ) | ||||||||||||||||||||
| Japan 3Win foreign currency swaps |
2,054 | 2,285 | 184 | 177 | 184 | 177 | — | — | ||||||||||||||||||||||||
| Japanese fixed annuity hedging instruments |
1,945 | 2,119 | 514 | 608 | 540 | 608 | (26 | ) | — | |||||||||||||||||||||||
| Credit contracts |
||||||||||||||||||||||||||||||||
| Credit derivatives that purchase credit protection |
1,134 | 1,730 | 23 | (5 | ) | 35 | 18 | (12 | ) | (23 | ) | |||||||||||||||||||||
| Credit derivatives that assume credit risk [1] |
2,212 | 2,035 | (545 | ) | (376 | ) | 2 | 7 | (547 | ) | (383 | ) | ||||||||||||||||||||
| Credit derivatives in offsetting positions |
5,020 | 5,175 | (43 | ) | (57 | ) | 101 | 60 | (144 | ) | (117 | ) | ||||||||||||||||||||
| Equity contracts |
||||||||||||||||||||||||||||||||
| Equity index swaps and options |
1,433 | 188 | 23 | (10 | ) | 36 | 5 | (13 | ) | (15 | ) | |||||||||||||||||||||
| Variable annuity hedge program |
||||||||||||||||||||||||||||||||
| U.S. GMWB product derivatives [2] |
34,569 | 40,255 | (2,538 | ) | (1,611 | ) | — | — | (2,538 | ) | (1,611 | ) | ||||||||||||||||||||
| U.S. GMWB reinsurance contracts |
7,193 | 8,767 | 443 | 280 | 443 | 280 | — | — | ||||||||||||||||||||||||
| U.S. GMWB hedging instruments |
16,406 | 17,856 | 894 | 467 | 1,022 | 647 | (128 | ) | (180 | ) | ||||||||||||||||||||||
| U.S. macro hedge program |
6,819 | 13,057 | 357 | 203 | 357 | 203 | — | — | ||||||||||||||||||||||||
| International program product derivatives [2] |
2,009 | 2,023 | (30 | ) | (14 | ) | — | — | (30 | ) | (14 | ) | ||||||||||||||||||||
| International program hedging instruments |
28,719 | 12,691 | 542 | 233 | 672 | 243 | (130 | ) | (10 | ) | ||||||||||||||||||||||
| Other |
||||||||||||||||||||||||||||||||
| GMAB, GMWB, and GMIB reinsurance contracts |
21,627 | 21,423 | (3,207 | ) | (2,633 | ) | — | — | (3,207 | ) | (2,633 | ) | ||||||||||||||||||||
| Coinsurance and modified coinsurance reinsurance contracts |
50,756 | 51,934 | 2,630 | 1,722 | 2,901 | 2,342 | (271 | ) | (620 | ) | ||||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Total non-qualifying strategies |
188,356 | 187,224 | (1,198 | ) | (1,285 | ) | 6,713 | 4,711 | (7,911 | ) | (5,996 | ) | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Total cash flow hedges, fair value hedges, and non-qualifying strategies |
$ | 196,608 | $ | 196,887 | $ | (1,044 | ) | $ | (1,200 | ) | $ | 7,070 | $ | 4,986 | $ | (8,114 | ) | $ | (6,186 | ) | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Balance Sheet Location |
||||||||||||||||||||||||||||||||
| Fixed maturities, available-for-sale |
$ | 416 | $ | 441 | $ | (45 | ) | $ | (26 | ) | $ | — | $ | — | $ | (45 | ) | $ | (26 | ) | ||||||||||||
| Other investments |
51,231 | 51,633 | 1,971 | 1,453 | 2,745 | 2,021 | (774 | ) | (568 | ) | ||||||||||||||||||||||
| Other liabilities |
28,717 | 20,318 | (254 | ) | (357 | ) | 981 | 343 | (1,235 | ) | (700 | ) | ||||||||||||||||||||
| Consumer notes |
35 | 39 | (4 | ) | (5 | ) | — | — | (4 | ) | (5 | ) | ||||||||||||||||||||
| Reinsurance recoverables |
55,140 | 58,834 | 3,073 | 2,002 | 3,344 | 2,622 | (271 | ) | (620 | ) | ||||||||||||||||||||||
| Other policyholder funds and benefits payable |
61,069 | 65,622 | (5,785 | ) | (4,267 | ) | — | — | (5,785 | ) | (4,267 | ) | ||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| Total derivatives |
$ | 196,608 | $ | 196,887 | $ | (1,044 | ) | $ | (1,200 | ) | $ | 7,070 | $ | 4,986 | $ | (8,114 | ) | $ | (6,186 | ) | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||||||
| [1] | The derivative instruments related to this strategy are held for other investment purposes. |
| [2] | These derivatives are embedded within liabilities and are not held for risk management purposes. |
F-40
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Investments and Derivative Instruments (continued)
Change in Notional Amount
The net decrease in notional amount of derivatives since December 31, 2010, was primarily due to the following:
| • | The decrease of $8.7 billion in the combined GMWB hedging program, which includes the GMWB product, reinsurance, and hedging derivatives, was primarily a result of policyholder lapses and withdrawals. |
| • | The U.S. macro hedge program notional decreased $6.2 billion primarily due to the expiration of certain out of the money options in January of 2011. |
| • | During 2011, the Company significantly strengthened its hedge protection of variable annuity products offered in Japan. As such, the notional amount related to the international program hedging instruments increased by $16.0 billion as the Company entered into additional foreign currency denominated interest rate swaps and swaptions, currency forwards, currency options and equity futures. |
| • | The coinsurance and modified coinsurance reinsurance contract notional decreased $1.2 billion primarily due to policyholder lapses and withdrawals. |
Change in Fair Value
The improvement in the total fair value of derivative instruments since December 31, 2010, was primarily related to the following:
| • | The fair value related to the international program hedging instruments increased as a result of the additional notional added during the year, as well as strengthening of the Japanese yen, lower global equity markets, and a decrease in interest rates. |
| • | The decrease in the combined GMWB hedging program, which includes the GMWB product, reinsurance, and hedging derivatives, was primarily a result of a general decrease in long-term interest rates and higher interest rate volatility. |
| • | Under an internal reinsurance agreement with an affiliate, the decrease in fair value associated with the GMAB, GMWB, and GMIB reinsurance contracts along with a portion of the GMWB related derivatives are ceded to the affiliated reinsurer and result in an offsetting fair value of the coinsurance and modified coinsurance reinsurance contracts. |
Cash Flow Hedges
For derivative instruments that are designated and qualify as cash flow hedges, the effective portion of the gain or loss on the derivative is reported as a component of OCI and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing hedge ineffectiveness are recognized in current earnings. All components of each derivative’s gain or loss were included in the assessment of hedge effectiveness.
The following table presents the components of the gain or loss on derivatives that qualify as cash flow hedges:
| Derivatives in Cash Flow Hedging Relationships |
||||||||||||||||||||||||||
| Gain (Loss) Recognized in OCI on Derivative (Effective Portion) |
Net Realized Capital Gains (Losses) Recognized in Income on Derivative (Ineffective Portion) |
|||||||||||||||||||||||||
| 2011 | 2010 | 2009 | 2011 | 2010 | 2009 | |||||||||||||||||||||
| Interest rate swaps |
$ | 245 | $ | 232 | $ | (357 | ) | $ | (2 | ) | $ | 2 | $ | 1 | ||||||||||||
| Foreign currency swaps |
(5 | ) | 3 | (177 | ) | — | (1 | ) | 75 | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||||||||
| Total |
$ | 240 | $ | 235 | $ | (534 | ) | $ | (2 | ) | $ | 1 | $ | 76 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|
||||||||||||||
| Derivatives in Cash Flow Hedging Relationships |
||||||||||||||
| Gain (Loss) Reclassified from AOCI into Income (Effective Portion) |
||||||||||||||
| 2011 | 2010 | 2009 | ||||||||||||
| Interest rate swaps |
Net realized capital gains (losses) | $ | 6 | $ | 5 | $ | — | |||||||
| Interest rate swaps |
Net investment income (loss) | 77 | 56 | 28 | ||||||||||
| Foreign currency swaps |
Net realized capital gains (losses) | (1 | ) | (7 | ) | (115 | ) | |||||||
| Foreign currency swaps |
Net investment income (loss) | — | — | 2 | ||||||||||
|
|
|
|
|
|
|
|||||||||
| Total |
$ | 82 | $ | 54 | $ | (85 | ) | |||||||
|
|
|
|
|
|
|
|||||||||
F-41
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Investments and Derivative Instruments (continued)
As of December 31, 2011, the before-tax deferred net gains on derivative instruments recorded in AOCI that are expected to be reclassified to earnings during the next twelve months are $76. This expectation is based on the anticipated interest payments on hedged investments in fixed maturity securities that will occur over the next twelve months, at which time the Company will recognize the deferred net gains (losses) as an adjustment to interest income over the term of the investment cash flows. The maximum term over which the Company is hedging its exposure to the variability of future cash flows (for forecasted transactions, excluding interest payments on existing variable-rate financial instruments) is approximately one year.
During the year ended December 31, 2011, the Company had no net reclassifications from AOCI to earnings resulting from the discontinuance of cash-flow hedges due to forecasted transactions that were no longer probable of occurring. For the years ended December 31, 2010 and 2009, the Company had less than $1 and $1 of net reclassifications, respectively, from AOCI to earnings resulting from the discontinuance of cash-flow hedges due to forecasted transactions that were no longer probable of occurring.
Fair Value Hedges
For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss on the derivative, as well as the offsetting loss or gain on the hedged item attributable to the hedged risk are recognized in current earnings. The Company includes the gain or loss on the derivative in the same line item as the offsetting loss or gain on the hedged item. All components of each derivative’s gain or loss were included in the assessment of hedge effectiveness.
The Company recognized in income gains (losses) representing the ineffective portion of fair value hedges as follows:
| Derivatives in Fair Value Hedging Relationships |
||||||||||||||||||||||||
| Gain (Loss) Recognized in Income [1] | ||||||||||||||||||||||||
| 2011 | 2010 | 2009 | ||||||||||||||||||||||
| Derivative | Hedged Item |
Derivative | Hedged Item |
Derivative | Hedged Item |
|||||||||||||||||||
| Interest rate swaps |
||||||||||||||||||||||||
| Net realized capital gains (losses) |
$ | — | $ | — | $ | (44 | ) | $ | 38 | $ | 72 | $ | (68 | ) | ||||||||||
| Benefits, losses and loss adjustment expenses |
(58 | ) | 54 | (1 | ) | 3 | (37 | ) | 40 | |||||||||||||||
| Foreign currency swaps |
||||||||||||||||||||||||
| Net realized capital gains (losses) |
(1 | ) | 1 | 8 | (8 | ) | 51 | (51 | ) | |||||||||||||||
| Benefits, losses and loss adjustment expenses |
(22 | ) | 22 | (12 | ) | 12 | 2 | (2 | ) | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Total |
$ | (81 | ) | $ | 77 | $ | (49 | ) | $ | 45 | $ | 88 | $ | (81 | ) | |||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| [1] | The amounts presented do not include the periodic net coupon settlements of the derivative or the coupon income (expense) related to the hedged item. The net of the amounts presented represents the ineffective portion of the hedge. |
F-42
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Investments and Derivative Instruments (continued)
Non-qualifying Strategies
For non-qualifying strategies, including embedded derivatives that are required to be bifurcated from their host contracts and accounted for as derivatives, the gain or loss on the derivative is recognized currently in earnings within net realized capital gains (losses). The following table presents the gain or loss recognized in income on non-qualifying strategies:
| Non-qualifying Strategies Gain (Loss) Recognized within Net Realized Capital Gains (Losses) |
||||||||||||
| December 31, | ||||||||||||
| 2011 | 2010 | 2009 | ||||||||||
| Interest rate contracts |
||||||||||||
| Interest rate swaps, caps, floors, and forwards |
$ | 20 | $ | 14 | $ | 32 | ||||||
| Foreign exchange contracts |
||||||||||||
| Foreign currency swaps and forwards |
1 | (3 | ) | (37 | ) | |||||||
| Japan 3Win foreign currency swaps [1] |
31 | 215 | (22 | ) | ||||||||
| Japanese fixed annuity hedging instruments [2] |
109 | 385 | (12 | ) | ||||||||
| Credit contracts |
||||||||||||
| Credit derivatives that purchase credit protection |
(8 | ) | (17 | ) | (379 | ) | ||||||
| Credit derivatives that assume credit risk |
(141 | ) | 157 | 137 | ||||||||
| Equity contracts |
||||||||||||
| Equity index swaps and options |
(67 | ) | 5 | (3 | ) | |||||||
| Variable annuity hedge program |
||||||||||||
| U.S. GMWB product derivatives |
(780 | ) | 486 | 4,686 | ||||||||
| U.S. GMWB reinsurance contracts |
131 | (102 | ) | (988 | ) | |||||||
| U.S. GMWB hedging instruments |
252 | (295 | ) | (2,234 | ) | |||||||
| U.S. macro hedge program |
(216 | ) | (445 | ) | (733 | ) | ||||||
| International program product derivative |
(12 | ) | 24 | 41 | ||||||||
| International program hedging instruments |
735 | (37 | ) | (179 | ) | |||||||
| Other |
||||||||||||
| GMAB, GMWB, and GMIB reinsurance contracts |
(326 | ) | (769 | ) | 1,106 | |||||||
| Coinsurance and modified coinsurance reinsurance contracts |
373 | 284 | (577 | ) | ||||||||
|
|
|
|
|
|
|
|||||||
| Total |
$ | 102 | $ | (98 | ) | $ | 838 | |||||
|
|
|
|
|
|
|
|||||||
| [1] | The associated liability is adjusted for changes in spot rates through realized capital gains and was ($100), ($273) and $64 for the years ended December 31, 2011, 2010 and 2009, respectively. |
| [2] | The associated liability is adjusted for changes in spot rates through realized capital gains and losses and was ($129), ($332) and $67 for the years ended December 31, 2011, 2010 and 2009, respectively. |
For the year ended December 31, 2011, the net realized capital gain (loss) related to derivatives used in non-qualifying strategies was primarily comprised of the following:
| • | The net gain associated with the international program hedging instruments was primarily driven by strengthening of the Japanese yen, lower global equity markets, and a decrease in interest rates. |
| • | The loss related to the combined GMWB hedging program, which includes the GMWB product, reinsurance, and hedging derivatives, was primarily a result of a general decrease in long-term interest rates and higher interest rate volatility. |
| • | The net loss associated with GMAB, GMWB, and GMIB reinsurance contracts, which are reinsured to an affiliated captive reinsurer, was primarily due to the strengthening of the Japanese yen and a decrease in equity markets. |
| • | The net gain on the coinsurance and modified coinsurance reinsurance agreement, which is accounted for as a derivative instrument primarily offsets the net loss on GMAB, GMWB, and GMIB reinsurance contracts. For a discussion related to the reinsurance agreement refer to Note 16 of the Notes to Consolidated Financial Statements for more information on this transaction. |
| • | The net loss on U.S. macro hedge program was primarily driven by time decay and a decrease in equity market volatility since the purchase date of certain options during the fourth quarter. |
F-43
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Investments and Derivative Instruments (continued)
For the year ended December 31, 2010, the net realized capital gain (loss) related to derivatives used in non-qualifying strategies was primarily comprised of the following:
| • | The net loss on derivatives associated with GMAB, GMWB, and GMIB reinsurance contracts, which are reinsured to an affiliated captive reinsurer, was primarily due to a decrease in Japan interest rates, an increase in Japan currency volatility and a decrease in Japan equity markets. |
| • | The net loss associated with the U.S. macro hedge program was primarily due to a higher equity market valuation, time decay, and lower implied market volatility. |
| • | The net gain on the Japanese fixed annuity hedging instruments was primarily due to the strengthening of the Japanese yen in comparison to the U.S. dollar. |
| • | The net gain related to the Japan 3 Win foreign currency swaps was primarily due to the strengthening of the Japanese yen in comparison to the U.S. dollar, partially offset by the decrease in U.S. long-term interest rates. |
| • | The net gain on the coinsurance and modified coinsurance reinsurance agreement, which is accounted for as a derivative instrument, primarily offsets the net loss on GMAB, GMWB, and GMIB reinsurance contracts. For a discussion related to the reinsurance agreement refer to Note 16 for more information on this transaction. |
| • | The net gain associated with credit derivatives that assume credit risk as a part of replication transactions resulted from credit spread tightening. |
| • | The gain related to the combined GMWB hedging program, which includes the GMWB product, reinsurance, and hedging derivatives, was primarily a result of liability model assumption updates during third quarter, lower implied market volatility, and outperformance of the underlying actively managed funds as compared to their respective indices, partially offset by a general decrease in long-term interest rates and rising equity markets. |
| • | The gain on Japan variable annuity hedges was primarily driven by the appreciation of Japanese yen in comparison to the euro. |
For the year ended December 31, 2009, the net realized capital gain (loss) related to derivatives used in non-qualifying strategies was primarily due to the following:
| • | The gain related to the net GMWB product, reinsurance, and hedging derivatives was primarily due to liability model assumption updates given favorable trends in policyholder experience, the relative outperformance of the underlying actively managed funds as compared to their respective indices, and the impact of the Company’s own credit standing. Additional net gains on GMWB related derivatives include lower implied market volatility and a general increase in long-term interest rates, partially offset by rising equity markets. |
| • | The net gain on derivatives associated with GMAB, GMWB, and GMIB reinsurance contracts, which are reinsured to an affiliated captive reinsurer, was primarily due to an increase in interest rates, an increase in the Japan equity markets, a decline in Japan equity market volatility, and liability model assumption updates for credit standing. |
| • | The net loss on the U.S. macro hedge program was primarily the result of a higher equity market valuation and the impact of trading activity. |
| • | The net loss on the coinsurance and modified coinsurance reinsurance agreement, which is accounted for as a derivative instrument, primarily offsets the net gain on GMAB, GMWB, and GMIB reinsurance contracts. For a discussion related to the reinsurance agreement refer to Note 16 for more information on this transaction. |
In addition, for the year ended December 31, 2009, the Company has incurred losses of $39 on derivative instruments due to counterparty default related to the bankruptcy of Lehman Brothers Inc. These losses were a result of the contractual collateral threshold amounts and open collateral calls in excess of such amounts immediately prior to the bankruptcy filing, as well as interest rate and credit spread movements from the date of the last collateral call to the date of the bankruptcy filing.
Refer to Note 10 for additional disclosures regarding contingent credit related features in derivative agreements.
F-44
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Investments and Derivative Instruments (continued)
Credit Risk Assumed through Credit Derivatives
The Company enters into credit default swaps that assume credit risk of a single entity, referenced index, or asset pool in order to synthetically replicate investment transactions. The Company will receive periodic payments based on an agreed upon rate and notional amount and will only make a payment if there is a credit event. A credit event payment will typically be equal to the notional value of the swap contract less the value of the referenced security issuer’s debt obligation after the occurrence of the credit event. A credit event is generally defined as a default on contractually obligated interest or principal payments or bankruptcy of the referenced entity. The credit default swaps in which the Company assumes credit risk primarily reference investment grade single corporate issuers and baskets, which include standard and customized diversified portfolios of corporate issuers. The diversified portfolios of corporate issuers are established within sector concentration limits and may be divided into tranches that possess different credit ratings.
The following tables present the notional amount, fair value, weighted average years to maturity, underlying referenced credit obligation type and average credit ratings, and offsetting notional amounts and fair value for credit derivatives in which the Company is assuming credit risk as of December 31, 2011 and 2010.
| As of December 31, 2011 |
||||||||||||||||||||||||||||
| Underlying Referenced Credit Obligation(s) [1] |
||||||||||||||||||||||||||||
| Credit Derivative type by derivative risk exposure |
Notional Amount [2] |
Fair Value |
Weighted Average Years to Maturity |
Type | Average Credit Rating |
Offsetting Notional Amount [3] |
Offsetting Fair Value [3] |
|||||||||||||||||||||
| Single name credit default swaps |
||||||||||||||||||||||||||||
| Investment grade risk exposure |
$ | 1,067 | $ | (18 | ) | 3 years | |
Corporate Credit/ Foreign Gov. |
|
A+ | $ | 915 | $ | (19 | ) | |||||||||||||
| Below investment grade risk exposure |
125 | (7 | ) | 2 years | Corporate Credit | B+ | 114 | (3 | ) | |||||||||||||||||||
| Basket credit default swaps [4] |
||||||||||||||||||||||||||||
| Investment grade risk exposure |
2,375 | (71 | ) | 3 years | Corporate Credit | BBB+ | 1,128 | 17 | ||||||||||||||||||||
| Investment grade risk exposure |
353 | (63 | ) | 5 years | CMBS Credit | BBB+ | 353 | 62 | ||||||||||||||||||||
| Below investment grade risk exposure |
477 | (441 | ) | 3 years | Corporate Credit | BBB+ | — | — | ||||||||||||||||||||
| Embedded credit derivatives |
||||||||||||||||||||||||||||
| Investment grade risk exposure |
25 | 24 | 3 years | Corporate Credit | BBB- | — | — | |||||||||||||||||||||
| Below investment grade risk exposure |
300 | 245 | 5 years | Corporate Credit | BB+ | — | — | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
| Total |
$ | 4,722 | $ | (331 | ) | $ | 2,510 | $ | 57 | |||||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
F-45
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Investments and Derivative Instruments (continued)
| As of December 31, 2010 |
||||||||||||||||||||||||||||
| Underlying Referenced Credit Obligation(s) [1] |
||||||||||||||||||||||||||||
| Credit Derivative type by derivative risk exposure |
Notional Amount [2] |
Fair Value |
Weighted Average Years to Maturity |
Type | Average Credit Rating |
Offsetting Notional Amount [3] |
Offsetting Fair Value [3] |
|||||||||||||||||||||
| Single name credit default swaps |
||||||||||||||||||||||||||||
| Investment grade risk exposure |
$ | 1,038 | $ | (6 | ) | 3 years | |
Corporate Credit/ Foreign Gov. |
|
A+ | $ | 945 | $ | (36 | ) | |||||||||||||
| Below investment grade risk exposure |
151 | (6 | ) | 3 years | Corporate Credit | BB- | 135 | (11 | ) | |||||||||||||||||||
| Basket credit default swaps [4] |
||||||||||||||||||||||||||||
| Investment grade risk exposure |
2,064 | (7 | ) | 4 years | Corporate Credit | BBB+ | 1,155 | (7 | ) | |||||||||||||||||||
| Investment grade risk exposure |
352 | (32 | ) | 6 years | CMBS Credit | A- | 352 | 32 | ||||||||||||||||||||
| Below investment grade risk exposure |
667 | (334 | ) | 4 years | Corporate Credit | BBB+ | — | — | ||||||||||||||||||||
| Embedded credit derivatives |
||||||||||||||||||||||||||||
| Investment grade risk exposure |
25 | 25 | 4 years | Corporate Credit | BBB- | — | — | |||||||||||||||||||||
| Below investment grade risk exposure |
325 | 286 | 6 years | Corporate Credit | BB | — | — | |||||||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
| Total |
$ | 4,622 | $ | (74 | ) | $ | 2,587 | $ | (22 | ) | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||||||||||||||
| [1] | The average credit ratings are based on availability and the midpoint of the applicable ratings among Moody’s, S&P, and Fitch. If no rating is available from a rating agency, then an internally developed rating is used. |
| [2] | Notional amount is equal to the maximum potential future loss amount. There is no specific collateral related to these contracts or recourse provisions included in the contracts to offset losses. |
| [3] | The Company has entered into offsetting credit default swaps to terminate certain existing credit default swaps, thereby offsetting the future changes in value of, or losses paid related to, the original swap. |
| [4] | Includes $2.7 billion and $2.6 billion as of December 31, 2011 and 2010, respectively, of standard market indices of diversified portfolios of corporate issuers referenced through credit default swaps. These swaps are subsequently valued based upon the observable standard market index. Also includes $478 and $467 as of December 31, 2011 and 2010, respectively, of customized diversified portfolios of corporate issuers referenced through credit default swaps. |
Collateral Arrangements
The Company enters into various collateral arrangements in connection with its derivative instruments, which require both the pledging and accepting of collateral. As of December 31, 2011 and 2010, collateral pledged having a fair value of $762 and $544, respectively, was included in fixed maturities, AFS, in the Consolidated Balance Sheets.
The following table presents the classification and carrying amount of loaned securities and derivative instruments collateral pledged.
| December 31, 2011 | December 31, 2010 | |||||||
| Fixed maturities, AFS |
$ | 762 | $ | 544 | ||||
| Short-term investments |
148 | — | ||||||
|
|
|
|
|
|||||
| Total collateral pledged |
$ | 910 | $ | 544 | ||||
|
|
|
|
|
|||||
As of December 31, 2011 and 2010, the Company had accepted collateral with a fair value of $2.4 billion and $1.4 billion, respectively, of which $1.9 billion and $1.1 billion, respectively, was derivative cash collateral which was invested and recorded in the Consolidated Balance Sheets in fixed maturities and short-term investments with corresponding amount recorded in other assets and other liabilities. The Company is only permitted by contract to sell or repledge the noncash collateral in the event of a default by the counterparty. As of December 31, 2011 and 2010, noncash collateral accepted was held in separate custodial accounts and were not included in the Company’s Consolidated Balance Sheets.
Securities on Deposit with States
The Company is required by law to deposit securities with government agencies in states where it conducts business. As of December 31, 2011 and 2010, the fair value of securities on deposit was approximately $14.
F-46
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
5. Reinsurance
Accounting Policy
The Company cedes insurance to affiliated and unaffiliated insurers in order to limit its maximum losses and to diversify its exposures and provide statutory surplus relief. Such arrangements do not relieve the Company of its primary liability to policyholders. Failure of reinsurers to honor their obligations could result in losses to the Company. The Company also assumes reinsurance from other insurers and is a member of and participates in reinsurance pools and associations. Reinsurance accounting is followed for ceded and assumed transactions that provide indemnification against loss or liability relating to insurance risk (i.e. risk transfer). If the ceded transactions do not provide risk transfer, the Company accounts for these transactions as financing transactions.
Reinsurance accounting is followed for ceded and assumed transactions that provide indemnification against loss or liability relating to insurance risk (i.e. risk transfer). To meet risk transfer requirements, a reinsurance agreement must include insurance risk, consisting of underwriting, investment, and timing risk, and a reasonable possibility of a significant loss to the reinsurer. If the ceded and assumed transactions do not meet risk transfer requirements, the Company accounts for these transactions as financing transactions.
Premiums, benefits, losses and loss adjustment expenses reflect the net effects of ceded and assumed reinsurance transactions. Included in other assets are prepaid reinsurance premiums, which represent the portion of premiums ceded to reinsurers applicable to the unexpired terms of the reinsurance agreements. Included in reinsurance recoverables are balances due from reinsurance companies for paid and unpaid losses and loss adjustment expenses and are presented net of an allowance for uncollectible reinsurance.
The Company reinsures certain of its risks to other reinsurers under yearly renewable term, coinsurance, and modified coinsurance arrangements, and variations thereof. The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies.
The Company evaluates the financial condition of its reinsurers and concentrations of credit risk. Reinsurance is placed with reinsurers that meet strict financial criteria established by the Company. As of December 31, 2011, 2010 and 2009, there were no reinsurance-related concentrations of credit risk greater than 10% of the Company’s stockholders’ equity. As of December 31, 2011, 2010, and 2009, the Company’s policy for the largest amount retained on any one life by the Life Insurance segment was $10.
Results
Insurance recoveries on ceded reinsurance agreements, which reduce death and other benefits, were $252, $324, and $450 for the years ended December 31, 2011, 2010, and 2009, respectively. The Company reinsures 31% of GMDB, as well as a portion of GMWB, on contracts issued prior to July 2007, offered in connection with its variable annuity contracts. The Company maintains reinsurance agreements with HLA, whereby the Company cedes both group life and group accident and health risk. Under these treaties, the Company ceded group life premium of $106, $129, and $178 in 2011, 2010, and 2009, respectively, and accident and health premium of $191 , $205, and $232, respectively, to HLA. Effective October 1, 2009, HLAI entered into a modified coinsurance and coinsurance with funds withheld reinsurance agreement with an affiliated captive reinsurer, White River Life Reinsurance (“WRR”). The agreement provides that HLAI will cede, and WRR will reinsure, a portion of the risk associated with direct written and assumed variable annuities and the associated GMDB and GMWB riders, HLAI assumed HLIKK’s variable annuity contract and rider benefits, and HLAI assumed HLL’s GMDB and GMWB annuity contract and rider benefits. Under this transaction, the Company ceded $71, $56, and $62 in 2011, 2010 and 2009, respectively. Refer to Note 16 of the Notes to Consolidated Financial Statements for further information.
Net fee income, earned premiums and other were comprised of the following:
| For the Years Ended December 31, | ||||||||||||
| 2011 | 2010 | 2009 | ||||||||||
| Gross fee income, earned premiums and other |
$ | 4,756 | $ | 4,756 | $ | 4,890 | ||||||
| Reinsurance assumed |
13 | 69 | 70 | |||||||||
| Reinsurance ceded |
(733 | ) | (759 | ) | (860 | ) | ||||||
|
|
|
|
|
|
|
|||||||
| Net fee income, earned premiums and other |
$ | 4,036 | $ | 4,066 | $ | 4,100 | ||||||
|
|
|
|
|
|
|
|||||||
F-47
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
6. Deferred Policy Acquisition Costs and Present Value of Future Profits
Accounting Policy
The Company capitalizes acquisition costs that vary with and are primarily related to the acquisition of new and renewal insurance contracts. The Company’s deferred policy acquisition cost (“DAC”) asset, which includes the present value of future profits, related to most universal life-type contracts (including variable annuities) is amortized over the estimated life of the contracts acquired in proportion to the present value of estimated gross profits (“EGPs”). EGPs are also used to amortize other assets and liabilities in the Company’s Consolidated Balance Sheets such as, sales inducement assets (“SIA”) and unearned revenue reserves (“URR”). Components of EGPs are used to determine reserves for universal life type contracts (including variable annuities) with death or other insurance benefits such as guaranteed minimum death, guaranteed minimum income and universal life secondary guarantee benefits. These benefits are accounted for and collectively referred to as death and other insurance benefit reserves and are held in addition to the account value liability representing policyholder funds.
For most contracts, the Company estimates gross profits over 20 years as EGPs emerging subsequent to that timeframe are immaterial. Products sold in a particular year are aggregated into cohorts. Future gross profits for each cohort are projected over the estimated lives of the underlying contracts, based on future account value projections for variable annuity and variable universal life products. The projection of future account values requires the use of certain assumptions including: separate account returns; separate account fund mix; fees assessed against the contract holder’s account balance; surrender and lapse rates; interest margin; mortality; and the extent and duration of hedging activities and hedging costs.
The Company determines EGPs from a single deterministic reversion to mean (“RTM”) separate account return projection which is an estimation technique commonly used by insurance entities to project future separate account returns. Through this estimation technique, the Company’s DAC model is adjusted to reflect actual account values at the end of each quarter. Through a consideration of recent market returns, the Company will unlock, or adjust, projected returns over a future period so that the account value returns to the long-term expected rate of return, providing that those projected returns do not exceed certain caps or floors. This Unlock for future separate account returns is determined each quarter.
In the third quarter of each year, the Company completes a comprehensive non-market related policyholder behavior assumption study and incorporates the results of those studies into its projection of future gross profits. Additionally, throughout the year, the Company evaluates various aspects of policyholder behavior and periodically revises its policyholder assumptions as credible emerging data indicates that changes are warranted. Upon completion of an assumption study or evaluation of credible new information, the Company will revise its assumptions to reflect its current best estimate. These assumption revisions will change the projected account values and the related EGPs in the DAC, SIA and URR amortization models, as well as, the death and other insurance benefit reserving models.
All assumption changes that affect the estimate of future EGPs including the update of current account values, the use of the RTM estimation technique, and policyholder behavior assumptions are considered an Unlock in the period of revision. An Unlock adjusts the DAC, SIA, URR and death and other insurance benefit reserve balances in the Consolidated Balance Sheets with an offsetting benefit or charge in the Consolidated Statements of Operations in the period of the revision. An Unlock that results in an after-tax benefit generally occurs as a result of actual experience or future expectations of product profitability being favorable compared to previous estimates. An Unlock that results in an after-tax charge generally occurs as a result of actual experience or future expectations of product profitability being unfavorable compared to previous estimates.
An Unlock revises EGPs to reflect the Company’s current best estimate assumptions. The Company also tests the aggregate recoverability of DAC by comparing the existing DAC balance to the present value of future EGPs.
Effective October 1, 2009, HLAI entered into a modified coinsurance and coinsurance with funds withheld reinsurance agreement with an affiliated captive reinsurer, White River Life Reinsurance (“WRR”). The agreement provides that HLAI will cede, and WRR will reinsure 100% of the in-force and prospective variable annuities and associated GMDB and GMWB riders written or reinsured by HLAI. This transaction resulted in a DAC Unlock of $2.0 billion, pre-tax and $1.3 billion, after-tax. See Note 16 of the Notes to Consolidated Financial Statements for further information on the transaction.
F-48
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
6. Deferred Policy Acquisition Costs and Present Value of Future Profits (continued)
Results
Changes in the DAC balance are as follows:
| 2011 | 2010 | 2009 | ||||||||||
| Balance, January 1 |
$ | 4,949 | $ | 5,779 | $ | 9,944 | ||||||
| Deferred costs |
533 | 521 | 674 | |||||||||
| Amortization — DAC |
(429 | ) | (381 | ) | (813 | ) | ||||||
| Amortization — Unlock benefit (charge), pre-tax [1] |
(187 | ) | 166 | (2,905 | ) | |||||||
| Amortization — DAC from discontinued operations |
— | (17 | ) | (11 | ) | |||||||
| Adjustments to unrealized gains and losses on securities available-for-sale and other[2] |
(269 | ) | (1,120 | ) | (1,080 | ) | ||||||
| Effect of currency translation |
1 | (10 | ) | 24 | ||||||||
| Cumulative effect of accounting change, pre-tax [3] |
— | 11 | (54 | ) | ||||||||
|
|
|
|
|
|
|
|||||||
| Balance, December 31 |
$ | 4,598 | $ | 4,949 | $ | 5,779 | ||||||
|
|
|
|
|
|
|
|||||||
| [1] | The most significant contributors to the Unlock charge recorded during the year ended December 31, 2011 were assumption changes which reduced expected future gross profits including additional costs associated with implementing the U.S. variable annuity macro hedge program, as well as actual separate account returns below our aggregated estimated return. |
| The most significant contributor to the Unlock benefit recorded during the twelve months ended December 31, 2010 was actual separate account returns above our aggregated estimated return and the impacts of assumption updates. |
| The most significant contributors to the Unlock amount recorded during the twelve months ended December 31, 2009 were a charge of $2.0 billion related to reinsurance of a block of in-force and prospective U.S. variable annuities and the associated GMDB and GMWB riders with an affiliated captive reinsurer, as well as actual separate account returns significantly below our aggregated estimated return for the first quarter of 2009, partially offset by actual returns greater than our aggregated estimated return for the period from April 1, 2009 to December 31, 2009. Also included in the unlock was a $49 charge related to DAC recoverability impairment associated with the decision to suspend sales in the U.K. variable annuity business |
| [2] | The most significant contributor to the adjustments was the effect of declining interest rates, resulting in unrealized gains on securities classified in AOCI. Other includes a $34 decrease as a result of the disposition of DAC from the sale of the Hartford Investments Canada Corporation in 2010. |
| [3] | For the year ended December 31, 2010 the effect of adopting new accounting guidance for embedded credit derivatives resulted in a decrease to retained earnings and, as a result, a DAC benefit. In addition, an offsetting amount was recorded in unrealized losses as unrealized losses decreased upon adoption of the new accounting guidance. |
| For the year ended December 31, 2009 the effect of adopting new accounting guidance for investments other- than- temporarily impaired resulted in an increase to retained earnings and, as a result, a DAC charge. In addition, an offsetting amount was recorded in unrealized losses as unrealized losses increased upon adoption of the new accounting guidance. |
As of December 31, 2011, estimated future net amortization expense of present value of future profits for the succeeding five years is $17, $16, $16, $15 and $15 in 2012, 2013, 2014, 2015 and 2016, respectively.
F-49
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
7. Goodwill
Accounting Policy
Goodwill represents the excess of costs over the fair value of net assets acquired. Goodwill is not amortized but is reviewed for impairment at least annually or more frequently if events occur or circumstances change that would indicate that a triggering event for a potential impairment has occurred. During the fourth quarter of 2011, the Company changed the date of its annual impairment test for all reporting units to October 31st from January 1st. As a result, all reporting units performed an impairment test on October 31, 2011 in addition to the annual impairment test performed on January 1, 2011. The change was made to be consistent across all of the parent company’s reporting units and to more closely align the impairment testing date with the long-range planning and forecasting process. The Company has determined that this change in accounting principle is preferable under the circumstances and does not result in any delay, acceleration or avoidance of impairment. As it was impracticable to objectively determine projected cash flows and related valuation estimates as of each October 31 for periods prior to October 31, 2011 without applying information that has been learned since those periods, the Company has prospectively applied the change in the annual goodwill impairment testing date from October 31, 2011.
The goodwill impairment test follows a two-step process. In the first step, the fair value of a reporting unit is compared to its carrying value. If the carrying value of a reporting unit exceeds its fair value, the second step of the impairment test is performed for purposes of measuring the impairment. In the second step, the fair value of the reporting unit is allocated to all of the assets and liabilities of the reporting unit to determine an implied goodwill value. If the carrying amount of the reporting unit’s goodwill exceeds the implied goodwill value, an impairment loss is recognized in an amount equal to that excess.
Management’s determination of the fair value of each reporting unit incorporates multiple inputs into discounted cash flow calculations, including assumptions that market participants would make in valuing the reporting unit. Assumptions include levels of economic capital, future business growth, earnings projections, assets under management for certain reporting units, and the weighted average cost of capital used for purposes of discounting. Decreases in the amount of economic capital allocated to a reporting unit, decreases in business growth, decreases in earnings projections and increases in the weighted average cost of capital will all cause a reporting unit’s fair value to decrease.
Results
The carrying amount of goodwill allocated to reporting segments is shown below.
| December 31, 2011 | December 31, 2010 | |||||||||||||||||||||||
| Gross | Accumulated Impairments |
Carrying Value |
Gross | Accumulated Impairments |
Carrying Value |
|||||||||||||||||||
| Individual Life |
$ | 224 | $ | — | $ | 224 | $ | 224 | — | $ | 224 | |||||||||||||
| Retirement Plans |
87 | — | 87 | 87 | — | 87 | ||||||||||||||||||
| Mutual Funds |
159 | — | 159 | 159 | — | 159 | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Total Goodwill |
$ | 470 | $ | — | $ | 470 | $ | 470 | $ | — | $ | 470 | ||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
The Company completed its annual goodwill assessment for the individual reporting units on January 1, 2011 and October 31, 2011, which resulted in no impairment of goodwill. All reporting units passed the first step of both impairment tests with a significant margin.
The Company completed its annual goodwill assessment for the individual reporting units on January 1, 2010, which resulted in no write-downs of goodwill in 2010. The reporting units passed the first step of their annual impairment tests with a significant margin with the exception of the Individual Life reporting unit. Individual Life completed the second step of the annual goodwill impairment test resulting in an implied goodwill value that was in excess of its carrying value. Even though the fair value of the reporting unit was lower than its carrying value, the implied level of goodwill in Individual Life exceeded the carrying amount of goodwill. In the hypothetical purchase accounting required by step two of the goodwill impairment test, the implied present value of future profits was substantially lower than that of the DAC asset removed in purchase accounting. A higher discount rate was used for calculating the present value of future profits as compared to that used for calculating the present value of estimated gross profits for DAC. As a result, in the hypothetical purchase accounting, implied goodwill exceeded the carrying amount of goodwill.
The Company completed its annual goodwill assessment for the individual reporting units of the Company on January 1,2009 and concluded that the fair value of each reporting unit for which goodwill had been allocated was in excess of the respective reporting unit’s carrying value.
F-50
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
8. Separate Accounts, Death Benefits and Other Insurance Benefit Features
Accounting Policy
The Company records the variable portion of individual variable annuities, 401(k), institutional, 403(b)/457, private placement life and variable life insurance products within separate accounts. Separate account assets are reported at fair value and separate account liabilities are reported at amounts consistent with separate account assets. Investment income and gains and losses from those separate account assets accrue directly to the policyholder, who assumes the related investment risk, and are offset by the related liability changes reported in the same line item in the Consolidated Statements of Operations. The Company earns fees for investment management, certain administrative expenses, and mortality and expense risks assumed which are reported in fee income.
Certain contracts classified as universal life-type include death and other insurance benefit features including GMDB offered with variable annuity contracts, or secondary guarantee benefits offered with universal life (“UL”) insurance contracts. GMDBs have been written in various forms as described in this note. UL secondary guarantee benefits ensure that the policy will not terminate, and will continue to provide a death benefit, even if there is insufficient policy value to cover the monthly deductions and charges. These death and other insurance benefit features require an additional liability be held above the account value liability representing the policyholders’ funds. This liability is reported in reserve for future policy benefits in the Company’s Consolidated Balance Sheets. Changes in the death and other insurance benefit reserves are recorded in benefits, losses and loss adjustment expenses in the Company’s Consolidated Statements of Operations.
Consistent with the Company’s policy on DAC Unlock, the Company regularly evaluates estimates used and adjusts the additional liability balance, with a related charge or credit to benefits, losses and loss adjustment expense. For further information on the DAC Unlock, see Note 6 Deferred Policy Acquisition Costs and Present Value of Future Benefits.
The Company reinsures the GMDBs associated with its in-force block of business. The Company also assumes, through reinsurance, minimum death, income, withdrawal and accumulation benefits offered by an affiliate. The death and other insurance benefit liability is determined by estimating the expected present value of the benefits in excess of the policyholder’s expected account value in proportion to the present value of total expected assessments. The additional death and other insurance benefits and net reinsurance costs are recognized ratably over the accumulation period based on total expected assessments.
Results
Changes in the gross GMDB and UL secondary guarantee benefits are as follows:
| GMDB | UL Secondary Guarantees |
|||||||
| Liability balance as of January 1, 2011 |
$ | 1,115 | $ | 113 | ||||
| Incurred |
271 | 53 | ||||||
| Paid |
(276 | ) | — | |||||
| Unlock |
48 | 62 | ||||||
|
|
|
|
|
|||||
| Liability — gross, as of December 31, 2011 |
$ | 1,158 | $ | 228 | ||||
|
|
|
|
|
|||||
| Reinsurance Recoverable— as of January 1, 2011 |
$ | 686 | $ | 30 | ||||
| Incurred |
128 | (8 | ) | |||||
| Paid |
(143 | ) | — | |||||
| Unlock |
53 | — | ||||||
|
|
|
|
|
|||||
| Reinsurance Recoverable — as of December 31, 2011 |
$ | 724 | $ | 22 | ||||
|
|
|
|
|
|||||
| GMDB | UL Secondary Guarantees |
|||||||
| Liability balance as of January 1, 2010 |
$ | 1,304 | $ | 76 | ||||
| Incurred |
286 | 39 | ||||||
| Paid |
(350 | ) | — | |||||
| Unlock |
(125 | ) | (2 | ) | ||||
|
|
|
|
|
|||||
| Liability — gross, as of December 31, 2010 |
$ | 1,115 | $ | 113 | ||||
|
|
|
|
|
|||||
| Reinsurance Recoverable— as of January 1, 2010 |
$ | 802 | $ | 22 | ||||
| Incurred |
125 | 8 | ||||||
| Paid |
(177 | ) | — | |||||
| Unlock |
(64 | ) | — | |||||
|
|
|
|
|
|||||
| Reinsurance Recoverable — as of December 31, 2010 |
$ | 686 | $ | 30 | ||||
|
|
|
|
|
|||||
F-51
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
8. Separate Accounts, Death Benefits and Other Insurance Benefit Features (continued)
The following table provides details concerning GMDB and GMIB exposure as of December 31, 2011:
| Breakdown of Variable Annuity Account Value by GMDB/GMIB Type | ||||||||||||||||
| Maximum anniversary value (“MAV”) [1] |
Account Value (“AV”) [8] |
Net amount at Risk (“NAR”) [9] |
Retained Net Amount at Risk (“RNAR”) [9] |
Weighted Average Attained Age of Annuitant |
||||||||||||
| MAV only |
$ | 20,718 | 5,998 | $ | 483 | 68 | ||||||||||
| With 5% rollup [2] |
1,469 | 521 | 37 | 68 | ||||||||||||
| With Earnings Protection Benefit Rider (“EPB”) [3] Benefit Rider (“EPB”) [3] |
5,378 | 940 | 21 | 65 | ||||||||||||
| With 5% rollup & EPB |
585 | 169 | 7 | 68 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Total MAV |
28,150 | 7,628 | 548 | |||||||||||||
| Asset Protection Benefit (APB) [4] |
22,343 | 3,139 | 610 | 66 | ||||||||||||
| Lifetime Income Benefit (LIB)—Death Benefit [5] |
1,095 | 120 | 37 | 64 | ||||||||||||
| Reset [6] (5-7 years) |
3,139 | 307 | 165 | 68 | ||||||||||||
| Return of Premium [7] /Other |
21,512 | 876 | 243 | 65 | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Subtotal U.S. GMDB |
$ | 76,239 | $ | 12,070 | $ | 1,603 | 67 | |||||||||
| Less: General Account Value with U.S. GMBD |
7,251 | |||||||||||||||
|
|
|
|||||||||||||||
| Subtotal Separate Account Liabilities with GMDB |
68,988 | |||||||||||||||
| Separate Account Liabilities without U.S. GMDB |
74,871 | |||||||||||||||
|
|
|
|||||||||||||||
| Total Separate Account Liabilities |
$ | 143,859 | ||||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Japan GMDB [10], [11] |
$ | 16,983 | $ | 5,167 | $ | — | 68 | |||||||||
| Japan GMIB [10], [11] |
$ | 16,262 | $ | 4,805 | $ | — | 67 | |||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| [1] | MAV: the GMDB is the greatest of current AV, net premiums paid and the highest AV on any anniversary before age 80 (adjusted for withdrawals). |
| [2] | Rollup: the GMDB is the greatest of the MAV, current AV, net premium paid and premiums (adjusted for withdrawals) accumulated at generally 5% simple interest up to the earlier of age 80 or 100% of adjusted premiums. |
| [3] | EPB GMDB is the greatest of the MAV, current AV, or contract value plus a percentage of the contract’s growth. The contract’s growth is AV less premiums net of withdrawals, subject to a cap of 200% of premiums net of withdrawals. |
| [4] | APB GMDB is the greater of current AV or MAV, not to exceed current AV plus 25% times the greater of net premiums and MAV (each adjusted for premiums in the past 12 months). |
| [5] | LIB GMDB is the greatest of current AV, net premiums paid, or for certain contracts a benefit amount that ratchets over time, generally based on market performance. |
| [6] | Reset GMDB is the greatest of current AV, net premiums paid and the most recent five to seven year anniversary AV before age 80 (adjusted for withdrawals). |
| [7] | ROP: the GMDB is the greater of current AV and net premiums paid. |
| [8] | AV includes the contract holder’s investment in the separate account and the general account. |
| [9] | NAR is defined as the guaranteed benefit in excess of the current AV. RNAR is NAR reduced for reinsurances. NAR and RNAR are highly sensitive to equity market movements and increase when equity markets decline. |
| [10] | Assumed GMDB includes a ROP and MAV (before age 80) paid in a single lump sum. GMIB is a guarantee to return initial investment, adjusted for earnings liquidity, paid through a fixed annuity, after a minimum deferral period of 10, 15 or 20 years. The guaranteed remaining balance (“GRB”) related to the Japan GMIB was $21.1 billion and $20.9 billion as of December 31, 2011 and December 31, 2010, respectively. The GRB related to the Japan GMAB and GMWB was $567 and $570 as of December 31, 2011 and December 31, 2010, respectively. These liabilities are not included in the Separate Account as they are not legally insulated from the general account liabilities of the insurance enterprise. As of December 31, 2011, 100% of RNAR is reinsured to an affiliate. See Note 10 of the Notes to Consolidated Financial statements. |
| [11] | Policies with a guaranteed living benefit (a GMWB in the US or a GMIB in Japan) also have a guaranteed death benefit. The NAR for each benefit is shown, however these benefits are not additive. When a policy terminates due to death, any NAR related to GMWB or GMIB is released. Similarly, when a policy goes into benefit status on a GMWB or GMIB, its GMDB NAR is released. |
See Note 3 of the Notes to Consolidated Financial Statements for a description of the Company’s guaranteed living benefits that are accounted for at fair value.
Account balances of contracts with guarantees were invested in variable separate accounts as follows:
| Asset type |
December 31, 2011 | December 31, 2010 | ||||||
| Equity securities (including mutual funds) |
$ | 61,472 | $ | 75,601 | ||||
| Cash and cash equivalents |
$ | 7,516 | 8,365 | |||||
|
|
|
|
|
|||||
| Total |
$ | 68,988 | $ | 83,966 | ||||
|
|
|
|
|
|||||
As of December 31, 2011 and December 31, 2010, approximately 17% and 15%, respectively, of the equity securities above were invested in fixed income securities through these funds and approximately 83% and 85%, respectively, were invested in equity securities.
F-52
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
9. Sales Inducements
Accounting Policy
The Company currently offers enhanced crediting rates or bonus payments to contract holders on certain of its individual and group annuity products. The expense associated with offering a bonus is deferred and amortized over the life of the related contract in a pattern consistent with the amortization of deferred policy acquisition costs. Amortization expense associated with expenses previously deferred is recorded over the remaining life of the contract. Consistent with the Unlock, the Company unlocked the amortization of the sales inducement asset. See Note 6 for more information concerning the Unlock.
Results
Changes in deferred sales inducement activity were as follows for the years ended December 31:
| 2011 | 2010 | 2009 | ||||||||||
| Balance, beginning of year |
$ | 197 | $ | 194 | $ | 533 | ||||||
| Sales inducements deferred |
6 | 10 | 43 | |||||||||
| Amortization—Unlock |
(4 | ) | (9 | ) | (286 | ) | ||||||
| Amortization charged to income |
(13 | ) | 2 | (96 | ) | |||||||
|
|
|
|
|
|
|
|||||||
| Balance, end of year |
$ | 186 | $ | 197 | $ | 194 | ||||||
|
|
|
|
|
|
|
|||||||
10. Commitments and Contingencies
Accounting Policy
Management evaluates each contingent matter separately. A loss is recorded if probable and reasonably estimable. Management establishes reserves for these contingencies at its “best estimate,” or, if no one number within the range of possible losses is more probable than any other, the Company records an estimated reserve at the low end of the range of losses.
Litigation
The Company is involved in claims litigation arising in the ordinary course of business, both as a liability insurer defending or providing indemnity for third-party claims brought against insureds and as an insurer defending coverage claims brought against it. The Company accounts for such activity through the establishment of unpaid loss and loss adjustment expense reserves. Management expects that the ultimate liability, if any, with respect to such ordinary-course claims litigation, after consideration of provisions made for potential losses and costs of defense, will not be material to the consolidated financial condition, results of operations or cash flows of the Company.
The Company is also involved in other kinds of legal actions, some of which assert claims for substantial amounts. These actions include, among others and in addition to the matter described below, putative state and federal class actions seeking certification of a state or national class. Such putative class actions have alleged, for example, improper sales practices in connection with the sale of life insurance and other investment products; and improper fee arrangements in connection with investment products and structured settlements. The Company also is involved in individual actions in which punitive damages are sought, such as claims alleging bad faith in the handling of insurance claims. Management expects that the ultimate liability, if any, with respect to such lawsuits, after consideration of provisions made for estimated losses, will not be material to the consolidated financial condition of the Company. Nonetheless, given the large or indeterminate amounts sought in certain of these actions, and the inherent unpredictability of litigation, the outcome in certain matters could, from time to time, have a material adverse effect on the Company’s results of operations or cash flows in particular quarterly or annual periods.
Apart from the inherent difficulty of predicting litigation outcomes, particularly the matter specifically identified below purports to seek substantial damages for unsubstantiated conduct spanning a multi-year period based on novel and complex legal theories. The alleged damages are not quantified or factually supported in the complaint, and, in any event, the Company’s experience shows that demands for damages often bear little relation to a reasonable estimate of potential loss. The matter is in the earliest stages of litigation, with no substantive legal decisions by the court defining the scope of the claims or the potentially available damages. The Company has not yet answered the complaint or asserted its defenses, and fact discovery has not yet begun. Accordingly, management cannot reasonably estimate the possible loss or range of loss, if any, or predict the timing of the eventual resolution of this matter.
F-53
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
10. Commitments and Contingencies (continued)
Mutual Fund Fees Litigation — In October 2010, a derivative action was brought on behalf of six Hartford retail mutual funds in the United States District Court for the District of Delaware, alleging that Hartford Investment Financial Services, LLC (“HIFSCO”) received excessive advisory and distribution fees in violation of its statutory fiduciary duty under Section 36(b) of the Investment Company Act of 1940. In February 2011, a nearly identical derivative action was brought against HIFSCO in the United States District Court for the District of New Jersey, on behalf of six additional Hartford retail mutual funds. Both actions were assigned to the Honorable Renee Marie Bumb, a judge in the District of New Jersey who was sitting by designation with respect to the Delaware action. Plaintiffs in each action seek to rescind the investment management agreements and distribution plans between HIFSCO and the funds and to recover the total fees charged thereunder or, in the alternative, to recover any improper compensation HIFSCO received. In addition, plaintiffs in the New Jersey action seek recovery of lost earnings. HIFSCO moved to dismiss both actions and, in September 2011, the motions to dismiss were granted in part and denied in part, with leave to amend the complaints. In November 2011, a stipulation of voluntary dismissal was filed in the Delaware action and plaintiffs in the New Jersey action filed an amended complaint on behalf of six mutual funds, seeking the same relief as in their original complaint. HIFSCO disputes the allegations and has filed a partial motion to dismiss.
Derivative Commitments
Certain of the Company’s derivative agreements contain provisions that are tied to the financial strength ratings of the individual legal entity that entered into the derivative agreement as set by nationally recognized statistical rating agencies. If the legal entity’s financial strength were to fall below certain ratings, the counterparties to the derivative agreements could demand immediate and ongoing full collateralization and in certain instances demand immediate settlement of all outstanding derivative positions traded under each impacted bilateral agreement. The settlement amount is determined by netting the derivative positions transacted under each agreement. If the termination rights were to be exercised by the counterparties, it could impact the legal entity’s ability to conduct hedging activities by increasing the associated costs and decreasing the willingness of counterparties to transact with the legal entity. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that are in a net liability position as of December 31, 2011, is $403. Of this $403, the legal entities have posted collateral of $425 in the normal course of business. Based on derivative market values as of December 31, 2011, a downgrade of one level below the current financial strength ratings by either Moody’s or S&P could require an additional $15 to be posted as collateral. Based on derivative market values as of December 31, 2011, a downgrade by either Moody’s or S&P of two levels below the legal entities’ current financial strength ratings would not require additional collateral to be posted. These collateral amounts could change as derivative market values change, as a result of changes in our hedging activities or to the extent changes in contractual terms are negotiated. The nature of the collateral that we would post, if required, would be primarily in the form of U.S. Treasury bills and U.S. Treasury notes.
Lease Commitments
The rent paid to Hartford Fire for operating leases was $19, $15 and $25 for the years ended December 31, 2011, 2010 and 2000, respectively. Future minimum lease commitments are as follows:
| 2012 |
$ | 16 | ||
| 2013 |
12 | |||
| 2014 |
8 | |||
| 2015 |
6 | |||
| 2016 |
4 | |||
| Thereafter |
7 | |||
|
|
|
|||
| Total |
$ | 53 | ||
|
|
|
F-54
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
10. Commitments and Contingencies (continued)
Unfunded Commitments
As of December 31, 2011, the Company has outstanding commitments totaling $852, of which $399 is largely related to commercial whole loans expected to fund in the first half of 2012. Additionally, $376 is committed to fund limited partnerships and other alternative investments. These capital commitments may be called by the partnership during the commitment period (on average two to four years) to fund the purchase of new investments and partnership expenses. Once the commitment period expires, the Company is under no obligation to fund the remaining unfunded commitment but may elect to do so. The remaining outstanding commitments are related to various funding obligations associated with private placement securities. These have a commitment period of one month to one year.
Guaranty Fund and Other Insurance-related Assessments
In all states, insurers licensed to transact certain classes of insurance are required to become members of a guaranty fund. In most states, in the event of the insolvency of an insurer writing any such class of insurance in the state, members of the funds are assessed to pay certain claims of the insolvent insurer. A particular state’s fund assesses its members based on their respective written premiums in the state for the classes of insurance in which the insolvent insurer was engaged. Assessments are generally limited for any year to one or two percent of premiums written per year depending on the state.
The Company accounts for guaranty fund and other insurance assessments in accordance with Accounting Standards Codification 405-30, “Accounting by Insurance and Other Enterprises for Insurance-Related Assessments”. Liabilities for guaranty funds and other insurance-related assessments are accrued when an assessment is probable, when it can be reasonably estimated, and when the event obligating the Company to pay an imposed or probable assessment has occurred. Liabilities for guaranty funds and other insurance-related assessments are not discounted and are included as part of other liabilities in the Consolidated Balance Sheets. As of December 31, 2011 and 2010, the liability balance was $43 and $7, respectively. As of December 31, 2011 and 2010, $26 and $9, respectively, related to premium tax offsets were included in other assets. In 2011, the Company recognized $22 for expected assessments related to the Executive Life Insurance Company of New York (ELNY) insolvency.
11. Income Tax
Accounting Policy
The Company recognizes taxes payable or refundable for the current year and deferred taxes for the tax consequences of differences between the financial reporting and tax basis of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years the temporary differences are expected to reverse.
The Company is included in The Hartford’s consolidated Federal income tax return. The Company and The Hartford have entered into a tax sharing agreement under which each member in the consolidated U.S. Federal income tax return will make payments between them such that, with respect to any period, the amount of taxes to be paid by the Company, subject to certain tax adjustments, is consistent with the “parent down” approach. Under this approach, the Company’s deferred tax assets and tax attributes are considered realized by it so long as the group is able to recognize (or currently use) the related deferred tax asset or attribute. Thus the need for a valuation allowance is determined at the consolidated return level rather than at the level of the individual entities comprising the consolidated group.
The Company recorded a deferred tax asset valuation allowance that is adequate to reduce the total deferred tax asset to an amount that will more likely than not be realized. The deferred tax asset valuation allowance was $89 as of December 31, 2011 and $139 as of December 31, 2010. In assessing the need for a valuation allowance, management considered future taxable temporary difference reversals, future taxable income exclusive of reversing temporary differences and carryforwards, taxable income in open carryback years, as well as other tax planning strategies. These tax planning strategies include holding a portion of debt securities with market value losses until recovery, selling appreciated securities to offset capital losses, business considerations such as asset-liability matching, and the sales of certain corporate assets. Management views such tax planning strategies as prudent and feasible and will implement them, if necessary, to realize the deferred tax asset. Based on the availability of additional tax planning strategies identified in the second quarter of 2011, the Company released $56, or 100% of the valuation allowance associated with investment realized capital losses. Future economic conditions and debt market volatility, including increases in interest rates, can adversely impact the Company’s tax planning strategies and in particular the Company’s ability to utilize tax benefits on previously recognized realized capital losses.
F-55
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
11. Income Tax (continued)
Results
Income tax expense (benefit) is as follows:
| For the years ended December 31, | ||||||||||||
| 2011 | 2010 | 2009 | ||||||||||
| Income Tax Expense (Benefit) |
||||||||||||
| Current - U.S. Federal |
$ | (176 | ) | $ | 49 | $ | 300 | |||||
| - International |
— | 5 | — | |||||||||
|
|
|
|
|
|
|
|||||||
| Total Current |
$ | (176 | ) | 54 | 300 | |||||||
|
|
|
|
|
|
|
|||||||
| Deferred - U.S. Federal Excluding NOL Carryforward |
76 | 175 | (2,387 | ) | ||||||||
| - Net Operating Loss Carryforward |
(163 | ) | (1 | ) | 688 | |||||||
|
|
|
|
|
|
|
|||||||
| Total Deferred |
(87 | ) | 174 | (1,699 | ) | |||||||
|
|
|
|
|
|
|
|||||||
| Total Income tax expense (benefit) |
$ | (263 | ) | $ | 228 | $ | (1,399 | ) | ||||
|
|
|
|
|
|
|
|||||||
Deferred tax assets (liabilities) include the following as of December 31:
| Deferred Tax Assets |
2011 | 2010 | ||||||
| Tax basis deferred policy acquisition costs |
$ | 479 | $ | 531 | ||||
| Investment-related items |
92 | 348 | ||||||
| Insurance product derivatives |
2,011 | 1,792 | ||||||
| NOL Carryover |
252 | 83 | ||||||
| Minimum tax credit |
387 | 542 | ||||||
| Foreign tax credit carryovers |
17 | — | ||||||
| Depreciable & Amortizable assets |
37 | 48 | ||||||
| Other |
23 | 1 | ||||||
|
|
|
|
|
|||||
| Total Deferred Tax Assets |
3,298 | 3,345 | ||||||
| Valuation Allowance |
(89 | ) | (139 | ) | ||||
|
|
|
|
|
|||||
| Net Deferred Tax Assets |
3,209 | 3,206 | ||||||
|
|
|
|
|
|||||
| Deferred Tax Liabilities |
||||||||
| Financial statement deferred policy acquisition costs and reserves |
(827 | ) | (1,000 | ) | ||||
| Net unrealized gain on investments |
(735 | ) | (5 | ) | ||||
| Employee benefits |
(41 | ) | (33 | ) | ||||
| Other |
(30 | ) | ||||||
|
|
|
|
|
|||||
| Total Deferred Tax Liabilities |
(1,603 | ) | (1,068 | ) | ||||
|
|
|
|
|
|||||
| Total Deferred Tax Asset (Liability) |
1,606 | 2,138 | ||||||
|
|
|
|
|
|||||
As of December 31, 2011 and 2010, the deferred tax asset included the expected tax benefit attributable to foreign net operating losses of $ 359 and $310, which have no expiration. The Company had a current income tax recoverable of $330 as of December 31, 2011 and a current income tax recoverable of $258 as of December 31, 2010.
If the Company were to follow a “separate entity” approach, the current tax benefit related to any of the Company’s tax attributes realized by virtue of its inclusion in The Hartford’s consolidated tax return would have been recorded directly to surplus rather than income. These benefits were $0, $0 and $65 for 2011, 2010 and 2009, respectively.
Included in the Company’s December 31, 2011 $1.6 billion net deferred tax asset is $1.8 billion relating to items treated as ordinary for federal income tax purposes, and a $238 net deferred tax liability for items classified as capital in nature. The $238 capital items are comprised of $497 of gross deferred tax assets related to realized capital losses and $735 of gross deferred tax liabilities related to net unrealized capital gains.
F-56
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
11. Income Tax (continued)
The Company or one or more of its subsidiaries files income tax returns in the U.S. federal jurisdiction, and various states and foreign jurisdictions. The Company is no longer subject to U.S. federal, state and local, or non-U.S. income tax examinations for years prior to 2007. The audit of the years 2007-2009 commenced during 2010 and is expected to conclude by the end of 2012, with no material impact on the consolidated financial condition or results of operations. In addition, in the second quarter of 2011, the Company recorded a tax benefit of $52 as a result of a resolution of a tax matter with the IRS for the computation of the dividends-received deduction (DRD) for years 1998, 2000 and 2001. Management believes that adequate provision has been made in the financial statements for any potential assessments that may result from tax examinations and other tax-related matters for all open tax years. The Company’s unrecognized tax benefits are settled with the parent consistent with the terms of the tax sharing agreement described above.
A reconciliation of the tax provision at the U.S. Federal statutory rate to the provision (benefit) for income taxes is as follows:
| For the years ended December 31, | ||||||||||||
| 2011 | 2010 | 2009 | ||||||||||
| Tax provision at the U.S. federal statutory rate |
(7 | ) | 332 | $ | (1,239 | ) | ||||||
| Dividends received deduction |
(201 | ) | (145 | ) | (181 | ) | ||||||
| Foreign related investments |
(1 | ) | 3 | 28 | ||||||||
| Valuation Allowance |
(50 | ) | 58 | 31 | ||||||||
| Other |
(4 | ) | (20 | ) | (38 | ) | ||||||
|
|
|
|
|
|
|
|||||||
| Total |
$ | (263 | ) | $ | 228 | $ | (1,399 | ) | ||||
|
|
|
|
|
|
|
|||||||
12. Debt
Short-Term Debt
The Company became a member of the Federal Home Loan Bank of Boston (“FHLBB”) in May 2011. Membership allows the Company access to collateralized advances, which may be used to support various spread-based business and enhance liquidity management. The Connecticut Department of Insurance (“CTDOI”) will permit the Company to pledge up to $1.48 billion in qualifying assets to secure FHLBB advances for 2012. The amount of advances that can be taken are dependent on the asset types pledged to secure the advances. The pledge limit is recalculated annually based on statutory admitted assets and capital and surplus. The Company would need to seek the prior approval of the CTDOI if there were a desire to exceed these limits. As of December 31, 2011, the Company had no advances outstanding under the FHLBB facility.
Consumer Notes
The Company issued consumer notes through its Retail Investor Notes Program prior to 2009. A consumer note is an investment product distributed through broker-dealers directly to retail investors as medium-term, publicly traded fixed or floating rate, or a combination of fixed and floating rate, notes. Consumer notes are part of the Company’s spread-based business and proceeds are used to purchase investment products, primarily fixed rate bonds. Proceeds are not used for general operating purposes. Consumer notes maturities may extend up to 30 years and have contractual coupons based upon varying interest rates or indexes (e.g. consumer price index) and may include a call provision that allows the Company to extinguish the notes prior to its scheduled maturity date. Certain Consumer notes may be redeemed by the holder in the event of death. Redemptions are subject to certain limitations, including calendar year aggregate and individual limits. The aggregate limit is equal to the greater of $1 or 1% of the aggregate principal amount of the notes as of the end of the prior year. The individual limit is $250 thousand per individual. Derivative instruments are utilized to hedge the Company’s exposure to market risks in accordance with Company policy.
As of December 31, 2011, these consumer notes have interest rates ranging from 4% to 5% for fixed notes and, for variable notes, based on December 31, 2011 rates, either consumer price index plus 100 to 260 basis points, or indexed to the S&P 500, Dow Jones Industrials, foreign currency, or the Nikkei 225. The aggregate maturities of Consumer Notes are as follows: $155 in 2012, $78 in 2013, $13 in 2014, $30 in 2015, $18 in 2016 and $20 thereafter. For 2011, 2010 and 2009, interest credited to holders of consumer notes was $15, $25 and $51, respectively.
F-57
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
13. Statutory Results
The domestic insurance subsidiaries of the Company prepare their statutory financial statements in conformity with statutory accounting practices prescribed or permitted by the applicable state insurance department which vary materially from U.S. GAAP. Prescribed statutory accounting practices include publications of the National Association of Insurance Commissioners (“NAIC”), as well as state laws, regulations and general administrative rules. The differences between statutory financial statements and financial statements prepared in accordance with GAAP vary between domestic and foreign jurisdictions. The principal differences are that statutory financial statements do not reflect deferred policy acquisition costs and limit deferred income taxes, life benefit reserves predominately use interest rate and mortality assumptions prescribed by the NAIC, bonds are generally carried at amortized cost and reinsurance assets and liabilities are presented net of reinsurance.
The statutory net income amounts for the years ended December 31, 2011, 2010 and 2009, and the statutory capital and surplus amounts as of December 31, 2011, 2010 and 2009 in the table below are based on actual statutory filings with the applicable regulatory authorities.
| For the years ended December 31, | ||||||||||||
| 2011 | 2010 | 2009 | ||||||||||
| Combined statutory net (loss) income |
$ | (669 | ) | $ | 208 | $ | 1,866 | |||||
|
|
|
|
|
|
|
|||||||
| Statutory capital and surplus |
$ | 5,920 | $ | 5,832 | $ | 5,365 | ||||||
|
|
|
|
|
|
|
|||||||
Statutory accounting practices do not consolidate the net (loss) income of subsidiaries as performed under U.S. GAAP. Therefore, the combined statutory net (loss) income above presents the total statutory net income of the Company and its other insurance subsidiaries to present a comparable statutory net (loss) income.
In December 2009, the NAIC issued Statement of Statutory Accounting Principles (“SSAP”) No. 10R, Income Taxes – Revised, A Temporary Replacement of SSAP No. 10. SSAP No. 10R was updated in September 2010 and is effective for annual periods December 31, 2009 and interim and annual periods of 2010 and 2011. SSAP No. 10R increases the realization period for deferred tax assets from one year to three years and increases the asset recognition limit from 10% to 15% of adjusted statutory capital and surplus.
Dividends
Dividends to the Company from its insurance subsidiaries are restricted, as is the ability of the Company to pay dividends to its parent company. Future dividend decisions will be based on, and affected by, a number of factors, including the operating results and financial requirements of the Company on a stand-alone basis and the impact of regulatory restrictions.
The payment of dividends by Connecticut-domiciled insurers is limited under the insurance holding company laws of Connecticut. These laws require notice to and approval by the state insurance commissioner for the declaration or payment of any dividend, which, together with other dividends or distributions made within the preceding twelve months, exceeds the greater of (i) 10% of the insurer’s policyholder surplus as of December 31 of the preceding year or (ii) net income (or net gain from operations, if such company is a life insurance company) for the twelve-month period ending on the thirty-first day of December last preceding, in each case determined under statutory insurance accounting principles. In addition, if any dividend of a Connecticut-domiciled insurer exceeds the insurer’s earned surplus, it requires the prior approval of the Connecticut Insurance Commissioner. The insurance holding company laws of the other jurisdictions in which the Company’s insurance subsidiaries are incorporated (or deemed commercially domiciled) generally contain similar (although in certain instances somewhat more restrictive) limitations on the payment of dividends.
The Company’s subsidiaries are permitted to pay up to a maximum of approximately $399 in dividends in 2012 without prior approval from the applicable insurance commissioner. In 2011, the Company received dividends of $7 from its subsidiaries. With respect to dividends to its parent, the Company’s dividend limitation under the holding company laws of Connecticut is $592 in 2012. However, because the Company’s earned surplus is negative as of December 31, 2011, the Company will not be permitted to pay any dividends to its parent in 2012 without prior approval from the Connecticut Insurance Commissioner until such time as earned surplus becomes positive. In 2011, the Company did not pay dividends to its parent company.
F-58
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
14. Pension Plans, Postretirement, Health Care and Life Insurance Benefit and Savings Plans
Pension Plans
Hartford Life’s employees are included in The Hartford’s non-contributory defined benefit pension, The Hartford Retirement Plan for U.S. Employees, and postretirement health care and life insurance benefit plans. Defined benefit pension expense, postretirement health care and life insurance benefits expense allocated by The Hartford to the Company, was $45, $43 and $32 for the years ended December 31, 2011, 2010 and 2009, respectively.
Investment and Savings Plan
Substantially all U.S. employees are eligible to participate in The Hartford’s Investment and Savings Plan under which designated contributions may be invested in common stock of The Hartford or certain other investments. These contributions are matched, up to 3% of compensation, by The Hartford. In 2004, The Hartford began allocating a percentage of base salary to the Plan for eligible employees. In 2011, employees whose prior year earnings were less than $110,000 received a contribution of 1.5% of base salary and employees whose prior year earnings were more than $110,000 received a contribution of 0.5% of base salary. The cost to Hartford Life for this plan was approximately $9, $13 and $13 for the years ended December 31, 2011, 2010 and 2009, respectively.
15. Stock Compensation Plans
The Hartford has three primary stock-based compensation plans. The Company is included in these plans and has been allocated compensation expense of $14, $32 and $25 for the years ended December 31, 2011, 2010 and 2009, respectively. The Company’s income tax benefit recognized for stock-based compensation plans was $5, $11 and $7 for the years ended December 31, 2011, 2010 and 2009, respectively. The Company did not capitalize any cost of stock-based compensation.
16. Transactions with Affiliates
Parent Company Transactions
Transactions of the Company with Hartford Fire Insurance Company, Hartford Holdings and its affiliates relate principally to tax settlements, reinsurance, insurance coverage, rental and service fees, payment of dividends and capital contributions. In addition, an affiliated entity purchased group annuity contracts from the Company to fund structured settlement periodic payment obligations assumed by the affiliated entity as part of claims settlements with property casualty insurance companies and self-insured entities. As of December 31, 2011 and 2010, the Company had $54 and $53 of reserves for claim annuities purchased by affiliated entities. For the years ended December 31, 2011, 2010, and 2009, the Company recorded earned premiums of $12, $18, and $285 for these intercompany claim annuities. In the fourth quarter of 2008, the Company issued a payout annuity to an affiliate for $2.2 billion of consideration. The Company will pay the benefits associated with this payout annuity over 12 years.
Substantially all general insurance expenses related to the Company, including rent and employee benefit plan expenses are initially paid by The Hartford. Direct expenses are allocated to the Company using specific identification, and indirect expenses are allocated using other applicable methods. Indirect expenses include those for corporate areas which, depending on type, are allocated based on either a percentage of direct expenses or on utilization.
The Company has issued a guarantee to retirees and vested terminated employees (“Retirees”) of The Hartford Retirement Plan for U.S. Employees (“the Plan”) who retired or terminated prior to January 1, 2004. The Plan is sponsored by The Hartford. The guarantee is an irrevocable commitment to pay all accrued benefits which the Retiree or the Retiree’s designated beneficiary is entitled to receive under the Plan in the event the Plan assets are insufficient to fund those benefits and The Hartford is unable to provide sufficient assets to fund those benefits. The Company believes that the likelihood that payments will be required under this guarantee is remote.
In 1990, Hartford Fire guaranteed the obligations of the Company with respect to life, accident and health insurance and annuity contracts issued after January 1, 1990. The guarantee was issued to provide an increased level of security to potential purchasers of HLIC’s products. Although the guarantee was terminated in 1997, it still covers policies that were issued from 1990 to 1997. As of December 31, 2011 and 2010, no recoverables have been recorded for this guarantee, as the Company was able to meet these policyholder obligations.
Reinsurance Assumed from Affiliates
Prior to June 1, 2009, yen and U.S. dollar based fixed market value adjusted (“MVA”) annuity products, written by HLIKK, were sold to customers in Japan. HLIKK, a wholly owned Japanese subsidiary of Hartford Life, Inc., subsequently reinsured in-force and prospective MVA annuities to the Company effective September 1, 2004. As of December 31, 2011 and 2010, $2.6 billion and $2.7 billion, respectively, of the account value had been assumed by the Company.
F-59
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
16. Transactions with Affiliates (continued)
A subsidiary of the Company, Hartford Life and Annuity Insurance Company (“HLAI”), entered into a reinsurance agreement with HLIKK effective August 31, 2005. HLAI assumed in-force and prospective GMIB riders. Via amendment, effective July 31, 2006, HLAI also assumed GMDB on covered contracts that have an associated GMIB rider in force on or after July 31, 2006. GMIB riders issued prior to April 1, 2005 were recaptured, while GMIB riders issued by HLIKK subsequent to April 1, 2005, continue to be reinsured by HLAI. Additionally, a tiered reinsurance premium structure was implemented.
HLAI has three additional reinsurance agreements with HLIKK covering certain variable annuity contracts. Effective September 30, 2007, HLAI assumed 100% of the in-force and prospective GMAB, GMIB and GMDB risks issued by HLIKK. Effective February 29, 2008, HLAI assumed 100% of the in-force and prospective GMIB and GMDB riders issued by HLIKK. Effective October 1, 2008, HLAI assumed 100% of the in-force and prospective GMDB riders issued on or after April 1, 2005 by HLIKK. The GMDB reinsurance is accounted for as a Death Benefit and Other Insurance Benefit Reserves which is not reported at fair value. The liability for the assumed GMDB reinsurance was $50 and $54 and the net amount at risk for the assumed GMDB reinsurance was $5.0 billion and $4.1 billion at December 31, 2011 and 2010, respectively.
While the form of the agreement between HLAI and HLIKK for the GMIB business is reinsurance, in substance and for accounting purposes the agreement is a free standing derivative. As such, the reinsurance agreement for the GMIB business is recorded at fair value on the Company’s balance sheet, with prospective changes in fair value recorded in net realized capital gains (losses) in net income (loss). The fair value of the GMIB liability was $3.2 billion and $2.6 billion at December 31, 2011 and 2010, respectively.
Effective November 1, 2010, HLAI entered into a reinsurance agreement with Hartford Life Limited Ireland, (“HLL”), a wholly owned UK subsidiary of HLAI. Through this agreement, HLL agreed to cede, and HLAI agreed to reinsure, GMDB and GMWB risks issued by HLL on its variable annuity business. The GMDB reinsurance is accounted for as a Death Benefit and Other Insurance Benefit Reserves which is not reported at fair value. The liability for the assumed GMDB reinsurance was $5 and $8 and the net amount at risk for the assumed GMDB reinsurance was $80 and $23 at December 31, 2011 and 2010, respectively.
While the form of the agreements between HLAI and HLIKK, and HLAI and HLL for the GMAB/GMWB business is reinsurance, in substance and for accounting purposes these agreements are free standing derivatives. As such, the reinsurance agreements for the GMAB/GMWB business are recorded at fair value on the Company’s Consolidated Balance Sheets, with prospective changes in fair value recorded in net realized capital gains (losses) in net income (loss). The fair value of the GMAB/GMWB liability was $37 and $43 at December 31, 2011 and 2010, respectively.
Reinsurance Ceded to Affiliates
Effective October 1, 2009, and amended on November 1, 2010, HLAI, a subsidiary of HLIC, entered into a modified coinsurance (“modco”) and coinsurance with funds withheld reinsurance agreement with White River Life Reinsurance (“WRR”), an affiliated captive insurance company. The agreement provides that HLAI will cede, and WRR will reinsure a portion of the risk associated with direct written and assumed variable annuities and the associated GMDB and GMWB riders, HLAI assumed HLIKK’s variable annuity contract and rider benefits, and HLAI assumed HLL’s GMDB and GMWB annuity contract and rider benefits.
Under modco, the assets and the liabilities, and under coinsurance with funds withheld, the assets, associated with the reinsured business will remain on the consolidated balance sheet of HLIC in segregated portfolios, and WRR will receive the economic risks and rewards related to the reinsured business through modco and funds withheld adjustments. These adjustments are recorded as an adjustment to operating expenses.
For the year ended December 31, 2011 the impact of this transaction was a decrease to earnings of $323 after-tax. Included in this amount are net realized capital gains of $503, which represents the change in valuation of the derivative associated with this transaction. In addition, the balance sheet of the Company reflects a modco reinsurance (payable)/recoverable, a deposit liability as well as a net reinsurance recoverable that is comprised of an embedded derivative. The balance of the modco reinsurance (payable)/recoverable, deposit liability and net reinsurance recoverable were ($2.9) billion, $0, $2.6 billion and $(864), $78, and $1.7 billion at December 31, 2011 and December 31, 2010, respectively.
F-60
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
16. Transactions with Affiliates (continued)
At inception of the contract, HLIC recognized in net income the unlock of the unearned revenue reserve, sales inducement asset and deferred policy acquisition costs related to the direct U.S. variable annuity business of HLAI as well as the impact of remitting the premiums and reserves to WRR. The following table illustrates the transaction’s impact on the Company’s Statement of Operations as of December 31, 2010 and 2009, respectively.
| 2011 | 2010 | 2009 | ||||||||||
| Fee Income and other |
$ | — | $ | — | $ | 84 | ||||||
| Earned premiums |
(71 | ) | (56 | ) | (62 | ) | ||||||
| Net realized gains (losses) |
503 | 546 | (629 | ) | ||||||||
|
|
|
|
|
|
|
|||||||
| Total revenues |
432 | 490 | (607 | ) | ||||||||
| Benefits, losses and loss adjustment expenses |
(51 | ) | (40 | ) | (51 | ) | ||||||
| Amortization of deferred policy acquisition costs and present value of future profits |
— | — | 1,883 | |||||||||
| Insurance operating costs and other expenses |
972 | (348 | ) | (9 | ) | |||||||
|
|
|
|
|
|
|
|||||||
| Total expenses |
921 | (388 | ) | 1,823 | ||||||||
| Income (loss) before income taxes |
(489 | ) | 878 | (2,430 | ) | |||||||
| Income tax expense (benefit) |
(166 | ) | 308 | (851 | ) | |||||||
|
|
|
|
|
|
|
|||||||
| Net income (loss) |
$ | (323 | ) | $ | 570 | $ | (1,579 | ) | ||||
|
|
|
|
|
|
|
|||||||
| [1] | At inception of contract, HLIC recognized in net income the unlock of the unearned revenue reserve, sales inducement asset and deferred policy acquisition costs related to the direct U.S. variable annuity business of HLAI as well as the impact of remitting the premium and reserves to WRR. 2009 figures illustrate the transaction’s impact at inception on the Company’s Statement of Operations and the fourth quarter of 2009 activity. |
Effective November 1, 2007, HLAI entered into a modco and coinsurance with funds withheld agreement with Champlain Life Reinsurance Company, an affiliate captive insurance company, to provide statutory surplus relief for certain life insurance policies. The Agreement is accounted for as a financing transaction for U.S. GAAP. A standby unaffiliated third party Letter of Credit supports a portion of the statutory reserves that have been ceded to the Champlain Life Reinsurance Company.
17. Restructuring, Severance and Other Costs
During the year ended December 31, 2009, the Company completed a review of several strategic alternatives with a goal of preserving capital, reducing risk and stabilizing its ratings. These alternatives included the potential restructuring, discontinuation or disposition of various business lines. Following that review, the Company announced that it would suspend all new sales in its European operations and suspend sales of certain IIP business. The Company has also executed on plans to change the management structure of the organization and reorganized the nature and focus of certain of the Company’s operations. These plans resulted in termination benefits to current employees, costs to terminate leases and other contracts and asset impairment charges. The Company completed these restructuring activities and executed final payment during the year ended December 31, 2010.
The following pre-tax charges were incurred during the year ended December 31, 2009 in connection with these restructuring activities:
| Severance benefits |
$ | 19 | ||
| Asset impairment charges |
26 | |||
| Other contract termination charges |
5 | |||
|
|
|
|||
| Total restructuring, severance and other costs |
$ | 50 | ||
|
|
|
The amounts incurred during the year ended December 31, 2009 were recorded in Insurance operating costs and other expenses within the Company’s Other category. There were no restructuring or severance costs incurred in 2011 and 2010.
F-61
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
18. Sale of Assets and Joint Venture
Servicing Agreement of Hartford Life Private Placement LLC
On November 22, 2011, the Company entered into an agreement with Philadelphia Financial Group, Inc. (“Philadelphia Financial”) whereby Philadelphia Financial will acquire certain assets that are used to administer the Company’s private placement life insurance (“PPLI”) businesses currently administered by Hartford Life Private Placement, LLC (“HLPP”), an affiliate of the Company. The PPLI business administered by HLPP includes the life insurance owned by banks, corporations and high net worth individuals, and group annuity policies. The transaction is expected to close in the second quarter of 2012, subject to regulatory approvals and closing conditions. Upon closing, Philadelphia Financial and the Company will enter into a servicing agreement whereby Philadelphia Financial will service the PPLI businesses administered by HLPP. The Company will retain certain corporate functions associated with this business as well as the mortality risk on the insurance policies. Under the terms of the transaction, Philadelphia Financial will receive certain future income from the policies and pay the Company $118 at closing, resulting in an estimated deferred gain between $65 and $75 after-tax, which will be amortized over the estimated life of the underlying insurance policies. The actual amount may be different. The deferred gain is not expected to have a material impact on the Company’s results of operations in future periods. The assets and liabilities of the PPLI business are included in the Runoff Operations segment.
Sale of Joint Venture Interest in ICATU Hartford Seguros, S.A.
On November 23, 2009, the Company entered into a Share Purchase Agreement to sell its joint venture interest in ICATU Hartford Seguros, S.A. (“IHS”), its Brazilian insurance operation, to its partner, ICATU Holding S.A., for $135. The transaction closed in 2010, and the Company received cash proceeds of $130, which was net of capital gains tax withheld of $5. The investment in IHS was reported as an equity method investment in Other assets. As a result of the Share Purchase Agreement, the Company recorded in 2009, an asset impairment charge, net of unrealized capital gains and foreign currency translation adjustments, in net realized capital losses of $44, after-tax.
See Note 19 for sale of subsidiaries that met the criteria for discontinued operations.
19. Discontinued Operations
During the fourth quarter of 2010, the Company completed the sales of its indirect wholly-owned subsidiaries Hartford Investments Canada Corporation (“HICC”) and Hartford Advantage Investment, Ltd. (“HAIL”). The Company recognized a net realized capital gain of $41, after-tax, on the sale of HICC and a net realized capital loss of $4, after-tax, on the sale of HAIL. HICC was previously included in the Mutual Funds reporting segment and HAIL was included in the Runoff reporting segment. The Company does not expect these sales to have a material impact on the Company’s future earnings.
The following table presents the combined amounts related to the operations of HICC and HAIL, which have been reflected as discontinued operations in the Consolidated Statements of Operations.
| For the years ended December 31, |
||||||||
| 2010 | 2009 | |||||||
| Revenues |
||||||||
| Fee income and other |
$ | 36 | $ | 29 | ||||
| Net realized capital losses |
— | (1 | ) | |||||
|
|
|
|
|
|||||
| Total revenues |
36 | 28 | ||||||
| Benefits, losses and expenses |
||||||||
| Insurance operating and other expenses |
28 | 24 | ||||||
| Amortization of deferred policy acquisition costs and present value of future profits |
17 | 11 | ||||||
|
|
|
|
|
|||||
| Total benefits, losses and expenses |
45 | 35 | ||||||
| Loss before income taxes |
(9 | ) | (7 | ) | ||||
| Income tax benefit |
(3 | ) | (2 | ) | ||||
|
|
|
|
|
|||||
| Loss from operations of discontinued operations, net of tax |
(6 | ) | (5 | ) | ||||
| Net realized capital gain on disposal, net of tax |
37 | — | ||||||
|
|
|
|
|
|||||
| Income (loss) from discontinued operations, net of tax |
$ | 31 | $ | (5 | ) | |||
|
|
|
|
|
|||||
F-62
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
20. Quarterly Results For 2011 and 2010 (Unaudited)
| Three Months Ended | ||||||||||||||||||||||||||||||||
| March 31, | June 30, | September 30, | December 31, | |||||||||||||||||||||||||||||
| 2011 | 2010 | 2011 | 2010 | 2011 | 2010 | 2011 | 2010 | |||||||||||||||||||||||||
| Total revenues |
$ | 1,181 | $ | 1,247 | $ | 1,772 | $ | 2,203 | $ | 2,537 | $ | 1,229 | $ | 1,113 | $ | 1,302 | ||||||||||||||||
| Total benefits, losses and expenses |
877 | 1,238 | 1,505 | 2,392 | 3,385 | 690 | 855 | 712 | ||||||||||||||||||||||||
| Income (loss) from continuing operations, net of tax |
239 | (7 | ) | 324 | (84 | ) | (525 | ) | 379 | 206 | 433 | |||||||||||||||||||||
| Income (loss) from discontinued operations, net of tax |
— | (1 | ) | — | (1 | ) | — | (3 | ) | — | 36 | |||||||||||||||||||||
| Net income (loss) |
239 | (8 | ) | 324 | (85 | ) | (525 | ) | 376 | 206 | 469 | |||||||||||||||||||||
| Less: Net income (loss) attributable to the noncontrolling interest |
1 | 2 | 1 | 3 | (4 | ) | 2 | 2 | 1 | |||||||||||||||||||||||
| Net income (loss) attributable to Hartford Life Insurance Company |
$ | 238 | $ | (10 | ) | $ | 323 | $ | (88 | ) | $ | (521 | ) | $ | 374 | $ | 204 | $ | 468 | |||||||||||||
F-63
Schedule SUMMARY OF INVESTMENTS OTHER THAN INVESTMENTS IN AFFILIATES
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
SUMMARY OF INVESTMENTS—OTHER THAN INVESTMENTS IN AFFILIATES
($ in millions)
| As of December 31, 2011 | ||||||||||||
| Type of Investment |
Cost | Fair Value |
Amount at which shown on Balance Sheet |
|||||||||
| Fixed maturities |
||||||||||||
| Bonds and notes |
||||||||||||
| U.S. government and government agencies and authorities (guaranteed and sponsored) |
$ | 5,687 | $ | 6,018 | $ | 6,018 | ||||||
| States, municipalities and political subdivisions |
1,504 | 1,557 | 1,557 | |||||||||
| Foreign governments |
1,121 | 1,224 | 1,224 | |||||||||
| Public utilities |
5,507 | 6,101 | 6,101 | |||||||||
| All other corporate bonds |
22,577 | 24,128 | 24,128 | |||||||||
| All other mortgage-backed and asset-backed securities |
9,840 | 8,750 | 8,750 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total fixed maturities, available-for-sale |
46,236 | 47,778 | 47,778 | |||||||||
| Fixed maturities, at fair value using fair value option |
1,476 | 1,317 | 1,317 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total fixed maturities |
47,712 | 49,095 | 49,095 | |||||||||
|
|
|
|
|
|
|
|||||||
| Equity securities |
||||||||||||
| Common stocks |
||||||||||||
| Industrial, miscellaneous and all other |
285 | 294 | 294 | |||||||||
| Non-redeemable preferred stocks |
158 | 104 | 104 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total equity securities, available-for-sale |
443 | 398 | 398 | |||||||||
| Equity securities, trading |
1,860 | 1,967 | 1,967 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total equity securities |
2,303 | 2,365 | 2,365 | |||||||||
|
|
|
|
|
|
|
|||||||
| Mortgage loans |
4,182 | 4,382 | 4,182 | |||||||||
| Policy loans |
1,952 | 2,099 | 1,952 | |||||||||
| Investments in partnerships and trusts |
1,376 | 1,376 | 1,376 | |||||||||
| Futures, options and miscellaneous |
1,110 | 1,974 | 1,974 | |||||||||
| Short-term investments |
3,882 | 3,882 | 3,882 | |||||||||
|
|
|
|
|
|
|
|||||||
| Total investments |
$ | 62,517 | $ | 65,173 | $ | 64,826 | ||||||
|
|
|
|
|
|
|
|||||||
S-1
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
SUPPLEMENTARY INSURANCE INFORMATION
(In millions)
| Segment |
Deferred Policy Acquisition Costs and Present Value of Future Profits |
Future Policy
Benefits, Unpaid Losses and Loss Adjustment Expenses |
Unearned Premiums |
Other Policyholder Funds and Benefits Payable |
||||||||||||
| As of December 31, 2011 |
||||||||||||||||
| Individual Annuity |
$ | 1,186 | $ | 2,326 | $ | 29 | $ | 16,985 | ||||||||
| Individual Life |
2,558 | 1,011 | 1 | 7,014 | ||||||||||||
| Retirement Plans |
714 | 436 | 2 | 7,959 | ||||||||||||
| Mutual Funds |
27 | — | — | 4 | ||||||||||||
| Runoff Operations |
113 | 7,511 | 74 | 14,983 | ||||||||||||
| Other |
— | 547 | 15 | — | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Consolidated |
$ | 4,598 | $ | 11,831 | $ | 121 | $ | 46,945 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| As of December 31, 2010 |
||||||||||||||||
| Individual Annuity |
$ | 1,303 | $ | 2,089 | $ | 22 | $ | 16,835 | ||||||||
| Individual Life |
2,620 | 850 | 1 | 6,352 | ||||||||||||
| Retirement Plans |
842 | 458 | 3 | 6,841 | ||||||||||||
| Mutual Funds |
43 | — | — | 4 | ||||||||||||
| Runoff Operations |
141 | 7,441 | 72 | 15,615 | ||||||||||||
| Other |
— | 547 | 15 | — | ||||||||||||
|
|
|
|
|
|
|
|
|
|||||||||
| Consolidated |
$ | 4,949 | $ | 11,385 | $ | 113 | $ | 45,647 | ||||||||
|
|
|
|
|
|
|
|
|
|||||||||
S-2
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
SCHEDULE III
SUPPLEMENTARY INSURANCE INFORMATION (continued)
| Segment |
Earned Premiums, Fee Income and Other |
Net Investment Income |
Benefits, Losses and Loss Adjustment Expenses |
Amortization of Deferred Policy Acquisition Costs and Present Value of Future Profits |
Insurance Operating Costs and Other Expenses [1] |
Net
Written Premiums |
||||||||||||||||||
| For the year ended December 31, 2011 |
||||||||||||||||||||||||
| Individual Annuity |
$ | 1,651 | $ | 769 | $ | 1,080 | $ | 186 | $ | 742 | N/A | |||||||||||||
| Individual Life |
858 | 420 | 761 | 219 | 194 | N/A | ||||||||||||||||||
| Retirement Plans |
380 | 396 | 308 | 134 | 354 | N/A | ||||||||||||||||||
| Mutual Funds |
569 | 1 | — | 47 | 374 | N/A | ||||||||||||||||||
| Runoff Operations |
221 | 941 | 852 | 30 | 982 | N/A | ||||||||||||||||||
| Other |
357 | 39 | 92 | — | 267 | N/A | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Consolidated |
$ | 4,036 | $ | 2,566 | $ | 3,093 | $ | 616 | $ | 2,913 | N/A | |||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| For the year ended December 31, 2010 |
||||||||||||||||||||||||
| Individual Annuity |
$ | 1,721 | $ | 813 | $ | 1,057 | $ | (39 | ) | $ | 287 | N/A | ||||||||||||
| Individual Life |
819 | 362 | 591 | 120 | 199 | N/A | ||||||||||||||||||
| Retirement Plans |
359 | 364 | 278 | 27 | 340 | N/A | ||||||||||||||||||
| Mutual Funds |
580 | (1 | ) | — | 51 | 385 | N/A | |||||||||||||||||
| Runoff Operations |
254 | 1,221 | 1,168 | 56 | 128 | N/A | ||||||||||||||||||
| Other |
333 | 100 | 92 | — | 292 | N/A | ||||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Consolidated |
$ | 4,066 | $ | 2,859 | $ | 3,186 | $ | 215 | $ | 1,631 | N/A | |||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| For the year ended December 31, 2009 |
||||||||||||||||||||||||
| Individual Annuity |
$ | 1,549 | $ | 770 | $ | 1,374 | $ | 3,189 | $ | 526 | N/A | |||||||||||||
| Individual Life |
902 | 304 | 584 | 312 | 185 | N/A | ||||||||||||||||||
| Retirement Plans |
324 | 315 | 269 | 56 | 346 | N/A | ||||||||||||||||||
| Mutual Funds |
437 | (16 | ) | — | 50 | 315 | N/A | |||||||||||||||||
| Runoff Operations |
549 | 1,279 | 1,593 | 111 | 205 | N/A | ||||||||||||||||||
| Other |
339 | 196 | 239 | (2 | ) | 261 | N/A | |||||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
| Consolidated |
$ | 4,100 | $ | 2,848 | $ | 4,059 | $ | 3,716 | $ | 1,838 | N/A | |||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|
|
|||||||||||||
[1] Includes dividends and goodwill impairment.
N/A — Not applicable to life insurance pursuant to Regulation S-X.
S-3
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
REINSURANCE
REINSURANCE
(In millions)
| Percentage of | ||||||||||||||||||||
| Gross | Ceded to Other |
Assumed From Other |
Net | Amount Assumed |
||||||||||||||||
| Amount | Companies | Companies | Amount | to Net | ||||||||||||||||
| For the year ended December 31, 2011 |
||||||||||||||||||||
| Life insurance in force |
$ | 316,817 | $ | 130,029 | $ | 1,941 | $ | 188,729 | 1 | % | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Insurance Revenues |
||||||||||||||||||||
| Life insurance and annuities |
$ | 4,451 | $ | 531 | $ | 13 | $ | 3,933 | — | |||||||||||
| Accident and health insurance |
305 | 202 | — | 103 | — | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Total insurance Revenues |
$ | 4,756 | $ | 733 | $ | 13 | $ | 4,036 | — | |||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| For the year ended December 31, 2010 |
||||||||||||||||||||
| Life insurance in force |
$ | 359,644 | $ | 150,446 | $ | 2,027 | $ | 211,225 | 1 | % | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Insurance Revenues |
||||||||||||||||||||
| Life insurance and annuities |
$ | 4,440 | $ | 546 | $ | 69 | $ | 3,963 | 2 | % | ||||||||||
| Accident and health insurance |
316 | 213 | — | 103 | — | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Total insurance Revenues |
$ | 4,756 | $ | 759 | $ | 69 | $ | 4,066 | 2 | % | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| For the year ended December 31, 2009 |
||||||||||||||||||||
| Life insurance in force |
$ | 356,432 | $ | 145,639 | $ | 2,157 | $ | 212,950 | 1 | % | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Insurance Revenues |
||||||||||||||||||||
| Life insurance and annuities |
$ | 4,552 | $ | 628 | $ | 70 | $ | 3,994 | 2 | % | ||||||||||
| Accident and health insurance |
338 | 232 | — | 106 | — | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Total insurance Revenues |
$ | 4,890 | $ | 860 | $ | 70 | $ | 4,100 | 2 | % | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
S-4
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
VALUATION AND QUALIFYING ACCOUNTS
(In millions)
| Balance January 1, |
Charged to Costs and Expenses |
Translation Adjustment |
Write-offs/ Payments/ Other |
Balance December 31, |
||||||||||||||||
| 2011 |
||||||||||||||||||||
| Valuation allowance on deferred tax asset |
$ | 139 | $ | (50 | ) | $ | — | $ | — | $ | 89 | |||||||||
| Valuation allowance on mortgage loans |
62 | (25 | ) | — | (14 | ) | 23 | |||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| 2010 |
||||||||||||||||||||
| Valuation allowance on deferred tax asset |
80 | 59 | — | — | 139 | |||||||||||||||
| Valuation allowance on mortgage loans |
260 | 108 | — | (306 | ) | 62 | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| 2009 |
||||||||||||||||||||
| Valuation allowance on deferred tax asset |
49 | 31 | — | — | 80 | |||||||||||||||
| Valuation allowance on mortgage loans |
13 | 292 | — | (45 | ) | 260 | ||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
S-5
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, hereunto duly authorized.
| HARTFORD LIFE INSURANCE COMPANY | ||
| /s/ Beth A. Bombara | ||
| Beth A. Bombara | ||
| Chief Accounting Officer | ||
Date: February 24, 2012
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| Signature |
Title |
Date | ||
| /s/ David N. Levenson |
President and Director | February 24, 2012 | ||
| David N. Levenson |
||||
| /s/ David G. Bedard |
Executive Vice President, Chief Financial Officer | February 24, 2012 | ||
| David G. Bedard |
||||
| /s/ Beth A. Bombara |
Chief Accounting Officer | February 24, 2012 | ||
| Beth A. Bombara |
||||
| /s/ Mark Niland |
Senior Vice President and Director | February 24, 2012 | ||
| Mark Niland |
||||
II-1
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2011
FORM 10-K
The exhibits attached to this Form 10-K are those that are required by Item 601 of Regulation S-K.
| Exhibit No. |
Description | |
| 3.01 |
Restated Certificate of Incorporation of Hartford Life Insurance Company (the “Company”), effective April 2, 1982, as amended by Amendment No. 1, effective August 3, 1984, as amended by Amendment No. 2 effective December 31, 1996, as amended by Amendment No. 3, effective July 25, 2000 (incorporated herein by reference to Exhibit 3.01 to the Company’s Form 10-K for the fiscal year ended December 31, 2004). | |
| 3.02 |
Amended By-Laws of Hartford Life Insurance Company, effective July 31, 2007, (incorporated herein by reference to Exhibit 3.02 to the Company’s Form 10-K for the year ended December 31, 2004). | |
| 4.01 |
Restated Certificate of Incorporation and By-Laws of Hartford Life Insurance Company (included as Exhibits 3.01 and 3.02, respectively). | |
| 10.01 |
Intercompany Liquidity Agreement between The Hartford Financial Services Group, Inc., Hartford Life and Accident Insurance Company and certain affiliates, including Hartford Life Insurance Company, effective December 31, 2010 (incorporated by reference to Exhibit 10.1 of the Company’s Current Report on Form 8-K, filed on January 5, 2011). | |
| 10.02 |
Preferred Partnership Agreement dated December 5, 2011 by and between The Hartford Financial Services Group, Inc., Hartford Life, Inc., Hartford Investment Financial Services, LLC, HL Investment Advisors, LLC and Wellington Management Company, LLP. *† | |
| 12.01 |
Computation of Ratio of Earnings to Fixed Charges* | |
| 18.01 |
Preferability letter from Deloitte & Touche LLP regarding change in accounting principle* | |
| 23.01 |
Consent of Deloitte & Touche LLP* | |
| 31.01 |
Certification of David N. Levenson, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002* | |
| 31.02 |
Certification of David G. Bedard, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002* | |
| 32.01 |
Certification of David N. Levenson, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002* | |
| 32.02 |
Certification of David G. Bedard, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002* | |
| 101.INS |
XBRL Instance Document [1] | |
| 101.SCH |
XBRL Taxonomy Extension Schema | |
| 101.CAL |
XBRL Taxonomy Extension Calculation Linkbase | |
| 101.DEF |
XBRL Taxonomy Extension Definition Linkbase | |
| 101.LAB |
XBRL Taxonomy Extension Label Linkbase | |
| 101.PRE |
XBRL Taxonomy Extension Presentation Linkbase | |
| [1] | Includes the following materials contained in this Annual Report on Form 10-K for the quarter ended December 31, 2011 formatted in XBRL (eXtensible Business Reporting Language) (i) the Consolidated Statements of Operations, (ii)the Consolidated Statements of Comprehensive Income (Loss), (iii) the Consolidated Balance Sheets, (iv) the Consolidated Statements of Changes in Equity, (v) the Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements, which is tagged as blocks of text. |
| * | Filed with the Securities and Exhange Commission as an exhibit to this report. |
| † | Confidential treatment has been requested for the redacted portions of this agreement. A complete copy of this agreement, including the redacted portions, has been filed separately with the Securities and Exchange Commission. |
II-2
Exhibit 10.02
CONFIDENTIAL TREATMENT REQUESTED – Confidential portions of this document have been redacted and filed separately with the Commission.
PREFERRED PARTNERSHIP
AGREEMENT
by and among
THE HARTFORD FINANCIAL SERVICES GROUP, INC.,
HARTFORD LIFE, INC.,
HARTFORD INVESTMENT FINANCIAL SERVICES, LLC,
HL INVESTMENT ADVISORS, LLC
and
WELLINGTON MANAGEMENT COMPANY, LLP
Dated as of December 5, 2011
TABLE OF CONTENTS
| ARTICLE I | ||
| DEFINITIONS | ||
| Section 1.1 Definitions |
1 | |
| ARTICLE II | ||
| PREFERRED PARTNERSHIP | ||
| Section 2.1 Preferred Subadviser |
11 | |
| Section 2.2 Preferred Partner |
11 | |
| Section 2.3 Certain Restrictions on Wellington Subadvisory Business |
12 | |
| Section 2.4 Wellington Portfolio Managers |
12 | |
| Section 2.5 Fixed Income Hartford Funds |
13 | |
| Section 2.6 Wellington Termination Right |
13 | |
| Section 2.7 Hartford Termination Right |
13 | |
| Section 2.8 No Further Restrictions on HIMCO |
13 | |
| Section 2.9 Fiduciary Duties |
13 | |
| Section 2.10 Update of Certain Schedules |
14 | |
| ARTICLE III | ||
| FEES | ||
| Section 3.1 Agreement With Respect to Fees |
14 | |
| Section 3.2 Fee Waivers for Fixed Income Mandates |
15 | |
| ARTICLE IV | ||
| REPRESENTATIONS AND WARRANTIES OF HARTFORD | ||
| Section 4.1 Organization and Standing |
16 | |
| Section 4.2 Power and Authority |
16 | |
| Section 4.3 Non-Contravention; Consents |
16 | |
| ARTICLE V | ||
| REPRESENTATIONS AND WARRANTIES OF WELLINGTON | ||
| Section 5.1 Organization and Standing |
17 | |
| Section 5.2 Power and Authority |
17 | |
| Section 5.3 Non-Contravention; Consents |
17 | |
i
| ARTICLE VI | ||||
| COVENANTS | ||||
| Section 6.1 Brand |
17 | |||
| Section 6.2 Periodic Certifications |
18 | |||
| Section 6.3 Notice of a Hartford Sale |
18 | |||
| Section 6.4 Right of First Refusal |
20 | |||
| Section 6.5 Notice of Wellington Change of Control Event |
21 | |||
| Section 6.6 Notice of HIG Change of Control Event |
21 | |||
| Section 6.7 IPO or Spin Out |
22 | |||
| ARTICLE VII | ||||
| CONFIDENTIALITY | ||||
| Section 7.1 Treatment of Confidential Information |
22 | |||
| Section 7.2 Permitted Disclosure |
22 | |||
| Section 7.3 Effect of Termination |
23 | |||
| Section 7.4 Ownership of Confidential Information |
23 | |||
| Section 7.5 Disclosure Related to Sale |
23 | |||
| Section 7.6 Equitable Relief |
23 | |||
| ARTICLE VIII | ||||
| DISPUTE RESOLUTION | ||||
| Section 8.1 Disputes; Resolution by Executive Officers |
23 | |||
| Section 8.2 Injunctive Relief |
24 | |||
| ARTICLE IX | ||||
| TERM AND TERMINATION OF PREFERRED PARTNERSHIP; MAKE-WHOLE PAYMENT |
||||
| Section 9.1 Term |
24 | |||
| Section 9.2 Termination |
24 | |||
| Section 9.3 Effect of Termination |
25 | |||
| Section 9.4 Make-Whole Payment |
26 | |||
| Section 9.5 Determination of Total Enterprise Value |
26 | |||
| ARTICLE X | ||||
| MISCELLANEOUS | ||||
| Section 10.1 Amendments; Extension; Waiver |
27 | |||
| Section 10.2 Entire Agreement |
27 | |||
| Section 10.3 Interpretation |
28 | |||
ii
| Section 10.4 Severability |
28 | |||
| Section 10.5 Notices |
28 | |||
| Section 10.6 Binding Effect; Persons Benefiting; No Assignment |
29 | |||
| Section 10.7 Disclaimers |
29 | |||
| Section 10.8 Specific Performance |
30 | |||
| Section 10.9 Counterparts |
30 | |||
| Section 10.10 Governing Law; Waiver of Jury Trial |
30 | |||
| Section 10.11 Certain Understandings |
30 |
iii
TABLE OF SCHEDULES
| SCHEDULE A |
EXECUTIVE OFFICERS | |
| SCHEDULE B | HARTFORD HLS FUNDS | |
| SCHEDULE C | BROKER-DEALERS* | |
| SCHEDULE D | INTENTIONALLY OMITTED | |
| SCHEDULE E | WELLINGTON PORTFOLIO MANAGERS* | |
| SCHEDULE F | FIXED INCOME FUND MANDATES | |
| SCHEDULE G | FEE REVISIONS ON EXISTING HARTFORD FUNDS* | |
| SCHEDULE H | ALLOCATIONS SERVICE FEES* | |
* Portions of this exhibit have been omitted pursuant to a Confidential Treatment Request submitted to the Securities and Exchange Commission on the date hereof. Redacted information has been filed separately with the Securities and Exchange Commission.
iv
PREFERRED PARTNERSHIP AGREEMENT
This PREFERRED PARTNERSHIP AGREEMENT, dated as of December 5, 2011 (as amended from time to time, the “Agreement”), is by and among The Hartford Financial Services Group, Inc., a Delaware corporation (together with any successor thereto or permitted assignee thereof, “Hartford”), Hartford Life, Inc., a Delaware corporation (“HLI”), Hartford Investment Financial Services, LLC, a Delaware limited liability company, HL Investment Advisors, LLC, a Connecticut limited liability company, and Wellington Management Company, LLP, a Massachusetts limited liability partnership (together with any successor thereto or permitted assignee thereof, “Wellington”).
RECITALS:
WHEREAS, the Hartford Parties (as defined below) and Wellington seek to establish a relationship pursuant to which Wellington will serve as preferred subadviser to the Hartford Funds (as defined below), and Hartford will serve as Wellington’s preferred partner with respect to the Covered Funds (as defined below), on the terms and conditions set forth in this Agreement;
WHEREAS, the Hartford Parties and Wellington desire to make certain representations, warranties, covenants and agreements in connection with the arrangements contemplated by this Agreement; and
WHEREAS, the parties hereto desire to enter into this Agreement.
NOW, THEREFORE, in consideration of the mutual covenants, promises and representations set forth herein, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows:
ARTICLE I
DEFINITIONS
Section 1.1 Definitions. For all purposes in this Agreement, the following terms shall have the following respective meanings (which shall apply equally to the singular and plural form of any such term as the context requires):
“Affiliate” means, with respect to any Person, any other Person that directly or indirectly through one or more intermediaries, controls, is controlled by or is under common control with such first Person; provided, however, that, for the avoidance of doubt, Wellington is not an Affiliate of Hartford or any of its Affiliates and vice versa for purposes of this Agreement or any other purpose. “Control,” when used with respect to any specified Person, means the possession, directly or indirectly, of the power to direct (or cause the direction of) the management and policies of such Person, whether through the ownership of voting securities or other voting interests, by contract or otherwise; and the terms “controlling” and “controlled” have correlative meanings to the foregoing. For purposes of the definition of “Control,” a general partner, managing member or managing partner of a Person shall always be considered
to control such Person. Notwithstanding the foregoing sentences of this definition, (i) neither Allianz SE nor any of its Affiliates shall be deemed to be an Affiliate of Hartford or any of its Affiliates for purposes of this Agreement and (ii) no natural person that is a partner of Wellington shall be deemed to be an Affiliate of Wellington.
“Agreement” shall have the meaning set forth in the Preamble.
“Applicable Law” means, with respect to any Person, any statute, law, ordinance, rule, regulation, order writ, injunction, directive, judgment, decree or other requirement of any Governmental Authority (including any applicable requirements of any SRO) to the extent applicable to such Person or any of its properties, assets, officers, directors, members, partners, employees or agents.
“Appraiser” means a nationally recognized investment bank that (a) is listed as one of the top twenty such investment banks in the “League Table of Financial Advisors to Americas M&A: Value” as published by The Mergermarket Group (www.mergermarket.com) for the most recent calendar quarter preceding the date on which such investment bank is hired and (b) has not provided material investment banking services to any Party or any of its Affiliates within the 12-month period immediately preceding the date on which such investment bank is hired in connection with Section 9.5, nor is expected to do so in the subsequent 12-month period.
“Bankruptcy Event” means, with respect to the applicable Person, the occurrence of any of the following events: (i) such Person makes a general assignment for the benefit of creditors; (ii) such Person files a voluntary petition in bankruptcy; (iii) such Person is adjudged bankrupt or insolvent, or has entered against him an order for relief in any bankruptcy or insolvency proceeding or vacated within 90 days of such order; (iv) such Person files a petition or answer seeking any reorganization, arrangement, composition, readjustment, liquidation, dissolution or similar relief under any statute, regulation or law; (v) such Person files an answer or other pleading admitting or failing to contest the material allegations of a petition filed against such Person in any proceeding of this nature; (vi) such Person seeks, consents to, or acquiesces in the appointment of, a trustee, receiver, or liquidator of all or any substantial part of such Person’s properties; (vii) if 60 days after the commencement of any proceeding against such Person seeking reorganization, arrangement, composition, readjustment, liquidation, dissolution or similar relief under any statute, law or regulation or the entry of any order for relief, the proceeding has not been dismissed or stayed, or the order vacated or stayed; or (viii) if within 90 days after the appointment without his consent or acquiescence of a trustee, receiver or liquidator of such Person or of all or any substantial part of his properties, the appointment is not vacated or stayed, or if within 90 days after the expiration of any such stay, the appointment is not vacated.
“Business Day” means any day other than a Saturday, Sunday or a day on which the New York Stock Exchange is closed.
“Closing AUM Percentage” shall equal the quotient (expressed as a percentage) of (i) the total assets under management of the Legacy Hartford Funds that are subadvised by Wellington immediately prior to consummation of a Hartford Sale or HIG Change of Control Event (as applicable) divided by (ii) the total assets under management of all of the Legacy Hartford Funds as of such time.
2
“Confidential Information” means any and all information, materials and know-how, whether disclosed prior to, on or after the date of this Agreement, regardless of the form in which it is communicated or maintained, whether oral, electronic, visual, written or in any other form or medium, together with all tangible and intangible embodiments and copies thereof, that are delivered or disclosed by any Party or its representatives or agents to the other Party or its representatives or agents or otherwise obtained by any Party or its representatives or agents under this Agreement. The term “Confidential Information” shall (i) include (a) any extracts, derivatives or summaries that contain or otherwise reflect any such information and (b) the existence and terms of this Agreement and (ii) not include any information (excluding the existence and terms of this Agreement) that:
(a) is or becomes publicly known without fault on the part of the disclosing Party or its representatives;
(b) has been received by a Party at any time from a source (other than another Party) that, to the knowledge of the receiving Party, has the right to disclose such Confidential Information;
(c) was otherwise known by the disclosing Party prior to disclosure to such Party by another Party; or
(d) is developed by the disclosing Party independently from and without use of or reference to any Confidential Information.
“Consolidator” means any Person that is engaged, directly or through a subsidiary or Affiliate, in the business of managing publicly traded liquid securities with total assets under management of $[***] billion or more for third parties (whether via mutual funds, managed accounts or otherwise). For the avoidance of doubt, any registered mutual fund sponsored or advised by any Person shall be third party assets for purposes of calculating the assets under management under this definition.
“Covered Fund” means an open-end, closed-end or actively managed exchange-traded fund registered under the Investment Company Act (i) for which Wellington serves as the sole investment adviser or subadviser, (ii) the shares of which are offered and sold primarily to retail investors in the United States through one or more broker-dealers that are not Affiliates of the sponsor or manager of the applicable fund and (iii) that is offered on a stand-alone basis. The term “Covered Fund” shall not include (i) a fund registered under the Investment Company Act that is sponsored or managed by The Vanguard Group, Inc. (or any successor thereto) or its Affiliates, (ii) a fund registered under the Investment Company Act or a Sleeve that, in either case, represents one of multiple investment approaches in a bundled investment option to the end investor (e.g., the fund or Sleeve is part of a multi-Sleeve or multi-manager fund or suite of funds,
Certain information in this exhibit, marked by “[***]” has been redacted and will be filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended. Confidential treatment has been requested with respect to the redacted portions.
3
fund of funds or target date fund that includes funds or Sleeves for which parties other than Wellington serve as investment adviser or sub-adviser), (iii) any portion of a fund registered under the Investment Company Act that represents one of multiple investment approaches offered by multiple managers or investment advisers in a bundled investment option to the end investor, (iv) a fund registered under the Investment Company Act sold primarily in conjunction with a variable insurance product and (v) any money market fund.
“Cure Period” shall have the meaning set forth in Section 9.2(b)(ii).
“EDGAR” means the SEC’s Electronic Data Gathering, Analysis and Retrieval system.
“Encumbrance” means any lien, pledge, security interest, claim, charge, easement, limitation, commitment, encroachment, restriction or encumbrance of any kind or nature whatsoever.
“Exchange Act” means the Securities Exchange Act of 1934, as amended, and all rules and regulations of the SEC thereunder.
“Executive Officers” means the individuals listed on Schedule A and any successor to any such individual. Hartford and Wellington may update the individuals listed as Executive Officers of them on Schedule A by written notice to the other, provided any such individual shall be an executive officer of Hartford or Wellington.
“FINRA” means the Financial Industry Regulatory Authority or any successor thereto.
“Fixed Income Fund Mandates” shall have the meaning set forth in Section 2.5.
“Governmental Authority” means any nation, state, territory, province, county, city or other unit or subdivision thereof or any entity, authority, agency, department, board, commission, instrumentality, court or other judicial body authorized on behalf of any of the foregoing to exercise legislative, judicial, regulatory or administrative functions of or pertaining to government, and any governmental or non-governmental self-regulatory organization.
“Hartford” shall have the meaning set forth in the Preamble.
“Hartford Adviser” means Hartford Investment Financial Services, LLC, HL Investment Advisors, LLC or any Affiliate of Hartford that may, from time to time, act as investment adviser to any Hartford Fund, together with any successor thereto or permitted assignee thereof.
“Hartford Funds” means all open-end, closed-end and actively managed exchange-traded funds registered under the Investment Company Act and advised by Hartford or any of its Affiliates (including the Hartford Advisers). Notwithstanding the foregoing, the term Hartford Funds shall not include:
4
(i) any open-end fund registered under the Investment Company Act organized after the date of this Agreement that is sponsored by and offered exclusively to and through Hartford’s variable annuity, variable life or retirement plan businesses,
(ii) Hartford Portfolio Diversifier HLS Fund,
(iii) American Funds Growth-Income HLS Fund,
(iv) American Funds Bond HLS Fund,
(v) American Funds New World HLS Fund,
(vi) American Funds International HLS Fund,
(vii) American Funds Global Bond HLS Fund,
(viii) American Funds Global Growth and Income HLS Fund,
(ix) American Funds Blue Chip Income & Growth HLS Fund,
(x) American Funds Growth-Income HLS Fund,
(xi) American Funds Growth HLS Fund,
(xii) American Funds Asset Allocation HLS Fund,
(xiii) American Funds Global Growth HLS Fund,
(xiv) American Funds Global Small Capitalization HLS Fund,
(xv) The Hartford Money Market Fund,
(xvi) Hartford Money Market HLS Fund (or any other money market fund sponsored by Hartford),
(xvii) Hartford Index HLS Fund, and
(xviii) any other American Fund that satisfies clause (i) of this definition.
“Hartford Funds Board” means the boards of directors or trustees, as the case may be, of each of the Hartford Funds.
“Hartford HLS Funds” means the funds set forth on Schedule B hereto.
“Hartford Parties” means Hartford, HLI, Hartford Investment Financial Services, LLC and HL Investment Advisors, LLC.
“Hartford Sale” means an HMF Sale or a Non-HMF Sale.
5
“HIG Change of Control Event” means (a) any event (or series of related events consummated pursuant to a common plan or arrangement) where any “person” or “group” (as such terms are used in Section 13(d) and 14(d) of the Exchange Act) is or becomes the “beneficial owner” (as defined in Rules 13d-3 and 13d-5 under the Exchange Act, except that a Person will be deemed to have “beneficial ownership” of all securities that such Person has the right to acquire, whether such right is exercisable immediately or in the future), directly or indirectly, of more than 50% of the voting power of the outstanding voting stock of Hartford (other than with respect to one or more Persons beneficially owning proxies to vote more than 50% of the voting stock of Hartford at an annual or special meeting which is not for the purpose of approving a merger or other acquisition transaction or, where such proxies are held by a Consolidator, to replace a majority of the directors) or (b) any transaction (including any merger, capital stock exchange, asset acquisition, stock purchase, reorganization or other similar transaction, including a joint venture or obtaining a majority interest through contractual arrangements) (or series of related transactions implemented pursuant to a common plan or arrangement) pursuant to which (i) more than 50% of the voting stock of Hartford is converted into or exchanged for cash, securities or other property or Hartford conveys, transfers, leases or otherwise disposes of all or substantially all of the assets of Hartford (other than (x) a transfer of such assets to one or more controlled, wholly-owned Affiliates of Hartford or (y) any such transaction where the Persons who were the beneficial owners of the outstanding voting stock of Hartford immediately prior to such transaction beneficially own immediately following such transaction, directly or indirectly (including, without limitation, through one or more holding companies or subsidiaries), 50% or more of the outstanding voting stock of the corporation or other entity resulting from such transaction) or (ii) without limitation of clause (i)with respect to mergers and consolidations, Persons who were the beneficial owners of the outstanding voting stock of Hartford immediately prior to such transaction beneficially do not own, immediately following such transaction, directly or indirectly (including, without limitation, through one or more holding companies or subsidiaries), 50% or more of the outstanding voting stock of the corporation or other entity resulting from such transaction immediately following such transaction).
“HIG Change of Control Notice” shall have the meaning set forth in Section 6.6.
“HIMCO” means Hartford Investment Management Company.
“HLI” shall have the meaning set forth in the Preamble.
“HMF Business” means the business, assets and operations of the mutual fund business of Hartford and its Affiliates (including the Hartford Advisers), including the sponsoring and management of the Hartford Funds. By way of example, the HMF Business as of the date of this Agreement shall be deemed to include the business, assets and operations of the mutual fund business described in the Confidential Information Memorandum prepared by Hartford and its representatives, dated March 31, 2011.
“HMF Sale” means any direct or indirect sale, issuance, conveyance, transfer or other disposition (whether occurring in a single transaction or as part of a series of related transactions consummated pursuant to a common plan or arrangement) of or an interest in 25% or more of the voting, equity or economics rights or assets (by market value) of the HMF
6
Business (including via the sale, issuance, conveyance, transfer or other disposition of the equity of any direct or indirect owner of the HMF Business), other than (i) any such transaction solely involving a controlled, wholly-owned Affiliate of Hartford, (ii) an initial public offering or spin out of the HMF Business, (iii) a HIG Change of Control Event or, for the avoidance of doubt, any indirect sale, issuance, conveyance, transfer or other disposition involving Hartford or any successor of Hartford (but no other Hartford Affiliate) where the Persons who were the beneficial owners of the outstanding voting stock of Hartford or any successor of Hartford immediately prior to such transaction beneficially own, immediately following such transaction, directly or indirectly (including, without limitation, through one or more holding companies or subsidiaries) 50% or more of the outstanding voting stock of the corporation or other entity resulting from such transaction immediately following such transaction or (iv) a Non-HMF Sale; provided that, solely for purposes of Section 6.4, the reference in this definition to “25%” shall be replaced with “50%”.
“Investment Company Act” means the Investment Company Act of 1940, as amended, and all rules and regulations of the SEC thereunder.
“Legacy Hartford Funds” means the Hartford Funds existing at the closing of the Hartford Sale or HIG Change of Control Event, as applicable.
“Make-Whole Payment” shall have the meaning set forth in Section 9.4(a).
“Material Adverse Effect” means with respect to Hartford or Wellington, as applicable, any change, effect, event, occurrence, state of facts or development that could reasonably be expected to cause the applicable Party to be unable to perform its obligations hereunder in any material respect.
“Non-Hartford Covered Fund AUM” shall equal the total assets under management of Wellington in Covered Funds not sponsored or managed by Hartford or one of its Affiliates, calculated as of the specified measurement date.
“Non-HMF Sale” means any HMF Sale (applied without giving effect to clause (iv) of such definition for purposes of this definition) that satisfies each of the following: (i) the transaction (or series of related transactions consummated pursuant to a common plan or arrangement) involves the sale, issuance, conveyance, transfer or other disposition of one or more Hartford businesses in addition to, or that includes, the HMF Business (including a business of which the HMF Business may be a business line or unit (e.g., Hartford’s Wealth Management Division), (ii) the net income of the HMF Business represents [***]% or more of the total net income of the Hartford businesses (including the HMF Business) involved in the applicable transaction and (iii) the HMF Business was not offered as being available for separate purchase (provided that, in the event that the HMF Business was offered as being available for separate purchase and Hartford thereafter determines that it will sell the HMF Business only as part of the larger sale of the Hartford businesses, such larger sale shall continue to be a Non-HMF-Sale and Wellington shall not have a right to participate in such larger sale under Section
Certain information in this exhibit, marked by “[***]” has been redacted and will be filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended. Confidential treatment has been requested with respect to the redacted portions.
7
6.3 or have a right of first refusal under Section 6.4 with respect to such larger sale). For purposes of this definition, net income shall be the net income for the 12 month period ended at the end of the calendar quarter ending immediately prior to the date on which the applicable Preliminary Hartford Sale Notice is required to be delivered as provided in or derived from Hartford’s financial statements for the applicable period filed with the SEC.
“Party” means each Person identified on the signature page hereto.
“Person” means any natural person, corporation, company, limited liability company, partnership (limited or general), limited liability partnership, joint venture, association, trust, unincorporated organization or other entity.
“Preliminary Hartford Sale Notice” shall have the meaning set forth in Section 6.3(a).
“Restricted Broker-Dealer” means any of the following: (i) any Person set forth on Schedule C hereto for so long as such Person is one of the top 25 (based on gross sales for all Hartford Funds using the most recently available reliable sales data) broker-dealers that has a written selling agreement with respect to Hartford Funds; (ii) any Person that, after the date hereof, becomes one of the top 25 (based on gross sales for all Hartford Funds using the most recently available reliable sales data) broker-dealers with a written selling agreement with respect to Hartford Funds; or (iii) any Person set forth on Schedule C by mutual agreement of Hartford and Wellington. Notwithstanding the foregoing clause (ii), no Person with whom Wellington is in active discussions with regarding a subadvisory engagement shall be a Restricted Broker-Dealer to the extent that such Person is not set forth on Schedule C in effect as of the date of the commencement of such discussions.
“ROFR Election Period” shall have the meaning set forth in Section 6.4(a).
“ROFR Exercise Notice” shall have the meaning set forth in Section 6.4(a).
“ROFR Notice” shall have the meaning set forth in Section 6.4(a).
“ROFR Sale” means an HMF Sale where a Consolidator will, after the consummation of the HMF Sale, own (or have a right to acquire) a direct or indirect interest in the HMF Business. For the avoidance of doubt, (i) a direct or indirect interest held by a Consolidator in its capacity as a limited partner (or similar passive investor) of a third party fund or “sidecar” fund investment solely for investment purposes shall not be a ROFR Sale and (ii) in the case of an HMF Sale where a Consolidator only provides debt financing (which may include a de minimus amount of an equity “kicker” in respect of such debt financing in a customary amount, as applicable), to a purchaser in connection therewith, such HMF Sale shall not be a ROFR Sale.
“SEC” means the Securities and Exchange Commission.
“Sleeve” means that portion of the assets of a fund registered under the Investment Company Act that is managed pursuant to a particular investment strategy within the broader investment strategy of the fund as a whole.
8
“SRO” shall mean any industry self-regulatory organization, agency, or authority or stock exchange, including FINRA, each national securities exchange in the U.S. and any other commission, board, agency or body, whether in the U.S. or foreign, that is charged with the supervision or regulation of brokers, dealers, securities underwriting or trading, stock exchanges, commodities exchanges, investment companies or investment advisers.
“TER” shall have the meaning set forth in Section 3.1(b).
“Term” shall have the meaning set forth in Section 9.1.
“Total Enterprise Value” means the total enterprise value of the HMF Business derived from a Hartford Sale or HIG Change of Control Event, as applicable, measured as of the closing of such Hartford Sale or HIG Change of Control Event, all as determined pursuant to Section 9.5. Total Enterprise Value shall take into account (i) any debt or equity instruments or assets received by Hartford and its Affiliates (including any equity interest in the purchaser), (ii) the net present value of any earn-out, contingent consideration or other future payment (determined using an appropriate discount rate in light of prevailing market conditions at the time, the conditions to the payment of such contingent amounts, and any other material factors relevant to the timing and likelihood of such future payments being made, including indemnity obligations) and (iii) the net debt for borrowed money (less all cash and cash equivalents), if any, of Hartford and its Affiliates allocable to the HMF Business as is determined by the Appraiser(s) to be appropriate. For the avoidance of doubt, in the case of a Hartford Sale or HIG Change of Control Event (as applicable) that involves, directly or indirectly, less than 100% of the HMF Business, Total Enterprise Value shall be determined as if 100% of the HMF Business had been sold in the Hartford Sale or HIG Change of Control Event (as applicable).
“Trigger Event” means (i) the termination or replacement, in whole or in part, of Wellington as subadviser to a Hartford Fund (including as a result of a fund merger or appointment of a co-manager for a Hartford Fund that was previously subadvised only by Wellington) or (ii) any Person other than Wellington (including any Affiliate of Hartford or internal management function) serving as subadviser for any portion of a Hartford Fund, or as adviser for a Hartford Fund with no subadviser, other than, (A) in either case, in connection with a Voluntary Resignation or (B) in the case of clause (ii), any Person acting in such capacity on the date of this Agreement but solely in respect of the Hartford Fund which such Person advises or subadvises on the date of this Agreement.
“Voluntary Resignation” means any resignation or other voluntary termination initiated by Wellington of its role as subadviser to a Legacy Hartford Fund, other than a resignation or other voluntary termination that results from Hartford or the Hartford Advisers recommending to the Hartford Funds Board any reduction in the rate of any subadvisory fee payable by any Hartford Fund.
“WAUM” shall equal the total assets under management of Wellington in Covered Funds (including Non-Hartford Covered Fund AUM), including assets managed through subadvisory relationships, calculated as of the specified measurement date.
“Wellington” shall have the meaning set forth in the Preamble.
9
“Wellington Change of Control Event” means (a) any event (or series of related events consummated pursuant to a common plan or arrangement) where any “person” or “group” (as such terms are used in Section 13(d) and 14(d) of the Exchange Act) is or becomes the “beneficial owner” (as defined in Rules 13d-3 and 13d-5 under the Exchange Act, except that a Person will be deemed to have “beneficial ownership” of all securities that such Person has the right to acquire, whether such right is exercisable immediately or in the future), directly or indirectly, of more than 50% of the voting power of the outstanding voting equity of Wellington (other than with respect to one or more Persons beneficially owning proxies to vote more than 50% of the voting stock of Hartford at an annual or special meeting which is not for the purpose of approving a merger or other acquisition transaction) or (b) any transaction (including any merger, capital stock exchange, asset acquisition, stock purchase, reorganization or other similar transaction, including a joint venture or obtaining a majority interest through contractual arrangements) (or series of related transactions implemented pursuant to a common plan or arrangement) pursuant to which (i) more than 50% of the voting equity of Wellington is converted into or exchanged for cash, securities or other property or Wellington conveys, transfers, leases or otherwise disposes of all or substantially all of the assets of Wellington (other than (x) a transfer of such assets to one or more Affiliates of Wellington or (y) any such transaction where the Persons who were the beneficial owners of the outstanding voting equity of Wellington immediately prior to such transaction beneficially own, directly or indirectly (including, without limitation, through one or more holding companies or subsidiaries), 50% or more of the outstanding voting stock of the corporation or other entity resulting from such transaction) or (ii) without limitation of clause (i), Persons who were the beneficial owners of the outstanding voting equity of Wellington immediately prior to such transaction beneficially do not own, immediately following such transaction directly or indirectly (including, without limitation, through one or more holding companies or subsidiaries), 50% or more of the outstanding voting stock of the corporation or other entity resulting from such transaction). Notwithstanding the foregoing, (x) the admittance and withdrawal of partners of Wellington in the ordinary course shall not be a Wellington Change of Control Event and (y) the partners of Wellington shall not be deemed to be a “group” solely as a result of their status as partners.
“Wellington Subadvised Percentage” shall equal:
(i) the Closing AUM Percentage, less
(ii) with respect to any Legacy Hartford Fund (or portion thereof) where a Trigger Event occurs following the consummation of the Hartford Sale or HIG Change of Control Event (as applicable), the quotient (expressed as a percentage) of (A) the assets under management of such Legacy Hartford Fund (or portion thereof) that were subadvised by Wellington immediately prior to the Trigger Event divided by (B) the total assets under management of all Legacy Hartford Funds at such time, plus
(iii) with respect to any Hartford Fund not subadvised by Wellington at the consummation of the Hartford Sale or HIG Change of Control Event (as applicable) that engages Wellington as subadviser following the consummation of the Hartford Sale or HIG Change of Control Event (as applicable), the quotient (expressed as a percentage) of (A) the assets under management of such Hartford Fund at the time of engagement that will be subadvised by Wellington divided by (B) the total assets under management of
10
all Legacy Hartford Funds at such time. Any Hartford Fund (other than a Legacy Hartford Fund) that engages Wellington as subadviser after the date of consummation of a Hartford Sale or HIG Change of Control Event (as applicable) shall be treated as a Legacy Hartford Fund solely for purposes of applying clauses (ii) and (iii) of this definition (including in the case of a subsequent Trigger Event with respect to any such Hartford Fund).
It is understood and agreed that any Legacy Hartford Fund in respect of which there is a Voluntary Resignation by Wellington, at any time, shall be deemed to continue to be advised by Wellington solely for purposes of the calculation of the Wellington Subadvised Percentage.
ARTICLE II
PREFERRED PARTNERSHIP
Section 2.1 Preferred Subadviser. (a) Subject to the terms and conditions of this Agreement (including Section 2.9), Wellington shall be the preferred subadviser to the Hartford Funds. Subject to the terms and conditions of this Agreement, each Hartford Adviser shall, and Hartford shall cause it to, recommend Wellington to the Hartford Funds Boards as subadviser to the Hartford Funds on terms substantially similar to the existing subadvisory agreements with Wellington (other than fee rates, which shall be reasonably acceptable to Hartford and Wellington), and Wellington shall serve in such capacity in each instance approved by the Hartford Funds Boards.
(b) Following the occurrence of a Trigger Event, no Hartford Adviser shall, and Hartford shall not permit any of them to, enter into any agreement for a new advisory or subadvisory engagement with respect to any Hartford Fund with any Person other than Wellington (including any Affiliate of Hartford or internal management function) if, after giving effect to the applicable Trigger Event and such new advisory or subadvisory agreement, Hartford believes in good faith that Wellington would serve as subadviser to less than [***]% of the total assets under management of all of the Hartford Funds (with such determination based upon the most recently reliable assets under management data and with it being understood and agreed that any Hartford Fund in respect of which there is a Voluntary Resignation by Wellington shall be deemed to continue to be advised by Wellington solely for purposes of such calculation).
Section 2.2 Preferred Partner. Subject to the terms and conditions of this Agreement, Hartford shall be the preferred partner of Wellington with respect to Covered Funds. Subject to the terms and conditions of this Agreement, Hartford shall, and shall cause Hartford Investment Financial Services, LLC, Hartford Securities Distribution Company, Inc., Hartford Life Distributors, LLC and any other registered broker-dealer Affiliate who serves as a principal underwriter for a Hartford Fund or is primarily engaged in wholesale distribution of the Hartford Funds to, use its good faith and commercially reasonable efforts to promote the distribution in the U.S. broker-sold mutual fund market of the Hartford Funds for which Wellington acts as subadviser.
Certain information in this exhibit, marked by “[***]” has been redacted and will be filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended. Confidential treatment has been requested with respect to the redacted portions.
11
Section 2.3 Certain Restrictions on Wellington Subadvisory Business.
(a) Wellington shall not, without the prior written consent of Hartford, enter into any agreement for a new engagement to (i) serve as the sole adviser or subadviser to any Covered Fund or (ii) serve as the sole adviser to any separately managed account or unified management account offered primarily to retail investors in the U.S. where, in the case of clauses (i) and (ii), such Covered Fund or account is (A) sponsored by a Restricted Broker-Dealer and (B) offered on a stand-alone basis to the end investor (i.e., the fund or account does not represent one of multiple investment approaches in a bundled investment option).
(b) Wellington shall not enter into any agreement for a new engagement to subadvise any Covered Fund that is not sponsored or managed by Hartford or a Hartford Adviser if, at the time of entering into such an agreement, Wellington believes in good faith that the assets under management of the new engagement at the time of initial funding will cause the Non-Hartford Covered Fund AUM to exceed [***]% of WAUM (with such determination based upon the most recently available reliable assets under management data).
(c) Prior to June 30, 2016, Wellington shall not enter into any agreement for a new engagement to subadvise any fixed-income Covered Fund other than a Covered Fund sponsored or managed by Hartford or a Hartford Adviser without the prior written consent of Hartford.
Section 2.4 Wellington Portfolio Managers. Wellington shall not assign an individual lead portfolio manager of any Hartford Fund(s) (or any portion of any other Hartford Fund with a substantially similar investment approach managed by the same individual) whose assets under management subadvised or otherwise managed by such individual exceeds $[***] billion (with such determination based upon the most recently available reliable assets under management data and determined, in the case of a lead portfolio manager that contributes to any other Hartford Fund with a substantially similar investment approach and for which the portfolio manager is not the lead portfolio manger, without regard to such other Hartford Fund, i.e., to avoid any double-counting of assets under management) to serve as a lead portfolio manager for a Covered Fund with a substantially similar investment approach to the applicable Hartford Fund(s) not sponsored or managed by Hartford or one of its Affiliates; provided, however, that an individual lead portfolio manager shall be permitted to manage a Covered Fund where such individual acted as portfolio manager to such Covered Fund at the time the assets under management of such Hartford Fund(s) exceeded $[***] billion. In addition, Wellington shall not assign an individual lead portfolio manager responsible for any Hartford Fund(s) listed on Schedule E hereto to serve as a lead portfolio manager for a Covered Fund with a substantially similar investment approach to the applicable Hartford Fund(s) not sponsored by Hartford or one of its Affiliates; provided, however, that this restriction shall cease to apply to the relevant portfolio manager when any milestone set forth on Schedule E for the applicable Covered Fund is not achieved. The list of Hartford Funds on Schedule E may be amended only upon the mutual written agreement of the Parties.
Certain information in this exhibit, marked by “[***]” has been redacted and will be filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended. Confidential treatment has been requested with respect to the redacted portions.
12
Section 2.5 Fixed Income Hartford Funds. No later than December 31, 2012, each Hartford Adviser shall, and Hartford shall cause it to, recommend to the Hartford Funds Board that Wellington be engaged as subadviser on all existing fixed income funds identified on Schedule F (together with any successor thereto whether by merger or otherwise, the “Fixed Income Fund Mandates”); provided that, if an event involving Wellington occurs after the date hereof that a Hartford Adviser determines prevents it from making a recommendation for any Fixed Income Fund Mandate as a result of the Hartford Adviser’s exercise of its fiduciary duties to the applicable Fixed Income Fund Mandate, the Hartford Adviser shall not be required to make such recommendation.
Section 2.6 Wellington Termination Right. Notwithstanding any other provision of this Agreement, Wellington shall have the right to terminate the provisions of this Article II within 60 days following (i) a breach of 2.1(b) by Hartford or a Hartford Adviser, (ii) the date on which Wellington receives notice from Hartford (or, if earlier, the date on which Wellington discovers) that any Hartford HLS Fund ceases to be offered as an investment option within the variable annuity and variable life contracts issued by Hartford or its Affiliates on the date hereof (including, for the avoidance of doubt, if Hartford or one of its Affiliates obtains a substitution order to replace any such Hartford HLS Fund) or (iii) the five year anniversary of this Agreement. For the avoidance of doubt, this Section 2.6 shall not give Wellington the right to terminate this Agreement under Section 9.2.
Section 2.7 Hartford Termination Right. Notwithstanding any other provision of this Agreement, the obligations of Hartford under Sections 6.4 and 9.4 shall terminate automatically without further action by the Parties if Wellington breaches its obligations under Sections 2.3 or 2.4 of this Agreement. In addition, Hartford shall have the right to terminate the provisions of this Article II within 60 days following (i) a breach by Wellington of its obligations under Section 2.3 or 2.4 or (ii) the five-year anniversary of this Agreement. For the avoidance of doubt, this Section 2.7 shall not give Hartford the right to terminate this Agreement under Section 9.2.
Section 2.8 No Further Restrictions on HIMCO. Subject to the terms of this Agreement (including Sections 2.5, 2.6, 9.2(b)(ii) and 9.4), HIMCO shall not be restricted in its ability to subadvise open-end, closed-end or actively managed exchange-traded funds (regardless of whether such funds are registered under the Investment Company Act).
Section 2.9 Fiduciary Duties.
(a) The Parties acknowledge that, to the extent provided by Applicable Law, (i) Wellington is a fiduciary to the Hartford Funds in its capacity as an investment adviser to the Hartford Funds for which it serves as subadviser and (ii) each Hartford Adviser is a fiduciary to the Hartford Funds for which it serves as investment adviser. Wellington acknowledges and agrees that Hartford shall not be deemed to have breached its obligations under Section 2.1(a) hereof to the extent that a failure to retain, hire or recommend Wellington for any subadvisory assignment under this Agreement is as a result of a Hartford Adviser’s exercise of its fiduciary duties to the applicable Hartford Fund(s) or the exercise by the Hartford Funds Board of its fiduciary duties. For the avoidance of doubt, the Parties acknowledge and
13
agree that (A) other than as expressly provided in the immediately preceding sentence, this Section 2.9 is not intended to, and shall not, modify, qualify, limit or in any way affect any of the contractual rights or obligations of the Parties under this Agreement and (B) notwithstanding the immediately preceding sentence, any action or failure to act by Hartford or one of its Affiliates or the Hartford Funds Board (including a decision to terminate or fail to hire Wellington as subadviser to a Hartford Fund) due, in whole or in part, to the exercise (or purported exercise) of a Hartford Adviser’s or the Hartford Funds Board’s fiduciary obligation shall not impact the inclusion or exclusion of the assets under management of or fees payable in respect of any Hartford Fund for any calculation under this Agreement (including for purposes of Sections 2.6, 9.2 and 9.4).
(b) In the event that any Hartford Adviser determines that it is required to recommend the termination of Wellington or is not able to recommend the hiring or continuation of Wellington as a subadviser to any Hartford Fund as a result of a Hartford Adviser’s exercise of its fiduciary duties to the applicable Hartford Fund(s), the Hartford Adviser shall provide notice (which may be oral) of any such determination to Wellington, with such notice containing a detailed explanation of the reasons for such determination. Such notice shall be provided to Wellington a reasonable amount of time prior to the time that the Hartford Funds Board is notified of such determination.
Section 2.10 Update of Certain Schedules. Within 10 Business Days after the end of each calendar year (other than 2011), Hartford shall deliver to Wellington an updated Schedule C that reflects any changes to such schedule as determined pursuant to the definition of “Restricted Broker-Dealer.” Within 30 days after the delivery of any updated Schedule C, Wellington shall inform Hartford if any new Person listed thereon is covered by the last sentence of the definition of “Restricted Broker-Dealer”, each of whom shall be removed from the updated Schedule C. In the event that either party objects to any change or failure to make a change to any updated Schedule C, the provisions of Section 8.1 shall apply.
ARTICLE III
FEES
Section 3.1 Agreement With Respect to Fees.
(a) Fees. Subject to the terms of this Agreement, the Hartford Advisers shall, and Hartford shall cause them to, recommend to the Hartford Funds Board the fee schedule described in Schedule G for each Hartford Fund identified therein.
(b) Certain Fee Reductions. The new subadvisory fees to be implemented for the funds identified in paragraph 2 of Schedule G are contingent on (i) the approval of the Hartford Funds Board and (ii) the Hartford Funds Board and Hartford reducing the Total Expense Ratio (“TER”) on each of these funds as provided in paragraph 2 of Schedule G. If the TER for any such fund increases for any reason (including via increased management fees or fee waiver removal, lapse or modification), Wellington shall be entitled to share pro rata in such increase.
14
(c) Prospective Fee Changes. Wellington shall not request that the Hartford Funds Board increase the fee rate payable by any existing Hartford Fund to which Wellington provides subadvisory services. The Hartford Advisers shall not, and Hartford shall not permit them to, recommend to the Hartford Funds Board any reduction in the rate of any subadvisory fee payable by any Hartford Fund (including those described in Section 3.1(f)) to which Wellington provides subadvisory services.
(d) Participation in Fee Reductions. Wellington and Hartford agree to share pro rata in any reduction in the fee rate paid by any existing Hartford Fund initiated by the Hartford Funds Board, including any fee waiver, as a result of any changes to the fee structure or computation implemented by the Hartford Funds Board; provided, however, that Wellington shall have an opportunity to discuss with the Hartford Funds Board any proposed reduction in such fee rate a reasonable amount of time prior to the Hartford Funds Board voting on such reduction. For the avoidance of doubt, Wellington shall not bear any portion of a fee decrease (however occurring) that is not initiated by the Hartford Funds Board.
(e) Participation in Fee Increases. Wellington and Hartford agree to share pro rata in any increase in the fee rate paid by any Hartford Fund, including via a removal, lapse or modification of any fee waiver, as a result of any changes to the fee structure or computation implemented by the Hartford Funds Board.
(f) Allocation Services Fees. The fee rate for asset allocation services to the Hartford Funds and Hartford-managed 529 plans to be provided by Wellington shall be as set forth on Schedule H. Wellington and Hartford agree to share pro rata in any reduction in the fee rate paid by any such Hartford Fund initiated by the Hartford Funds Board, including any fee waiver in excess of the fee waiver in effect as of the date hereof, as a result of any changes to the fee structure or computation implemented by the Hartford Funds Board. For the avoidance of doubt, Wellington shall not bear any portion of a fee decrease (however occurring) that is not initiated by the Hartford Funds Board.
Section 3.2 Fee Waivers for Fixed Income Mandates. Wellington shall implement a fee waiver program for each Fixed Income Fund Mandate that (i) maintains that subadvisory fee in effect as of the date of this Agreement on each of the Fixed Income Fund Mandates for the first two years Wellington subadvises each fund; and (ii) beginning with the first year after the initial two-year period described in clause (i), reduces the fee waiver by one third each year such that at the beginning of the fifth year that Wellington subadvises such funds, the fee waiver shall be equal to zero.
ARTICLE IV
REPRESENTATIONS AND WARRANTIES OF HARTFORD
Each Hartford Party severally but not jointly represents and warrants to Wellington as follows as of the date hereof, with each Hartford Party representing and warranting to Wellington only as to those items that are specifically applicable to each such entity:
15
Section 4.1 Organization and Standing. Hartford is a corporation duly incorporated, validly existing and in good standing under the laws of the State of Delaware. HLI is a corporation duly incorporated, validly existing and in good standing under the laws of the State of Delaware. Each of the Hartford Advisers is a limited liability company duly organized, validly existing and in good standing under the laws of the State of Delaware or the State of Connecticut, as applicable. Each Hartford Party is duly qualified to do business and is in good standing in each jurisdiction in which such qualification is required for the conduct of its business, except where the failure to be so qualified is not reasonably likely to have a Material Adverse Effect. Each Hartford Party has in effect all federal, state, local and foreign governmental authorizations required for it to carry on its business, except where the failure to obtain such authorizations is not reasonably likely to have a Material Adverse Effect.
Section 4.2 Power and Authority. Each Hartford Party has full corporate or limited liability power and authority, as the case may be, to carry on its business as presently being conducted and to execute and deliver this Agreement and to perform its obligations hereunder. The execution and delivery of this Agreement has been duly authorized by all necessary corporate action on the part of each Hartford Party. Assuming the due authorization, execution and delivery of this Agreement by Wellington, this Agreement constitutes a legal, valid and binding obligation of each Hartford Party, enforceable against it in accordance with its terms, except as such enforceability may be limited by bankruptcy, insolvency, reorganization, moratorium or similar laws relating to or affecting creditors generally.
Section 4.3 Non-Contravention; Consents.
(a) The execution, delivery and performance of this Agreement by each Hartford Party will not (i) violate, conflict with, or result in a breach of any provisions of, or constitute a default (or an event which, with notice or lapse of time or both, would constitute a default) under, or result in the termination of, or accelerate the performance required by, or result in a right of termination or acceleration (which is not expressly and permanently waived) under, or result in the creation of any Encumbrance upon any material assets of Hartford (or any of its Affiliates) under any of the terms, conditions or provisions of, (x) the organizational documents of Hartford (or the constituent documents of any of its Affiliates, as applicable), or (y) any note, bond, mortgage, indenture, deed of trust, license, lease, agreement or other instrument or obligation to which Hartford (or any of its Affiliates) is a party or by or to which it or any of its properties may be bound or subject; or (ii) violate in any material respect any Applicable Law.
(b) No material notice to, filing with, authorization of, exemption by, order or permit from, or consent or approval of, any Governmental Authority is necessary for any Hartford Party to enter into this Agreement or to complete any of the actions contemplated hereunder.
ARTICLE V
REPRESENTATIONS AND WARRANTIES OF WELLINGTON
Wellington represents and warrants to the Hartford Parties as follows as of the date hereof:
16
Section 5.1 Organization and Standing. Wellington is a limited liability partnership duly organized, validly existing and in good standing under the laws of the Commonwealth of Massachusetts. Wellington is duly qualified to do business and is in good standing in each state in which such qualification is required for the conduct of its business except where the failure to be so qualified is not reasonably likely to have a Material Adverse Effect. Wellington has in effect all federal, state, local and foreign governmental authorizations required for it to carry on its business, except where the failure to obtain such authorizations is not reasonably likely to have a Material Adverse Effect.
Section 5.2 Power and Authority. Wellington has full power and authority to carry on its business as presently being conducted. Wellington has all requisite limited liability partnership power and authority to execute and deliver this Agreement and to perform its obligations hereunder. The execution and delivery of this Agreement has been duly authorized by all requisite action on the part of Wellington. Assuming the due authorization, execution and delivery of this Agreement by Hartford, this Agreement constitutes a valid and binding obligation of Wellington, enforceable against it in accordance with its terms, except as such enforceability may be limited by bankruptcy, insolvency, reorganization, moratorium or similar laws relating to or affecting creditors generally.
Section 5.3 Non-Contravention; Consents.
(a) The execution, delivery and performance of this Agreement by Wellington will not (i) violate, conflict with, or result in a breach of any provisions of, or constitute a default (or an event which, with notice or lapse of time or both, would constitute a default) under, or result in the termination of, or accelerate the performance required by, or result in a right of termination or acceleration (which is not expressly and permanently waived) under, or result in the creation of any Encumbrance upon any material assets of Wellington (or any of its Affiliates) under any of the terms, conditions or provisions of, (x) the organizational documents of Wellington (or the constituent documents of any of its Affiliates, as applicable), or (y) any note, bond, mortgage, indenture, deed of trust, license, lease, agreement or other instrument or obligation to which Wellington (or any of its Affiliates) is a party or by or to which it or any of its properties may be bound or subject; or (ii) violate in any material respect any Applicable Law.
(b) No material notice to, filing with, authorization of, exemption by, order or permit from, or consent or approval of, any Governmental Authority is necessary for Wellington to enter into this Agreement or to complete any of the actions contemplated hereunder.
ARTICLE VI
COVENANTS
Section 6.1 Brand.
(a) Subject to mutually agreed documentation between Wellington and the Hartford Funds, Wellington shall permit the Hartford Funds to use the term “WMC” in the
17
name of any fund so long as it is (i) subadvised solely by Wellington and (ii) the applicable Hartford Fund name also includes the name of the Hartford Fund family (e.g., “Hartford”). Hartford hereby acknowledges and agrees that it and its Affiliates shall not acquire any right, title or interest in or to and shall not register (or cause the Hartford Funds to register) the term “WMC” (either alone or in connection with other words or terms), which term “WMC” is and shall remain the exclusive property of Wellington. The foregoing permitted use is subject to compliance by the Hartford Funds with such use and quality control requirements and guidelines as may be reasonably requested by Wellington.
(b) No Party shall use any written materials that include the other Party’s name or brand or any variation thereof or that are otherwise supplied by the other Party without the prior written consent of the other Party, which consent shall not be unreasonably withheld, delayed or conditioned.
Section 6.2 Periodic Certifications
(a) No later than five Business days following the date on which Wellington enters into an agreement with respect to an engagement described in Section 2.3(b), Wellington shall deliver a certificate to Hartford, signed by an Executive Officer of Wellington, setting forth, to the knowledge of such Executive Officer, the amount of Non-Hartford Covered Fund AUM and WAUM (which the Parties acknowledge will be based upon information obtained from third parties and thus will be subject to any errors or omissions that may be contained therein) and indicating the date(s) as of which such amounts were determined.
(b) No later than five Business days following a Trigger Event, Hartford shall deliver a certificate to Wellington, signed by an Executive Officer of Hartford, setting forth to the knowledge of such Executive Officer (i) for purposes of Section 2.6(i), the amount of assets under management of the Hartford Funds and the amount of such assets under management subadvised by Wellington and indicating the date(s) as of which such amounts were determined and (ii) for purposes of Section 9.4, the assets under management of the applicable Legacy Hartford Fund and the total assets under management for all Legacy Hartford Funds determined as of the specified measurement date.
(c) No later than ten Business days following the end of each calendar year (other than 2011), Wellington and Hartford shall deliver a certificate to the other, signed by an Executive Officer thereof, certifying that (i) in the case of Wellington, it has complied with its obligations under Sections 2.3, 2.4 and 3.1(c) and (ii) in the case of Hartford, it has complied with its obligations under Sections 2.1 (second sentence only) and 3.1(c).
Section 6.3 Notice of a Hartford Sale. (a) Promptly following a decision by Hartford or one of its Affiliates to take substantial steps to explore a potential Hartford Sale, including where Hartford (i) solicits formal interest in a potential Hartford Sale from any Person (other than a controlled, wholly-owned Affiliate of Hartford), (ii) hires an investment banker or broker to explore a potential Hartford Sale or (iii) engages in substantive negotiations with any Person (other than a controlled, wholly-owned Affiliate of Hartford) regarding a potential Hartford Sale, Hartford shall provide written notice to Wellington (a “Preliminary Hartford Sale Notice”), which notice shall describe in reasonable detail the nature of the action(s) triggering
18
the notice (including whether a Person who is a Consolidator is a potential purchaser (or other Person participating in or providing equity financing for the ROFR Sale)). Wellington may, at its option, elect to participate as a bidder in any process involving a potential HMF Sale, so long as such potential HMF Sale is to a Consolidator or is part of a common process whereby multiple bidders are solicited, on the same basis afforded to any other third party (which would include any term or condition as to the timing to submit a proposal); provided, however, that this opportunity of Wellington to participate as a bidder excludes any situation where Hartford has elected to negotiate exclusively with a single non-Consolidator bidder. Hartford shall keep Wellington informed on a current basis as to the status of any potential Hartford Sale as well as any material developments related to such proposed Hartford Sale. Within five Business Days of entering into a definitive written agreement that, if consummated would create a Hartford Sale (other than a Hartford Sale to Wellington), Hartford shall provide written notice to Wellington of such Hartford Sale; provided, however, that for the purposes of this Section 6.3, any notice requirement shall be satisfied upon any filing related to such transaction pursuant to the EDGAR system.
(b) In furtherance of Section 6.3(a), in connection with a ROFR Sale, subject to Wellington executing a non-disclosure agreement reasonably acceptable to Hartford and Wellington, from and after the delivery of the applicable Preliminary Hartford Sale Notice until the time, if any, that a potential HMF Sale is no longer a ROFR Sale (which period shall, for the avoidance of doubt, continue after the time, if any, that Wellington ceases to participate in the sales process), Hartford shall (and shall cause its Affiliates and representatives to), in connection with such ROFR Sale:
(i) provide Wellington and its representatives and financing sources with the same level of access to the properties, books and records and employees of Hartford and its Affiliates to conduct its due diligence review of the HMF Business as is provided to other potential purchasers;
(ii) as is reasonably requested by Wellington, discuss the status and timing of the sale process with Wellington and its representatives and financing sources;
(iii) promptly provide Wellington with written information regarding the structure, type and amount of consideration and other material terms related to any proposed ancillary commercial or strategic relationship contained in the bids received by any Consolidators in the second or later round (or first round where there is only one round) of the sales process (provided that the identity and any information that could reasonably be expected to reveal the identity of the Consolidator shall in no event be provided; provided further that such written information shall include a reasonable description of the nature and extent of the business of any Consolidator (without identifying such Consolidator by name) to the extent necessary for Wellington to evaluate the structure, type or amount of consideration or other material terms related to any proposed ancillary commercial or strategic relationship); and
19
(iv) promptly provide Wellington with copies of drafts (and mark-ups) of the primary and ancillary transaction agreements provided to or received from a Consolidator described in clause (iii) (provided that (A) the identity and any information that could reasonably be expected to reveal the identity of the Consolidator as well as any information regarding the Consolidator’s intentions with respect to the post-closing operations of the HMF Business to the extent related to Wellington shall be redacted and (B) notwithstanding clause (A), as soon as practicable prior to the delivery of the ROFR Notice (which shall not be later than the time Hartford selects a single Consolidator to pursue the ROFR Sale), Hartford shall disclose the name of the Consolidator who is the winning bidder).
(c) Within five Business Days of the closing of a Hartford Sale to any Person other than Wellington, Hartford shall provide written notice to Wellington of such Hartford Sale.
Section 6.4 Right of First Refusal.
(a) Prior to entering into any definitive agreement for a ROFR Sale, Hartford shall provide written notice to Wellington (the “ROFR Notice”). The ROFR Notice shall describe in reasonable detail the proposed ROFR Sale, including the name of the Consolidator, the structure, type and amount of all consideration to be paid in connection therewith and a copy of the primary transaction agreement and, to the extent necessary for Wellington to evaluate the structure, type or amount of consideration or other material terms related to any proposed ancillary commercial or strategic relationship to be entered into in connection with the proposed HMF Sale, any applicable ancillary agreement (each in substantially agreed form. Wellington shall have the right, exercisable in writing (a “ROFR Exercise Notice”) within ten Business Days of the receipt of the ROFR Notice (the “ROFR Election Period”), to elect to purchase the HMF Business in the place of the potential purchaser(s) on substantially similar material terms and conditions as those set forth in the ROFR Notice; provided that the type of consideration may provide for the substitution of cash in lieu of non-cash consideration (which will include the value of any commercial or strategic relationship to be entered into between Hartford or one of its Affiliates and a Consolidator as part of the ROFR Sale). In the event that Wellington delivers a ROFR Exercise Notice and Wellington and Hartford cannot agree on the valuation of any such relationship on or prior to the end of the 15 Business Day period in Section 6.4(b) (as may be extended), (x) the procedures of Section 9.5 shall apply to the determination of such value and (y) any signing and closing of any transaction between Wellington and Hartford shall not be subject to the agreement by them of such value on or prior to the end of the 15 Business Day period in Section 6.4(b) as may be extended (but subject to payment by Wellington of the amount determined in accordance with the procedures set forth in Section 9.5 at closing). For the avoidance of doubt, Wellington may elect to have one or more third parties (including an equity and/or debt financing provider) participate in the applicable proposed ROFR Sale.
(b) Following delivery of a ROFR Exercise Notice, Hartford and Wellington shall negotiate in good faith for 15 Business Days (as may be extended pursuant to this Section 6.4(b) in the immediately succeeding sentence) the terms and conditions of the
20
definitive transaction agreements. If Hartford and Wellington do not execute and deliver to one another the definitive transaction agreements within 15 Business Days of the delivery of the ROFR Exercise Notice (which period may be extended upon the mutual written agreement of the Parties for an additional seven Business Days if, at the end of the 15 Business Day period, the Parties are in substantial agreement as to the primary transaction agreement), Hartford shall be free for a period of 45 Business Days thereafter to execute and deliver all of the definitive transaction agreements described in the ROFR Notice for the ROFR Sale, which sale shall be on the same material terms and conditions as were set forth in the ROFR Notice (or on terms and conditions that are no more favorable to the purchaser (or other Person participating in or providing equity financing for the ROFR Sale) than the terms and conditions in the ROFR Notice). If the ROFR Sale is not consummated within 365 days from the execution and delivery of definitive documents in the ROFR Notice for the ROFR Sale, such proposed ROFR Sale shall require a new ROFR Notice and the provisions of this Section 6.4 shall apply anew to such proposed ROFR Sale.
(c) If Wellington has not delivered a ROFR Exercise Notice by the expiration of the ROFR Election Period, Hartford shall be free for a period of 45 Business Days thereafter to execute and deliver all of the definitive agreements described in the ROFR Notice for the ROFR Sale, which sale shall be on the same material terms and conditions as were set forth in the ROFR Notice (or on terms and conditions that are no more favorable to the purchaser (or other Person participating in or providing equity financing for the ROFR Sale) than the terms and conditions in the ROFR Notice). In the case of any proposed ROFR Sale (i) where any material term or condition changes from that term or condition as set forth in the ROFR Notice (other than a term or condition that is not more favorable to the purchaser (or other Person participating in or providing equity financing for the ROFR Sale) than the applicable term or condition in the ROFR Notice) or (ii) in respect of which a ROFR Exercise Notice is not delivered and (A) where all of the definitive agreements described in the ROFR Notice are not executed and delivered within the aforementioned 45 Business Day period or (B) the ROFR Sale is not consummated within 365 days from the execution and delivery of definitive documents, such proposed ROFR Sale shall require a new ROFR Notice and the provisions of this Section 6.4 shall apply anew to such proposed ROFR Sale.
Section 6.5 Notice of Wellington Change of Control Event. In the event that Wellington enters into a definitive written agreement that, if consummated, will create a Wellington Change of Control Event, Wellington shall provide written notice to Hartford promptly following the time that Wellington notifies any client of such Wellington Change of Control Event; provided, however, that for the purposes of this Section 6.5, any notice requirement shall be satisfied upon any filing related to such transaction pursuant to the EDGAR system.
Section 6.6 Notice of HIG Change of Control Event. In the event that Hartford or any Affiliate of Hartford enters into a definitive written agreement that, if consummated, will create a HIG Change of Control Event, Hartford shall provide prompt written notice to Wellington (“HIG Change of Control Notice”); provided, however, that for the purposes of this Section 6.6, any notice requirement shall be satisfied upon any filing related to such transaction pursuant to the EDGAR system.
21
Section 6.7 IPO or Spin Out. Promptly following such time, if any, as Hartford or its Affiliates decides to take substantial steps to undertake an initial public offering of the HMF Business or a spin-out transaction of the HMF Business, Hartford shall provide to Wellington notice of such fact (which notice may be oral).
ARTICLE VII
CONFIDENTIALITY
Section 7.1 Treatment of Confidential Information. Subject to Section 7.2, each Party shall, and shall cause its Affiliates to, hold all Confidential Information in strict confidence and shall not disclose any Confidential Information to any Person, except to directors, officers, partners, stockholders, employees and advisors of a Party or its Affiliates who need to know such information solely for the purpose of this Agreement, have been informed of the confidential nature of the Confidential Information and are bound by written agreements with the disclosing Party which contain restrictions regarding disclosure and use of the Confidential Information comparable to and no less restrictive than those set forth herein. Each Party shall take at least the same degree of care that each uses to protect its own confidential and proprietary information and materials of similar nature and importance to protect the confidentiality and avoid the unauthorized use, disclosure, publication or dissemination of any Confidential Information.
Section 7.2 Permitted Disclosure. (a) Notwithstanding Section 7.1, prior to making any regulatory filing with a Governmental Authority of this Agreement or the information contained herein (including a Form 8-K or Form 10-K filed by Hartford), the disclosing Party shall provide the other Party with a reasonable opportunity to comment on such documents and the redacted form of such documents, as applicable.
(b) Notwithstanding Section 7.1, in the event that any Party is requested under Applicable Law (including by oral questions, interrogatories, requests for information or documents, subpoena, civil investigative demand or similar process) to disclose Confidential Information, it is agreed that the disclosing Party shall provide the other Party with prompt notice of such event (to the extent possible) so that the non-disclosing Party may seek a protective order or other appropriate remedy or waive compliance with the applicable provisions of this Agreement by the disclosing Party; it being understood and agreed that, in the event that any Party, in the reasonable judgment of its counsel, is required under Applicable Law (including by oral questions, interrogatories, requests for information or documents, subpoena, civil investigative demand or similar process), to disclose Confidential Information, the disclosing Party may make such disclosures as required under such Applicable Law. In the event the non-disclosing Party determines to seek such protective order or other remedy, the disclosing Party shall cooperate with the non-disclosing Party in seeking such protective order or other remedy. In the event that such protective order or other remedy is not obtained and disclosure of Confidential Information is required, or the non-disclosing Party grants a waiver hereunder, (i) the disclosing Party (A) may, without liability hereunder furnish that portion (and only that portion) of the Confidential Material which, based upon the written advice of counsel to the disclosing Party, such Party is legally required to disclose and (B) shall exercise its commercially
22
reasonable efforts to have confidential treatment accorded any Confidential Information so furnished and (ii) the Parties agree to consult with each other as to the form and substance of such disclosure and provide the other with a reasonable time to review and comment on such disclosure as and to the extent possible.
Section 7.3 Effect of Termination. Upon termination of this Agreement, or at any time at any Party’s request, all Parties shall (i) immediately cease any and all use of the other Party’s Confidential Information in any way for any purpose, (ii) promptly, at the other Party’s instruction, either return to the other Party or destroy all materials (in written, electronic or other form) containing or constituting Confidential Information disclosed hereunder, including any and all copies, extracts, summaries and derivatives thereof, except that one copy of each such document or other media may be maintained for archival purposes, subject to protection and non-disclosure in accordance with the terms of this Agreement and (iii) as promptly as is reasonably practicable, cease any and all use of the other Party’s name, brand or any variation thereof. Upon the request of one Party, the other Party shall certify in writing the completion of such return and/or destruction.
Section 7.4 Ownership of Confidential Information. Each Party retains all right, title and interest in and to its own Confidential Information. No Party acquires any license or right to any Confidential Information or any intellectual property rights or other rights owned by the other Party, by implication or otherwise, except the limited right to use such Confidential Information solely for a purpose related to the subject matter of this Agreement but in all cases subject to the provisions of this Agreement (including Section 7.1).
Section 7.5 Disclosure Related to Sale. Notwithstanding any provision of this Agreement to the contrary, in connection with a Hartford Sale or HIG Change of Control Event or Wellington Change of Control Event or as part of any due diligence process related thereto, no Confidential Information of any Party (other than the existence and terms of this Agreement, including an unredacted version of this Agreement, which may not be provided prior to the delivery of a Preliminary Hartford Sale Notice in the case of a Hartford Sale) may be provided by any Party to any Person without the prior written consent of the other Parties.
Section 7.6 Equitable Relief. Each Party understands and agrees that, because of the unique nature of the Confidential Information, the Parties may suffer irreparable harm if the any Party fails to comply with any of its obligations under this Article VII, and monetary damages may be inadequate to compensate the injured Party for such breach. Accordingly, the Parties agree that each Party shall, in addition to any other remedies available to them under this Agreement, be entitled to seek injunctive or equitable relief to enforce the terms of this Article VII without posting a bond or other undertaking.
ARTICLE VIII
DISPUTE RESOLUTION
Section 8.1 Disputes; Resolution by Executive Officers. The Parties recognize that disputes as to certain matters may from time to time arise during the term of this Agreement. It is the desire of the Parties to facilitate the resolution of disputes arising under this
23
Agreement in an expedient manner by mutual cooperation and without resort to arbitration or litigation. To accomplish this objective, prior to the commencement of any litigation proceedings the Parties agree that, subject to Section 8.2, any disputes, controversies or differences which may arise between the Parties out of or in relation to or in connection with this Agreement shall be promptly presented to one or more of the Executive Officers for resolution. Upon receipt of notice of such dispute, controversy, or difference, one or more of the Executive Officers may request, and the Parties shall promptly (and in any event within five (5) Business Days) provide, such further information and documentation that is available to each Party and reasonably required to verify and evaluate the dispute, controversy, or difference. If the matter is not resolved within 30 Business Days following receipt by one or more the Executive Officers of all requested information and documentation, then any Party may thereafter pursue litigation proceedings.
Section 8.2 Injunctive Relief. Nothing in this Article VIII will preclude any Party from seeking equitable relief or interim or provisional relief from a court of competent jurisdiction, including a temporary restraining order, preliminary injunction or other interim equitable relief, concerning a dispute either prior to or during any dispute resolution under Section 8.1 if necessary to protect the interests of such Party, prevent material harm to such Party or to preserve the status quo pending the resolution of the dispute.
ARTICLE IX
TERM AND TERMINATION OF PREFERRED
PARTNERSHIP; MAKE-WHOLE PAYMENT
Section 9.1 Term. Subject to the provisions of Section 9.2 below, the term of this Agreement (as extended at any time by the parties in their respective sole discretions by mutual written agreement, the “Term”) shall commence on the date hereof and shall continue through June 5, 2018. No later than June 5, 2016 and, to the extent the Term is extended, no later than June 5 of each year thereafter, one or more Executive Officer of each Party will meet to discuss an extension of the Term; provided that no Party shall have any obligation to extend the Term (which decision will be made by each Party in its sole discretion) or negotiate such an extension in good faith.
Section 9.2 Termination.
(a) This Agreement shall terminate automatically without further action by the Parties upon:
(i) the closing of a Hartford Sale or HIG Change of Control Event; or
(ii) the closing of a Wellington Change of Control Event.
(b) This Agreement may be terminated by written notice from the terminating Party to the other Parties as follows:
24
(i) by Wellington, within 90 days following (A) December 31, 2012, if Fixed Income Fund Mandates representing at least [***]% of the total subadvisory revenues from the Fixed Income Fund Mandates for the twelve months ended December 31, 2012 have not entered into subadvisory contracts with Wellington that are in effect on December 31, 2012 or (B) June 30, 2013, if Fixed Income Fund Mandates representing [***]% of the assets under management of the Fixed Income Fund Mandates as of June 30, 2013 have not entered into subadvisory contracts with Wellington that are in effect on June 30, 2013;
(ii) by either Wellington or Hartford, without cost or penalty (including attorneys’ fees and costs), if at any time there is (A) any violation by the other Party of Applicable Law or violation of or default under any authorization of, exemption by, order or permit from any Governmental Authority relating to the HMF Business or Wellington or (B) any formal investigation into the foregoing or (C) any lawsuit or other legal proceeding involving the Hartford Parties or any broker-dealer referred to in Section 2.2, any Hartford Fund or Wellington that, in the case of clauses (A), (B) and (C), is reasonably likely to have a material adverse effect on the Hartford Funds and that, if curable, remains uncured for a period of 180 days (the “Cure Period”) following the earlier of the discovery or receipt of written notification thereof; provided, however, that any termination right under this Section 9.2(b)(ii) shall be deemed waived if not exercised within 60 days following the expiration of the Cure Period, provided that in the case of a formal investigation or pending lawsuit or other legal proceeding the Cure Period shall not commence until the final determination thereof;
(iii) by either Wellington or Hartford, without cost or penalty (including attorneys’ fees and costs) but subject to Section 9.3(d), if a Bankruptcy Event occurs with respect to the other Party; or
(iv) the closing of an initial public offering or spin-out transaction, as applicable, of the HMF Business prior to June 5, 2014, if and only if Wellington has provided written notice to Hartford indicating it has elected to terminate this Agreement upon (and subject to) such consummation.
Section 9.3 Effect of Termination In the event of termination of this Agreement pursuant to Section 9.2, this Agreement shall forthwith become void and have no effect without any liability on the part of any Party, other than the provisions set forth in
(a) Article VII and Article X;
(b) solely in the case of a termination pursuant to Section 9.2(a)(i), Sections 9.4 and 9.5;
Certain information in this exhibit, marked by “[***]” has been redacted and will be filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended. Confidential treatment has been requested with respect to the redacted portions.
25
(c) solely in the case of a termination pursuant to Section 9.2(b)(i) if, and only if, Hartford has breached its obligations under Section 2.5 hereof and a definitive agreement for a Hartford Sale or HIG Change of Control Event (as applicable) is entered into within five years of such termination under Section 9.2(b)(i), Sections 9.4 and 9.5; and
(d) solely in the case of a termination pursuant to Section 9.2(b)(iii) if, and only if, a Bankruptcy Event occurs with respect to any Hartford Party other than Hartford (but not, for the avoidance of doubt, upon a Bankruptcy Event of Hartford), Sections 9.4 and 9.5.
The provisions set forth in clauses (a), (b), (c) and (d) above shall survive any termination and remain in full force and effect according to their terms. Notwithstanding the foregoing, no Party shall be relieved or released from any liability arising out of its willful breach of any provision of this Agreement (including reasonable attorneys’ fees and expenses in connection with the enforcement of such Party’s rights under this Agreement).
Section 9.4 Make-Whole Payment.
(a) If, at the time of the closing of a Hartford Sale or HIG Change of Control Event (as applicable) or anytime during the five-year period following such closing, the Wellington Subadvised Percentage is less than [***]% after giving effect to the applicable Trigger Event, Hartford shall make a cash payment to Wellington (a “Make-Whole Payment”) in an amount equal to the product of (i) the Total Enterprise Value in respect of the Hartford Sale or HIG Change of Control Event (as applicable) times (ii)(A) in the case of an HMF Sale or a HIG Change of Control Event, [***] and (B) in the case of a Non-HMF Sale, [***]. The Make-Whole Payment only shall be payable once, with respect to the first to occur of any Hartford Sale or HIG Change of Control Event, as applicable.
(b) A Make-Whole Payment shall be made no later than 15 Business Days following the date on which the applicable Trigger Event occurred (or, if later, the date on which Total Enterprise Value is finally determined). A Make-Whole Payment shall be made by wire transfer of immediately available U.S. federal funds to the account or accounts designated in writing by Wellington no less than two Business Days prior to the Make-Whole Payment date.
(c) For the avoidance of doubt, a Hartford Sale or HIG Change of Control Event (as applicable) and Trigger Event and resulting Make-Whole Payment may occur after the termination of this Agreement solely to the extent provided in Section 9.3, and the obligations of Hartford related to the Make-Whole Payment shall terminate at the time of termination of this Agreement in all other instances. In no event shall a Hartford Sale or HIG Change of Control Event in which Wellington is the purchaser be deemed a Trigger Event or result in a Make Whole Payment.
Section 9.5 Determination of Total Enterprise Value. The Total Enterprise Value in respect of the Hartford Sale or HIG Change of Control Event (as applicable) shall be conclusively determined pursuant to this Section 9.5.
Certain information in this exhibit, marked by “[***]” has been redacted and will be filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended. Confidential treatment has been requested with respect to the redacted portions.
26
(a) Hartford and Wellington shall negotiate in good faith for a period of 10 Business Days (or such longer period as they may mutually agree in writing) in order to agree in writing on the Total Enterprise Value prior to engaging any Appraiser.
(b) If, at the end of the aforementioned period of negotiation, Hartford and Wellington have not agreed upon the Total Enterprise Value, they shall select an Appraiser by mutual agreement (not to be unreasonably withheld) within 10 Business Days after the expiration of such period of negotiation. In the event that they are unable to agree upon a mutually acceptable Appraiser within such period, each shall select one Appraiser no later than 10 Business Days after the end of such period, which Appraisers shall select a third Appraiser as soon as possible, each of which who shall be instructed to state the Total Enterprise Value (which, for the avoidance of doubt, shall conform to the definition of “Total Enterprise Value” as set forth in this Agreement) in writing as a number and not a range in a written report. The Members shall use commercially reasonable efforts to cause the Appraiser(s) to complete their work and issue their report as soon as possible and in no event more than 30 days after their engagement. If the respective determinations of the Total Enterprise Value vary by less than 10% of the highest Total Enterprise Value determination, the Total Enterprise Value shall be the average of the three Total Enterprise Value values. If the Total Enterprise Value determinations vary by 10% or more, the Total Enterprise Value shall be equal to the average of the two closest of the three Total Enterprise Value values. If any Appraiser is only willing to provide a range for the Total Enterprise Value, the average of the highest and lowest value in such range shall be deemed to be such Appraiser’s determination of the Total Enterprise Value if the range between such highest and lowest value is no more than 20%, otherwise, such range shall be disregarded and only the remaining determination(s) shall be used. The costs of the Appraiser shall be borne (x) if there is one Appraiser, equally by Hartford and Wellington or (y) if there are three Appraisers, by the respective party selecting such Appraiser and the cost of the third Appraiser shall be borne equally by Hartford and Wellington. The determination of the Appraiser(s) shall be final and binding on all of the Parties.
ARTICLE X
MISCELLANEOUS
Section 10.1 Amendments; Extension; Waiver. This Agreement may only be amended, altered or modified by a written instrument executed by each of the Parties hereto. The waiver by any Party hereto of a breach of any provision of this Agreement shall not operate or be construed as a further or continuing waiver of such breach or as a waiver of any other or subsequent breach. No failure on the part of any Party to exercise, and no delay in exercising, any right, power or remedy hereunder shall operate as a waiver thereof, and no single or partial exercise of such right, power or remedy by such Party shall preclude any other or further exercise thereof or the exercise of any other right, power or remedy.
Section 10.2 Entire Agreement. This Agreement (including the exhibits and schedules hereto) constitutes the entire understanding and agreement of the parties hereto, except as provided herein, and supersedes all prior agreements and understandings, written and oral, among the parties with respect to the subject matter hereof.
27
Section 10.3 Interpretation. When a reference is made in this Agreement to a section, exhibit or schedule, such reference shall be to a section, exhibit or schedule to this Agreement unless otherwise indicated. The table of contents and headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. Whenever the words “include,” “includes” or “including” are used in this Agreement, they shall be deemed to be followed by the words “without limitation.” Whenever the context may require, any pronouns used in this Agreement shall include the corresponding masculine, feminine or neuter forms and the singular form of nouns and pronouns shall include the plural and vice versa. The exhibits and schedules to this Agreement are hereby incorporated and made a part hereof and are an integral part of this Agreement. All exhibits and schedules annexed hereto or referred to herein are hereby incorporated in and made a part of this Agreement as if set forth in full herein.
Section 10.4 Severability. Any term or provision of this Agreement which is invalid or unenforceable in any jurisdiction shall, as to that jurisdiction, be ineffective to the extent of such invalidity or unenforceability without rendering invalid or unenforceable the remaining terms and provisions of this Agreement or affecting the validity or enforceability of any of the terms or provisions of this Agreement in any other jurisdiction. If any provision of this Agreement is so broad as to be unenforceable, the provision shall be interpreted to be only as broad as is enforceable.
Section 10.5 Notices. All notices and other communications hereunder shall be in writing (other than via electronic mail) and shall be deemed given and effective (i) when delivered, if delivered in person, (ii) when transmitted by fax (with confirmation of transmission received), (iii) three Business Days after mailing, if mailed by certified or registered mail (return receipt requested and obtained) or (iv) one Business Day after transmitted, if transmitted by a nationally recognized overnight courier to the parties at the following addresses (or at such other address for a party as shall be specified by like notice):
If to any Hartford Party:
Hartford Life, Inc.
200 Hopmeadow Street
Simsbury, CT 06089
Facsimile: 860 547-4721
Telephone: 860 547-5000
Attention: Director of Wealth Management Law
With a copy to:
The Hartford
One Hartford Plaza
Hartford, CT 06155
Attention: General Counsel
Facsimile: 860 547-4721
Telephone: 860 547-5000
Attention: General Counsel
28
With a copy to:
Dechert LLP
200 Clarendon Street, 27th Floor
Boston, Massachusetts 02116-5021
Attention: John O’Hanlon and David Schulman
Facsimile: 617-426-6567
If to Wellington:
Wellington Management Company, LLP
280 Congress Street
Boston, Massachusetts 02210
Attention: General Counsel
Facsimile: 617-790-7760
With a copy to:
Skadden, Arps, Slate, Meagher & Flom LLP 4
Times Square
New York, New York 10036
Attention: Stephen Arcano and David Hepp
Facsimile: 212-735-3000
Section 10.6 Binding Effect; Persons Benefiting; No Assignment. This Agreement shall inure to the benefit of and be binding upon the Parties and their respective successors and permitted assigns, if any. Nothing in this Agreement is intended or shall be construed to confer upon any Person other than the Parties and their successors and permitted assigns, if any, any right, remedy or claim under or by reason of this Agreement or any part hereof. Without the prior written consent of each Party, neither this Agreement nor any rights or obligations hereunder may be assigned, transferred or delegated by any Party.
Section 10.7 Disclaimers.
(a) Hartford represents and acknowledges that the representations and warranties set forth in Article IV constitute the sole and exclusive representations to Wellington in connection with this Agreement, and Wellington understands, acknowledges and agrees that all other representations and warranties of any kind or nature, express or implied, are specifically disclaimed by Hartford.
(b) Wellington represents and acknowledges that the representations and warranties set forth in Article V constitute the sole and exclusive representations to Hartford in connection with this Agreement, and Hartford understands, acknowledges and agrees that all other representations and warranties of any kind or nature, express or implied, are specifically disclaimed by Wellington.
(c) Notwithstanding the foregoing Sections 10.7(a) and 10.7(b), Hartford recognizes that Wellington does not waive, and Wellington recognizes that Hartford does not waive, any rights they may have based on a fraud claim, whether under statute or common law.
29
(d) IN NO EVENT SHALL ANY PARTY OR ITS AFFILIATES BE LIABLE, WHETHER IN CONTRACT, TORT (INCLUDING NEGLIGENCE) OR OTHERWISE, FOR ANY PUNITIVE OR CONSEQUENTIAL DAMAGES (INCLUDING LOST SAVINGS, LOST PROFIT OR BUSINESS INTERRUPTION EVEN IF A PARTY IS NOTIFIED IN ADVANCE OF SUCH POSSIBILITY) ARISING OUT OF OR PERTAINING TO THE SUBJECT MATTER OF THIS AGREEMENT; PROVIDED THAT THE FOREGOING SHALL NOT APPLY IN THE CASE OF (I) A BREACH BY WELLINGTON OF SECTION 2.3 OR 2.4 OR (II) A BREACH BY HARTFORD OF SECTION 6.3 OR 6.4 AND THE PARTIES ACKNOWLEDGE THAT A PARTY SHALL BE ENTITLED TO SEEK SUCH DAMAGES (OTHER THAN PUNITIVE DAMAGES) IN THE CASE OF ANY SUCH BREACH.
(e) This Agreement is not intended to, and shall not, create or result in any legal partnership, relationship of principal and agent, or joint venture among the Parties.
Section 10.8 Specific Performance. The Parties agree that if any of the provisions of this Agreement were not performed by the parties hereto in accordance with their specific terms or were otherwise breached, no adequate remedy at law would exist and damages would be difficult to determine, and that each party hereto will be entitled to specific performance to prevent such breaches of the provisions of this Agreement and to enforce specifically the terms and provisions hereof, in addition to any other remedy to which it may be entitled at law or in equity.
Section 10.9 Counterparts. This Agreement may be executed in two or more counterparts, each of which shall be deemed an original, but all of which taken together shall constitute one and the same agreement, it being understood that all of the parties need not sign the same counterpart.
Section 10.10 Governing Law; Waiver of Jury Trial. This Agreement shall be governed by and construed in accordance with the laws of the State of New York applicable to agreements made and to be performed entirely within the State of New York, without regard to the conflict of law provisions thereof that would result in the application of the laws of any other jurisdiction. Each of the parties hereto hereby irrevocably waives any and all right to trial by jury in any legal proceeding arising out of or related to this Agreement.
Section 10.11 Certain Understandings. Each of the Parties is a sophisticated legal entity or person that was advised by experienced counsel and, to the extent it deemed necessary, other advisors in connection with this Agreement. Accordingly, each of the Parties hereby acknowledges that (i) it has not relied or will rely in respect of this Agreement or the transactions contemplated hereby upon any document or written or oral information previously furnished to or discovered by it or its representatives, other than this Agreement and (ii) the parties’ respective rights and obligations with respect to this Agreement and the events giving rise thereto will be solely as set forth in this Agreement.
30
*******
31
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be executed as of the date first above written.
| THE HARTFORD FINANCIAL SERVICES GROUP, INC. | ||
| By: | /s/ Liam E. McGee | |
| Name: | Liam E. McGee | |
| Title: | Chairman and CEO | |
| HARTFORD LIFE, INC. | ||
| By: | /s/ David Levenson | |
| Name: | David Levenson | |
| Title: | President | |
| HARTFORD INVESTMENT FINANCIAL SERVICES, LLC | ||
| By: | /s/ James Davey | |
| Name: | James Davey | |
| Title: | CEO and President | |
| HL INVESTMENT ADVISORS, LLC | ||
| By: | /s/ James Davey | |
| Name: | James Davey | |
| Title: | CEO and President | |
| WELLINGTON MANAGEMENT COMPANY, LLP | ||
| By: | /s/ Perry M. Traquina | |
| Name: | Perry M. Traquina | |
| Title: | President and Chief Executive Officer | |
SCHEDULE A
EXECUTIVE OFFICERS
Hartford:
| 1. | Chief Financial Officer, Hartford Financial Services Group, Inc. |
| 2. | General Counsel, Hartford Financial Services Group, Inc. |
| 3. | Chief Executive Officer, Wealth Management |
| 4. | Chief Financial Officer, Wealth Management |
| 5. | Chief Executive Officer, Hartford Mutual Funds |
| 6. | Director of Wealth Management Law (or successor position) |
Wellington:
| 1. | Any Managing Partner |
| 2. | Chief Financial Officer |
| 3. | General Counsel |
| 4. | Director, Global Equity Portfolio Management |
| 5. | Director, Global Fixed Income Portfolio Management |
| 6. | Director, Global Relationship Group |
SCHEDULE B
HARTFORD HLS FUNDS
Hartford Advisers HLS Fund
Hartford Capital Appreciation HLS Fund
Hartford Disciplined Equity HLS Fund
Hartford Dividend and Growth HLS Fund
Hartford Global Growth HLS Fund
Hartford Healthcare HLS Fund
Hartford High Yield HLS Fund
Hartford Global Research HLS Fund
Hartford Growth HLS Fund
Hartford International Opportunities HLS Fund
Hartford MidCap HLS Fund
Hartford MidCap Value HLS Fund
Hartford Small Company HLS Fund
Hartford Small/Mid Cap Equity HLS Fund
Hartford Stock HLS Fund
Hartford Total Return Bond HLS Fund
Hartford Value HLS Fund
Hartford Growth Opportunities HLS Fund
Hartford SmallCap Growth HLS Fund
Hartford U.S. Government Securities HLS Fund
SCHEDULE C
BROKER-DEALERS
[***]
Certain information in this exhibit, marked by “[***]” has been redacted and will be filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended. Confidential treatment has been requested with respect to the redacted portions.
SCHEDULE D
INTENTIONALLY OMITTED
SCHEDULE E
WELLINGTON PORTFOLIO MANAGERS
[***]
Certain information in this exhibit, marked by “[***]” has been redacted and will be filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended. Confidential treatment has been requested with respect to the redacted portions.
SCHEDULE F
FIXED INCOME FUND MANDATES
The Hartford High Yield Fund
Hartford High Yield HLS Fund
The Hartford Floating Rate Fund
The Hartford Strategic Income Fund
The Hartford Corporate Opportunities Fund
The Hartford Total Return Bond Fund
Hartford Total Return Bond HLS Fund
The Hartford Municipal Opportunities Fund
The Hartford Municipal Real Return Fund
The Hartford Inflation Plus Fund
Hartford US Government Securities HLS Fund
The Hartford Short Duration Fund
The Hartford Floating Rate High Income Fund
SCHEDULE G
FEE REVISIONS ON EXISTING HARTFORD FUNDS
[***]
Certain information in this exhibit, marked by “[***]” has been redacted and will be filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended. Confidential treatment has been requested with respect to the redacted portions.
SCHEDULE H
ALLOCATION SERVICES FEES
[***]
Certain information in this exhibit, marked by “[***]” has been redacted and will be filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended. Confidential treatment has been requested with respect to the redacted portions.
EXHIBIT 12.01
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
COMPUTATION OF RATIOS OF EARNINGS TO FIXED CHARGES AND EARNINGS
TO COMBINED FIXED CHARGES AND PREFERRED STOCK DIVIDENDS
(In millions)
| Years Ended December 31, | ||||||||||||||||||||
| 2011 | 2010 | 2009 | 2008 | 2007 | ||||||||||||||||
| EARNINGS: |
||||||||||||||||||||
| Income (loss) from continuing operations before income taxes |
$ | (19 | ) | $ | 949 | $ | (3,541 | ) | $ | (5,834 | ) | $ | 1,147 | |||||||
| Add: Total fixed charges, before interest credited to contractholders |
— | — | — | — | 2 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Total earnings, before interest credited to contractholders |
(19 | ) | 949 | (3,541 | ) | (5,834 | ) | 1,149 | ||||||||||||
| Interest credited to contractholders [1] |
1,540 | 1,850 | 2,005 | 1,554 | 1,840 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Total earnings |
$ | 1,521 | $ | 2,799 | $ | (1,536 | ) | $ | (4,280 | ) | $ | 2,989 | ||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| FIXED CHARGES: |
||||||||||||||||||||
| Interest expense |
$ | — | $ | — | $ | — | $ | — | $ | — | ||||||||||
| Interest factor attributable to rentals and other |
— | — | — | — | 2 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Total fixed charges, before interest credited to contractholders |
— | — | — | — | 2 | |||||||||||||||
| Interest credited to contractholders [1] |
1,540 | 1,850 | 2,005 | 1,554 | 1,840 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| Total fixed charges |
$ | 1,540 | $ | 1,850 | $ | 2,005 | $ | 1,554 | $ | 1,842 | ||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| RATIOS: |
||||||||||||||||||||
| Total earnings to total fixed charges [2] |
NM | 1.5 | NM | NM | 1.6 | |||||||||||||||
| Deficiency of total earnings to total fixed charges [3] |
19 | — | $ | 3,541 | $ | 5,834 | — | |||||||||||||
| Ratios before interest credited to contractholders [4] |
||||||||||||||||||||
| Total earnings to total fixed charges [2] |
NM | NM | NM | NM | 574.5 | |||||||||||||||
|
|
|
|
|
|
|
|
|
|
|
|||||||||||
| [1] | Interest credited to contractholders includes interest credited on general account assets and interest credited on consumer notes. |
| [2] | Ratios of less than one-to-one are presented as “NM” or not meaningful. |
| [3] | Represents additional earnings that would be necessary to result in a one-to-one ratio. |
| [4] | This secondary ratio is disclosed for the convenience of policyholders invested in the Company’s general account and Consumer Note holders. |
EXHIBIT 18.01
February 24, 2012
Hartford Life Insurance Company
Hartford, CT
Dear Sirs/Madams:
We have audited the consolidated financial statements of Hartford Life Insurance Company and its subsidiaries (collectively, the “Company”) as of December 31, 2011 and 2010, and for each of the three years in the period ended December 31, 2011, included in your Annual Report on Form 10-K to the Securities and Exchange Commission and have issued our report thereon dated February 24, 2012, which expresses an unqualified opinion and includes an explanatory paragraph concerning the Company’s change in its method of accounting and reporting for variable interest entities and embedded credit derivatives as required by accounting guidance adopted in 2010, and for other-than-temporary impairments as required by accounting guidance adopted in 2009. Note 7 to such financial statements contains a description of your adoption during the year ended December 31, 2011 of your change in the date for the annual goodwill impairment test. In our judgment, such change is to an alternative accounting principle that is preferable under the circumstances.
Yours truly,
/s/ DELOITTE & TOUCHE LLP
DELOITTE & TOUCHE LLP
EXHIBIT 23.01
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We consent to the incorporation by reference in the following registration statements on Form S-3 of our report dated February 24, 2012, relating to the consolidated financial statements and financial statement schedules of Hartford Life Insurance Company (the “Company”) (which report expresses an unqualified opinion and includes an explanatory paragraph relating to the Company’s change in its method of accounting and reporting for variable interest entities and embedded credit derivatives as required by accounting guidance adopted in 2010, and for other-than-temporary impairments as required by accounting guidance adopted in 2009) appearing in this Annual Report on Form 10-K of Hartford Life Insurance Company for the year ended December 31, 2011.
Form S-3 Registration Nos.
333-133693
333-133694
333-133695
333-133707
333-157272
333-163640
333-165129
DELOITTE & TOUCHE LLP
Hartford, Connecticut
February 24, 2012
Exhibit 31.01
HARTFORD LIFE INSURANCE COMPANY
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ENACTED BY SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, Dave N. Levenson, certify that:
| 1. | I have reviewed this Annual Report on Form 10-K of Hartford Life Insurance Company; |
| 2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
| 3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
| 4. | The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
| (a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
| (b) | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
| (c) | Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
| (d) | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
| 5. | The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): |
| (a) | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
| (b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
Date: February 24, 2012
| By: | /s/ David N. Levenson | |
| President | ||
Exhibit 31.02
HARTFORD LIFE INSURANCE COMPANY
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ENACTED BY SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
I, David G. Bedard, certify that:
| 1. | I have reviewed this Annual Report on Form 10-K of Hartford Life Insurance Company; |
| 2. | Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; |
| 3. | Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; |
| 4. | The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: |
| (a) | Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; |
| (b) | Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; |
| (c) | Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and |
| (d) | Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and |
| 5. | The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): |
| (a) | All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and |
| (b) | Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. |
Date: February 24, 2012
| By: | /s/ David G. Bedard | |
| David G. Bedard Executive Vice President and Chief Financial Officer | ||
Exhibit 32.01
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ENACTED BY SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-K for the period ended December 31, 2011 of Hartford Life Insurance Company (the “Company”), filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned hereby certifies, pursuant to 18 U.S.C. section 1350 as enacted by section 906 of the Sarbanes-Oxley Act of 2002, that:
| 1) | The Report fully complies with the requirements of section 13(a) or section 15(d) of the Securities Exchange Act of 1934; and |
| 2) | The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. |
| /s/ David N. Levenson |
| Name: David N. Levenson Title: President Date: February 24, 2012 |
Exhibit 32.02
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350
AS ENACTED BY SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report on Form 10-K for the period ended December 31, 2011 of Hartford Life Insurance Company (the “Company”), filed with the Securities and Exchange Commission on the date hereof (the “Report”), the undersigned hereby certifies, pursuant to 18 U.S.C. section 1350 as enacted by section 906 of the Sarbanes-Oxley Act of 2002, that:
| 1) | The Report fully complies with the requirements of section 13(a) or section 15(d) of the Securities Exchange Act of 1934; and |
| 2) | The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. |
| /s/ David G. Bedard |
| Name: David G. Bedard Title: Executive Vice President and Chief Financial Officer Date: February 24, 2012 |
|
Reinsurance
|
12 Months Ended | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
|
Dec. 31, 2011
|
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Reinsurance [Abstract] | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| REINSURANCE |
SCHEDULE REINSURANCE
SCHEDULE IV REINSURANCE (In millions)
|
|||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
|
Stock Compensation Plans
|
12 Months Ended |
|---|---|
|
Dec. 31, 2011
|
|
| Stock Compensation Plans [Abstract] | |
| Stock Compensation Plans |
15. Stock Compensation Plans The Hartford has three primary stock-based compensation plans. The Company is included in these plans and has been allocated compensation expense of $14, $32 and $25 for the years ended December 31, 2011, 2010 and 2009, respectively. The Company’s income tax benefit recognized for stock-based compensation plans was $5, $11 and $7 for the years ended December 31, 2011, 2010 and 2009, respectively. The Company did not capitalize any cost of stock-based compensation. |