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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ____________ to ______________
Commission file number 0-19277
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 13-3317783
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
HARTFORD PLAZA, HARTFORD, CONNECTICUT 06115-1900
(Address of principal executive offices)
(860) 547-5000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No[ ]
As of October 31, 2002, there were outstanding 255,152,830 shares of Common
Stock, $0.01 par value per share, of the registrant.
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INDEX
PAGE
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Independent Accountants' Review Report 3
PART I. FINANCIAL INFORMATION
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ITEM 1. FINANCIAL STATEMENTS 4
Consolidated Statements of Income - Third Quarter and Nine Months
Ended September 30, 2002 and 2001 4
Consolidated Balance Sheets - September 30, 2002 and December 31, 2001 5
Consolidated Statements of Changes in Stockholders' Equity - Nine Months
Ended September 30, 2002 and 2001 6
Consolidated Statements of Cash Flows - Nine Months Ended September 30,
2002 and 2001 7
Notes to Consolidated Financial Statements 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 19
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 42
ITEM 4. CONTROLS AND PROCEDURES 42
PART II. OTHER INFORMATION
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ITEM 1. LEGAL PROCEEDINGS 42
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 43
Signature 45
Certifications 46
- 2 -
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
Board of Directors and Stockholders
The Hartford Financial Services Group, Inc.
Hartford, Connecticut
We have reviewed the accompanying consolidated balance sheet of The Hartford
Financial Services Group, Inc. and subsidiaries (the "Company") as of September
30, 2002, and the related consolidated statements of income for the third
quarter and nine months then ended, and changes in stockholders' equity and cash
flows for the nine months then ended. These consolidated financial statements
are the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and of making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to such consolidated financial statements for them to be in conformity
with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial information as of December 31, 2001, and
for the third quarter and nine months ended September 30, 2001, were not audited
or reviewed by us and, accordingly, we do not express an opinion or any other
form of assurance on them.
Deloitte & Touche LLP
Hartford, Connecticut
November 12, 2002
- 3 -
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------- -----------------------------
(IN MILLIONS, EXCEPT FOR PER SHARE DATA) 2002 2001 2002 2001
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(Unaudited) (Unaudited)
REVENUES
Earned premiums $ 2,650 $ 2,287 $ 7,609 $ 6,954
Fee income 627 654 1,961 1,942
Net investment income 729 714 2,161 2,124
Other revenue 115 121 348 362
Net realized capital losses (160) (54) (333) (91)
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TOTAL REVENUES 3,961 3,722 11,746 11,291
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BENEFITS, CLAIMS AND EXPENSES
Benefits, claims and claim adjustment expenses 2,433 2,886 7,064 7,435
Amortization of deferred policy acquisition costs and present value
of future profits 568 556 1,696 1,630
Insurance operating costs and expenses 567 513 1,661 1,461
Goodwill amortization -- 15 -- 43
Other expenses 199 178 563 532
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TOTAL BENEFITS, CLAIMS AND EXPENSES 3,767 4,148 10,984 11,101
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INCOME (LOSS) BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF
ACCOUNTING CHANGES 194 (426) 762 190
Income tax (benefit) expense (71) (323) 20 (207)
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INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGES 265 (103) 742 397
Cumulative effect of accounting changes, net of tax -- -- -- (34)
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NET INCOME (LOSS) $ 265 $ (103) $ 742 $ 363
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BASIC EARNINGS (LOSS) PER SHARE
Income (loss) before cumulative effect of accounting changes $ 1.06 $ (0.43) $ 3.00 $ 1.69
Cumulative effect of accounting changes, net of tax -- -- -- (0.15)
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NET INCOME (LOSS) $ 1.06 $ (0.43) $ 3.00 $ 1.54
DILUTED EARNINGS (LOSS) PER SHARE [1]
Income (loss) before cumulative effect of accounting changes $ 1.06 $ (0.43) $ 2.96 $ 1.66
Cumulative effect of accounting changes, net of tax -- -- -- (0.14)
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NET INCOME (LOSS) $ 1.06 $ (0.43) $ 2.96 $ 1.52
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Weighted average common shares outstanding 248.9 238.0 247.4 235.6
Weighted average common shares outstanding and dilutive potential
common shares [1] 250.5 238.0 250.3 239.5
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Cash dividends declared per share $ 0.26 $ 0.25 $ 0.78 $ 0.75
====================================================================================================================================
[1] In the absence of the third quarter 2001 net loss, 241.7 weighted average
common shares and dilutive potential common shares outstanding would have
been used in the calculation of diluted earnings per share for the quarter
ended September 30, 2001.
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
- 4 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
(IN MILLIONS, EXCEPT FOR SHARE DATA) 2002 2001
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(Unaudited)
ASSETS
Investments
-----------
Fixed maturities, available for sale, at fair value (amortized cost of $45,616 and
$39,154) $ 48,085 $ 40,046
Equity securities, available for sale, at fair value (cost of $1,082 and $1,289) 985 1,349
Policy loans, at outstanding balance 2,980 3,317
Other investments 2,051 1,977
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Total investments 54,101 46,689
Cash 413 353
Premiums receivable and agents' balances 2,628 2,432
Reinsurance recoverables 5,046 5,162
Deferred policy acquisition costs and present value of future profits 6,853 6,420
Deferred income taxes 281 693
Goodwill 1,722 1,722
Other assets 2,962 3,044
Separate account assets 101,533 114,720
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TOTAL ASSETS $ 175,539 $ 181,235
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LIABILITIES
Future policy benefits, unpaid claims and claim adjustment expenses
Property & Casualty $ 16,782 $ 16,678
Life 9,327 8,819
Other policyholder funds and benefits payable 22,336 19,355
Unearned premiums 3,973 3,436
Short-term debt 615 599
Long-term debt 2,595 1,965
Company obligated mandatorily redeemable preferred securities of subsidiary trusts
holding solely junior subordinated debentures 1,461 1,412
Other liabilities 5,974 5,238
Separate account liabilities 101,533 114,720
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164,596 172,222
COMMITMENTS AND CONTINGENCIES (NOTE 5)
STOCKHOLDERS' EQUITY
Common stock - par value $0.01, 750,000,000 and 400,000,000 shares authorized,
257,952,460 and 248,477,367 shares issued 3 2
Additional paid-in capital 2,766 2,362
Retained earnings 6,701 6,152
Treasury stock, at cost - 2,943,565 and 2,941,340 shares (37) (37)
Accumulated other comprehensive income 1,510 534
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TOTAL STOCKHOLDERS' EQUITY 10,943 9,013
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 175,539 $ 181,235
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SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
- 5 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2002 Accumulated Other Comprehensive Income (Loss)
--------------------------------------------------
Common Net Gain on Minimum
Stock/ Unrealized Cash-Flow Cumulative Pension Outstanding
Additional Treasury Gain on Hedging Translation Liability Shares
Paid-in Retained Stock, Securities, Instruments, Adjustments, Adjustment, (In
(In millions) (Unaudited) Capital Earnings at Cost net of tax net of tax net of tax net of tax Total thousands)
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BALANCE, BEGINNING OF PERIOD $2,364 $6,152 $(37) $606 $63 $(116) $(19) $9,013 245,536
Comprehensive income
Net income 742 742
Other comprehensive income, net
of tax [1]
Unrealized gain on securities [2] 899 899
Net gain on cash-flow hedging
instruments [3] 81 81
Translation adjustments (4) (4)
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Total other comprehensive income 976
--------
Total comprehensive income 1,718
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Issuance of shares under incentive
and stock purchase plans 89 89 2,170
Issuance of common stock in
underwritten offering 330 330 7,303
Issuance of equity units (33) (33)
Tax benefit on employee stock
options and awards 19 19
Dividends declared on common stock (193) (193)
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BALANCE, END OF PERIOD $2,769 $6,701 $(37) $1,505 $144 $(120) $(19) $10,943 255,009
==================================================================================================================================
NINE MONTHS ENDED SEPTEMBER 30, 2001 Accumulated Other Comprehensive Income (Loss)
--------------------------------------------------
Common Unrealized Net Gain on Minimum
Stock/ Gain Cash-Flow Cumulative Pension Outstanding
Additional Treasury (Loss) on Hedging Translation Liability Shares
Paid-in Retained Stock, Securities, Instruments, Adjustments, Adjustment, (In
(In millions) (Unaudited) Capital Earnings at Cost net of tax net of tax net of tax net of tax Total thousands)
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BALANCE, BEGINNING OF PERIOD $1,688 $5,887 $(480) $497 $-- $(113) $(15) $7,464 226,290
Comprehensive income
Net income 363 363
Other comprehensive income, net
of tax [1]
Cumulative effect of
accounting change [4] (1) 24 23
Unrealized gain on securities [2] 334 334
Net gain on cash-flow hedging
instruments [3] 68 68
Translation adjustments (10) (10)
-------
Total other comprehensive income 415
-------
Total comprehensive income 778
-------
Issuance of shares under incentive
and stock purchase plans 76 4 80 1,924
Issuance of common stock in
underwritten offering 169 446 615 10,000
Tax benefit on employee stock
options and awards 14 14
Treasury stock acquired (7) (7) (127)
Dividends declared on common stock (178) (178)
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BALANCE, END OF PERIOD $1,947 $6,072 $(37) $830 $92 $(123) $(15) $8,766 238,087
==================================================================================================================================
[1] Unrealized gain (loss) on securities is net of tax expense of $484 and $180
for the nine months ended September 30, 2002 and 2001, respectively. Net
gain on cash-flow hedging instruments is net of tax expense of $44 and $37
for the nine months ended September 30, 2002 and 2001, respectively. For the
nine months ended September 30, 2001, cumulative effect of accounting change
is net of tax benefit of $12. Translation adjustments are net of tax
benefits of $2 and $5 for the nine months ended September 30, 2002 and 2001,
respectively.
[2] Net of reclassification adjustment for gains (losses) realized in net income
of $(207) and $2 for the nine months ended September 30, 2002 and 2001,
respectively.
[3] Net of amortization adjustment of $3 and $5 to net investment income for the
nine months ended September 30, 2002 and 2001, respectively.
[4] For the nine months ended September 30, 2001, unrealized gain (loss) on
securities, net of tax, includes cumulative effect of accounting change of
$(23) to net income and $24 to net gain on cash-flow hedging instruments.
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
- 6 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED
SEPTEMBER 30,
----------------------------------
(IN MILLIONS) 2002 2001
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(Unaudited)
OPERATING ACTIVITIES
Net income $ 742 $ 363
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Change in receivables, payables and accruals (168) (54)
Change in reinsurance recoverables and other related assets 208 (527)
Amortization of deferred policy acquisition costs and present value of future profits 1,696 1,630
Additions to deferred policy acquisition costs and present value of future profits (2,129) (2,047)
Change in accrued and deferred income taxes 229 (210)
Increase in liabilities for future policy benefits, unpaid claims and claim adjustment
expenses and unearned premiums 1,086 1,866
Net realized capital losses 333 91
Depreciation and amortization 61 38
Cumulative effect of accounting changes, net of tax -- 34
Other, net 34 (125)
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NET CASH PROVIDED BY OPERATING ACTIVITIES 2,092 1,059
================================================================================================================================
INVESTING ACTIVITIES
Purchase of investments (15,992) (12,512)
Sale of investments 8,304 7,523
Maturity of investments 2,033 2,139
Purchase of business/affiliate -- (1,105)
Sale of affiliates 3 15
Additions to property, plant and equipment (128) (141)
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NET CASH USED FOR INVESTING ACTIVITIES (5,780) (4,081)
================================================================================================================================
FINANCING ACTIVITIES
Issuance of short-term debt 16 --
Issuance of long-term debt 617 400
Issuance of company obligated mandatorily redeemable preferred securities of subsidiary
trusts holding solely junior subordinated debentures -- 200
Issuance of common stock in underwritten offering 330 615
Net proceeds from investment and universal life-type contracts 2,885 2,027
Dividends paid (192) (176)
Acquisition of treasury stock -- (7)
Proceeds from issuance of shares under incentive and stock purchase plans 84 61
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NET CASH PROVIDED BY FINANCING ACTIVITIES 3,740 3,120
================================================================================================================================
Foreign exchange rate effect on cash 8 --
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Net increase in cash 60 98
Cash - beginning of period 353 227
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CASH - END OF PERIOD $ 413 $ 325
================================================================================================================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
- ------------------------------------------------
NET CASH (RECEIVED) PAID DURING THE PERIOD FOR:
Income taxes $ (162) $ 37
Interest $ 167 $ 150
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
- 7 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in millions except per share and per unit data or unless
otherwise stated)
(Unaudited)
NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES
(A) BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of The Hartford
Financial Services Group, Inc. and its subsidiaries ("The Hartford" or the
"Company") have been prepared in accordance with accounting principles generally
accepted in the United States of America. Less than majority-owned subsidiaries
in which The Hartford has at least a 20% interest are reported on the equity
basis.
In the opinion of management, these financial statements include all normal
recurring adjustments necessary to present fairly the consolidated financial
position, results of operations and cash flows for the periods presented.
On April 2, 2001, The Hartford acquired the U.S. individual life insurance,
annuity and mutual fund businesses of Fortis, Inc. (operating as "Fortis
Financial Group" or "Fortis"). The acquisition was accounted for as a purchase
transaction and, as such, the revenues and expenses generated by this business
from April 2, 2001 forward are included in the Company's Consolidated Statements
of Income.
Certain reclassifications have been made to prior year financial information to
conform to the current year classifications.
(B) SIGNIFICANT ACCOUNTING POLICIES
For a description of accounting policies, see Note 1 of Notes to Consolidated
Financial Statements included in The Hartford's 2001 Form 10-K Annual Report.
(C) ADOPTION OF NEW ACCOUNTING STANDARDS
In April 2002, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 145, "Rescission of
FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and
Technical Corrections". Under historical guidance, all gains and losses
resulting from the extinguishment of debt were required to be aggregated and, if
material, classified as an extraordinary item, net of related income tax effect.
SFAS No. 145 rescinds that guidance and requires that gains and losses from
extinguishment of debt be classified as extraordinary items only if they are
both unusual and infrequent in occurrence. SFAS No. 145 also amends SFAS No. 13,
"Accounting for Leases" for the required accounting treatment of certain lease
modifications that have economic effects similar to sale-leaseback transactions.
SFAS No. 145 requires that those lease modifications be accounted for in the
same manner as sale-leaseback transactions. The provisions of SFAS No. 145
related to the rescission of SFAS No. 4 are applicable in fiscal years beginning
after May 15, 2002 and will be effective for The Hartford January 1, 2003.
Adoption of the provisions of SFAS No. 145 related to the rescission of SFAS No.
4 is not expected to have a material impact on the Company's consolidated
financial condition or results of operations. The provisions of SFAS No. 145
related to SFAS No. 13 are effective for transactions occurring after May 15,
2002. Adoption of the provisions of SFAS No. 145 related to SFAS No. 13 did not
have a material impact on the Company's consolidated financial condition or
results of operations.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets". SFAS No. 144 establishes an accounting model for
long-lived assets to be disposed of by sale that applies to all long-lived
assets, including discontinued operations. SFAS No. 144 requires that those
long-lived assets be measured at the lower of carrying amount or fair value less
cost to sell, whether reported in continuing operations or in discontinued
operations. The provisions of SFAS No. 144 are effective for financial
statements issued for fiscal years beginning after December 15, 2001. Adoption
of SFAS No. 144 did not have a material impact on the Company's consolidated
financial condition or results of operations.
In June 2001, the FASB issued SFAS No. 141, "Business Combinations". SFAS No.
141 eliminates the pooling-of-interests method of accounting for business
combinations, requiring all business combinations to be accounted for under the
purchase method. Accordingly, net assets acquired are recorded at fair value
with any excess of cost over net assets assigned to goodwill.
SFAS No. 141 also requires that certain intangible assets acquired in a business
combination be recognized apart from goodwill. The provisions of SFAS No. 141
apply to all business combinations initiated after June 30, 2001. Adoption of
SFAS No. 141 did not have a material impact on the Company's consolidated
financial condition or results of operations.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets". Under SFAS No. 142, amortization of goodwill is precluded, however, its
recoverability must be periodically (at least annually) reviewed and tested for
impairment.
Goodwill must be tested at the reporting unit level for impairment in the year
of adoption, including an initial test performed within six months of adoption.
If the initial test indicates a potential impairment, then a more detailed
analysis to determine the extent of impairment must be completed within twelve
months of adoption.
During the second quarter of 2002, the Company completed the review and analysis
of its goodwill asset in accordance with the provisions of SFAS No. 142. The
result of the analysis indicated that each reporting unit's fair value exceeded
its carrying amount, including goodwill. As a result, goodwill for each
reporting unit was not considered impaired. Adoption of all other provisions of
SFAS No. 142 did not have a material impact on the Company's consolidated
financial condition or results of operations.
SFAS No. 142 also requires that useful lives for intangibles other than goodwill
be reassessed and remaining amortization periods be adjusted accordingly. (For
further discussion of the impact of SFAS No. 142, see Note 2.)
- 8 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)
(D) FUTURE ADOPTION OF NEW ACCOUNTING STANDARDS
In July 2002, the FASB issued SFAS No. 146 "Accounting for Certain Costs
Associated with Exit or Disposal Activities", which nullifies Emerging Issues
Task Force ("EITF") Issue No. 94-3, "Liability Recognition for Certain Employee
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)." SFAS No. 146 establishes a change in the
requirements for recognition of a liability for a cost associated with an exit
or disposal activity. This statement now requires liabilities to be recognized
when a company actually incurs the liability. Previously, under EITF Issue No.
94-3, liabilities were recognized at the date an entity committed to an exit
plan. Provisions of SFAS No. 146 are effective for activities initiated after
December 31, 2002. Adoption of this statement is not expected to have a material
impact on the Company's consolidated financial condition or results of
operations.
(E) EXPENSING STOCK OPTIONS
Beginning in January 2003, the Company will adopt the fair-value recognition
provisions of accounting for employee stock options under SFAS No. 123,
"Accounting for Stock-Based Compensation". The Company believes the use of the
fair-value method to record employee stock-based compensation expense is
consistent with the Company's accounting for all other forms of compensation.
This method of accounting for stock options will be used for all awards granted
or modified after January 1, 2003. The Company currently applies the intrinsic
value based provisions set forth in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees". SFAS No. 123 permits companies
either to use the fair-value method and recognize compensation expense upon the
issuance of stock options, thereby lowering earnings, or, alternatively, to
disclose the pro-forma impact of the issuance. Under current accounting rules,
if the Company had expensed options issued in 2002, the impact on earnings for
the full year would have been approximately $0.08 to $0.09 per diluted share. If
future options grants remain at the same level, the annual impact would increase
to approximately $0.25 to $0.27 per diluted share, considering the Company's
three-year vesting period.
The FASB is conducting a fast-track project, which proposes three optional
transition methods for entities that decide to voluntarily adopt the fair value
recognition principles of SFAS No. 123 and modifies the disclosure requirements
of that Statement. Under the guidance contained in an exposure draft issued by
the FASB, entities would have the ability to select any one of the three
proposed transition methods. While the Company is committed to expensing the
fair value of its option grants, the ultimate transition method to be used by
the Company will be determined at the completion of the FASB project.
NOTE 2. GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, the Company adopted SFAS No. 142 and accordingly
ceased all amortization of goodwill.
The following tables show net income and earnings per share for the third
quarter and nine months ended September 30, 2002 and 2001, with the 2001 periods
adjusted for goodwill amortization recorded during the specified period.
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------------------------
NET INCOME (LOSS) 2002 2001 2002 2001
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before cumulative effect of accounting changes $ 265 $ (103) $ 742 $ 397
Goodwill amortization, net of tax -- 13 -- 38
- -----------------------------------------------------------------------------------------------------------------------------------
Adjusted income (loss) before cumulative effect of accounting changes 265 (90) 742 435
Cumulative effect of accounting changes, net of tax -- -- -- (34)
- -----------------------------------------------------------------------------------------------------------------------------------
Adjusted net income (loss) $ 265 $ (90) $ 742 $ 401
===================================================================================================================================
BASIC EARNINGS (LOSS) PER SHARE
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before cumulative effect of accounting changes $ 1.06 $ (0.43) $ 3.00 $ 1.69
Goodwill amortization, net of tax -- 0.05 -- 0.16
- -----------------------------------------------------------------------------------------------------------------------------------
Adjusted income (loss) before cumulative effect of accounting changes 1.06 (0.38) 3.00 1.85
Cumulative effect of accounting changes, net of tax -- -- -- (0.15)
- -----------------------------------------------------------------------------------------------------------------------------------
Adjusted net income (loss) $ 1.06 $ (0.38) $ 3.00 $ 1.70
===================================================================================================================================
DILUTED EARNINGS (LOSS) PER SHARE
- -----------------------------------------------------------------------------------------------------------------------------------
Income (loss) before cumulative effect of accounting changes $ 1.06 $ (0.43) $ 2.96 $ 1.66
Goodwill amortization, net of tax -- 0.05 -- 0.15
- -----------------------------------------------------------------------------------------------------------------------------------
Adjusted income (loss) before cumulative effect of accounting changes 1.06 (0.38) 2.96 1.81
Cumulative effect of accounting changes, net of tax -- -- -- (0.14)
- -----------------------------------------------------------------------------------------------------------------------------------
Adjusted net income (loss) $ 1.06 $ (0.38) $ 2.96 $ 1.67
===================================================================================================================================
- 9 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 2. GOODWILL AND OTHER INTANGIBLE ASSETS (CONTINUED)
The following table shows the Company's acquired intangible assets that continue
to be subject to amortization and aggregate amortization expense. Except for
goodwill, the Company has no intangible assets with indefinite useful lives.
AS OF SEPTEMBER 30, 2002
----------------------------------------------
GROSS CARRYING ACCUMULATED NET
AMORTIZED INTANGIBLE ASSETS AMOUNT AMORTIZATION
- ------------------------------------------------------------------------------------------------------------------------------------
Present value of future profits $ 1,406 $ 244
Renewal rights 42 26
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Total $ 1,448 $ 270
====================================================================================================================================
Net amortization expense for the third quarter and nine months ended September
30, 2002 was $35 and $87, respectively.
Estimated future net amortization expense for the succeeding five years is as
follows.
For the year ended December 31,
- -------------------------------------- -- -----------
2002 $ 122
2003 $ 120
2004 $ 114
2005 $ 104
2006 $ 93
====================================== == ===========
The carrying amounts of goodwill as of September 30, 2002 and December 31, 2001
are shown below.
SEPTEMBER 30, 2002 DECEMBER 31, 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Life $ 796 $ 796
Property & Casualty 154 154
Corporate 772 772
- ------------------------------------------------------------------------------------------------------------------------------------
Total $ 1,722 $ 1,722
====================================================================================================================================
NOTE 3. DERIVATIVES AND HEDGING ACTIVITIES
The Company utilizes a variety of derivative instruments in the ordinary course
of business, including swaps, caps, floors, forwards and exchange traded futures
and options, to manage risk through one of four Company-approved objectives: to
hedge risk arising from interest rate, price or currency exchange rate
volatility; to manage liquidity; to control transaction costs; or to enter into
income enhancement and replication transactions. All of the Company's derivative
transactions are permitted uses of derivatives under the derivatives use plan
filed and/or approved, as applicable, by the State of Connecticut and State of
New York insurance departments.
For a detailed discussion of the Company's use of derivative instruments, see
Note 1(e) of Notes to Consolidated Financial Statements included in The
Hartford's December 31, 2001 Form 10-K Annual Report.
As of September 30, 2002, the Company reported $329 of derivative assets in
other investments and $204 of derivative liabilities in other liabilities.
Cash-Flow Hedges
For the third quarter and nine months ended September 30, 2002, the Company's
gross gains and losses representing the total ineffectiveness of all cash-flow
hedges were immaterial, with the net impact reported as realized capital gains
or losses. All components of each derivative's gain or loss are included in the
assessment of hedge effectiveness.
Gains and losses on derivative contracts that are reclassified from other
comprehensive income to current period earnings are included in the line item in
the Consolidated Statements of Income in which the hedged item is recorded. As
of September 30, 2002, approximately $5 of after-tax deferred net gains on
derivative instruments accumulated in other comprehensive income are expected to
be reclassified to earnings during the next twelve months. This expectation is
based on the anticipated interest payments on hedged investments in fixed
maturity securities that will occur over the next twelve months, at which time
the Company will recognize the deferred net gains/losses as an adjustment to
interest income over the term of the investment cash flows. The maximum term
over which the Company is hedging its exposure to the variability of future cash
flows (for all forecasted transactions, excluding interest payments on
variable-rate debt) is twelve months. As of September 30, 2002, the Company held
approximately $2.9 billion in derivative notional value related to strategies
categorized as cash-flow hedges. For the third quarter and nine months ended
September 30, 2002 and 2001, the net gain reclassifications from other
comprehensive income to earnings resulting from the discontinuance of cash-flow
hedges were immaterial.
- 10 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 3. DERIVATIVES AND HEDGING ACTIVITIES (CONTINUED)
Fair-Value Hedges
For the third quarter and nine months ended September 30, 2002, the Company's
gross gains and losses representing the total ineffectiveness of all fair-value
hedges were immaterial, with the net impact reported as realized capital gains
or losses. All components of each derivative's gain or loss are included in the
assessment of hedge effectiveness. As of September 30, 2002, the Company held
approximately $845 in derivative notional value related to strategies
categorized as fair-value hedges.
Other Risk Management Activities
The Company's other risk management activities primarily relate to strategies
used to reduce economic risk or enhance income, and do not receive hedge
accounting treatment. Swap agreements, interest rate cap and floor agreements
and option contracts are used to reduce economic risk. Income enhancement and
replication transactions include the use of written covered call options which
offset embedded equity call options, total return swaps and synthetic
replication of cash market instruments. The change in the value of all
derivatives held for other risk management purposes is reported in current
period earnings as realized capital gains or losses. As of September 30, 2002,
the Company held approximately $5.4 billion in derivative notional value related
to strategies categorized as Other Risk Management Activities.
NOTE 4. EARNINGS PER SHARE
The following tables present a reconciliation of net income and shares used in
calculating basic earnings per share to those used in calculating diluted
earnings per share.
Third Quarter Ended Nine Months Ended
-------------------------------------- -------------------------------------
Net Income Per Share Net Per Share
SEPTEMBER 30, 2002 (Loss) Shares Amount Income Shares Amount
- ------------------------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE
Income available to common shareholders $ 265 248.9 $ 1.06 $ 742 247.4 $ 3.00
============== ============
DILUTED EARNINGS PER SHARE
Options and contingently issuable shares -- 1.6 -- 2.9
------------------------ -------------------------
Income available to common shareholders plus assumed
conversions $ 265 250.5 $ 1.06 $ 742 250.3 $ 2.96
====================================================================================================================================
SEPTEMBER 30, 2001
- ------------------------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS (LOSS) PER SHARE
Income (loss) available to common shareholders $ (103) 238.0 $ (0.43) $ 363 235.6 $ 1.54
============== ============
DILUTED EARNINGS (LOSS) PER SHARE
Options and contingently issuable shares [1] -- -- -- 3.9
------------------------ -------------------------
Income (loss) available to common shareholders plus
assumed conversions [1] $ (103) 238.0 $ (0.43) $ 363 239.5 $ 1.52
====================================================================================================================================
[1] As a result of the net loss in the quarter ended September 30, 2001, SFAS
No. 128, "Earnings Per Share", requires the Company to use basic weighted
average shares outstanding in the calculation of third quarter 2001
diluted earnings per share, as the inclusion of options and contingently
issuable shares of 3.7 would have been antidilutive to the earnings per
share calculation. In the absence of the net loss, weighted average common
shares outstanding and dilutive potential common shares would have totaled
241.7.
Basic earnings per share reflects the actual weighted average number of shares
outstanding during the period. Diluted earnings per share includes the dilutive
effect of outstanding options, using the treasury stock method, and contingently
issuable shares. Under the treasury stock method, exercise of options is
assumed, with the proceeds used to repurchase common stock at the average market
price for the period. Contingently issuable shares are included upon
satisfaction of certain conditions related to the contingency.
NOTE 5. COMMITMENTS AND CONTINGENCIES
(A) LITIGATION
The Hartford is involved in claims litigation arising in the ordinary course of
business, both as a liability insurer defending third-party claims brought
against insureds or as an insurer defending coverage claims brought against it.
The Hartford accounts for such activity through the establishment of unpaid
claim and claim adjustment expense reserves. Subject to the discussion of the
litigation involving MacArthur Company and its subsidiary, Western MacArthur
Company, both former regional distributors of asbestos products (collectively or
individually, "MacArthur") in (d) below under the caption "Subsequent Events"
and the uncertainties discussed in (b) below under the caption "Asbestos and
Environmental Claims," management expects that the ultimate liability, if any,
with respect to such ordinary-course claims litigation, after consideration of
provisions made for potential losses and costs of defense, will not be material
to the consolidated financial condition, results of operations or cash flows of
The Hartford.
The Hartford is also involved in other kinds of legal actions, some of which
assert claims for substantial amounts. These actions include, among others,
putative state and federal class actions seeking certification of a state or
national class. Such putative class actions have alleged, for example,
underpayment of claims or improper underwriting practices in connection with
various kinds of insurance policies, such as personal and commercial
- 11 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
(A) LITIGATION (CONTINUED)
automobile, premises liability, and inland marine. The Hartford also is involved
in individual actions in which punitive damages are sought, such as claims
alleging bad faith in the handling of insurance claims. Management expects that
the ultimate liability, if any, with respect to such lawsuits, after
consideration of provisions made for potential losses and costs of defense, will
not be material to the consolidated financial condition of The Hartford.
Nonetheless, given the large or indeterminate amounts sought in certain of these
actions, and the inherent unpredictability of litigation, it is possible that an
adverse outcome in certain matters could, from time to time, have a material
adverse effect on the Company's consolidated results of operations or cash flows
in particular quarterly or annual periods.
On March 15, 2002, a jury in the U.S. District Court for the Eastern District of
Missouri issued a verdict in Bancorp Services, LLC ("Bancorp") v. Hartford Life
Insurance Company ("HLIC"), et al. in favor of Bancorp in the amount of $118.
The case involved claims of patent infringement, misappropriation of trade
secrets, and breach of contract against HLIC and its affiliate International
Corporate Marketing Group, Inc. ("ICMG"). The judge dismissed the patent
infringement claim on summary judgment. The jury's award was based on the last
two claims. On August 28, 2002, the Court entered an order awarding Bancorp
prejudgment interest on the breach of contract claim in the amount of $16.
HLIC and ICMG have moved the district court for, among other things, judgment as
a matter of law or a new trial, and intend to appeal the judgment if the
district court does not set it aside or substantially reduce it. In either
event, the Company's management, based on the opinion of its legal advisers,
believes that there is a substantial likelihood that the jury award will not
survive at its current amount. Based on the advice of legal counsel regarding
the potential outcome of this litigation, the Company recorded an $11 after-tax
charge in the first quarter of 2002 to increase litigation reserves associated
with this matter. Should HLIC and ICMG not succeed in eliminating or reducing
the judgment, a significant additional expense would be recorded in the future
related to this matter.
The Company is involved in arbitration with one of its primary reinsurers
relating to policies with death benefit guarantees written from 1994 to 1999.
The arbitration involves alleged breaches under the reinsurance treaties.
Although the Company believes that its position in this pending arbitration is
strong, an adverse outcome could result in a decrease to the Company's statutory
surplus and capital and potentially increase the death benefit costs incurred by
the Company in the future. The arbitration hearing began in October 2002.
(B) ASBESTOS AND ENVIRONMENTAL CLAIMS
The Hartford continues to receive claims that assert damages from asbestos and
environmental-related exposures. Asbestos claims relate primarily to injuries
asserted by those who came in contact with asbestos or products containing
asbestos. Environmental claims relate primarily to pollution and related
clean-up costs.
The Hartford receives asbestos and environmental claims made pursuant to several
different categories of insurance coverage. First, The Hartford wrote policies
as a primary liability insurance carrier. Second, The Hartford wrote excess
insurance policies that provide additional coverage for insureds that exhaust
their primary liability insurance coverage. Third, The Hartford acted as a
reinsurer assuming a portion of risks previously assumed by other insurers
writing primary, excess and reinsurance coverages. Writers of excess insurance
and reinsurance often receive information regarding potential exposures
significantly later than primary writers covering the same risk. The Hartford
may experience more difficulty and delays in estimating its exposures arising
from excess and reinsurance policies than it does in estimating exposures
arising from its activity as a primary insurance writer.
With regard to both environmental and particularly asbestos claims, uncertainty
exists which affects the ability of insurers and reinsurers to estimate the
ultimate reserves necessary for unpaid losses and related settlement expenses.
Conventional reserving techniques cannot reasonably estimate the ultimate cost
of these claims, particularly during periods where theories of law are in flux.
As a result of the factors discussed in the following paragraphs, the degree of
variability of reserve estimates for these exposures is significantly greater
than for other more traditional exposures. In particular, The Hartford believes
there is a high degree of uncertainty in the estimation of asbestos loss
reserves.
In the case of the reserves for asbestos exposures, factors contributing to the
high degree of uncertainty include inadequate development patterns, plaintiffs'
expanding theories of liability, the risks inherent in major litigation and
inconsistent emerging legal doctrines. There are complex legal issues concerning
the interpretation of various insurance policy provisions and whether those
losses are, or were ever intended to be, covered. Courts have reached
inconsistent conclusions as to when losses are deemed to have occurred and which
policies provide coverage; what types of losses are covered; whether there is an
insurer obligation to defend; how policy limits are determined; whether or not
particular claims are product/completed operation claims subject to an aggregate
limit and how policy exclusions and conditions are applied and interpreted.
Furthermore, insurers in general, including The Hartford, have recently
experienced an increase in the number of asbestos-related claims due to, among
other things, more intensive advertising by lawyers seeking asbestos claimants,
the increasing focus by plaintiffs on new and previously peripheral defendants
and an increase in the number of entities seeking bankruptcy protection as a
result of asbestos-related liabilities. Plaintiffs and insureds have sought to
utilize bankruptcy proceedings to accelerate and increase loss payments by
insurers. In addition, new classes of claims have been arising whereby some
asbestos-related defendants are asserting that their asbestos-related claims
fall within so-called non-products liability coverage contained within their
policies rather than products liability coverage and that the claimed
non-products coverage is not subject to any aggregate limit. Recently, many
insurers, including, in a limited number of instances, The Hartford, also have
been sued directly by asbestos claimants asserting that insurers had a duty to
protect the public from the dangers of asbestos. Management believes these
issues are not likely to be resolved in the near future. An adverse
determination of issues
- 12 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
(B) ASBESTOS AND ENVIRONMENTAL CLAIMS (CONTINUED)
relating to The Hartford's liability for asbestos claims could have a material
adverse effect on The Hartford's results of operations, financial condition and
liquidity.
Given the factors and emerging trends described above, The Hartford believes the
actuarial tools and other techniques it employs to estimate the ultimate cost of
paying claims for more traditional areas of insurance exposure are less
effective in estimating the necessary reserves for its asbestos exposures. The
Hartford continually evaluates new information and new methodologies to use in
evaluating its potential asbestos exposures. At any time, including the current
reporting period, The Hartford may be conducting one or more evaluations of
individual exposures, classes of exposures or all of its current and potential
exposures to asbestos claims. At any time analysis of newly identified
information or completion of one or more analyses could cause The Hartford to
change its estimates of its asbestos exposures and the effect of these changes
could be material to the Company's consolidated operating results and financial
condition in future periods.
Reserves and reserve activity in the Other Operations segment are categorized
and reported as either Asbestos, Environmental, or All Other activity.
Constantly evolving legal theories create significant uncertainties with respect
to what types of claims may ultimately arise from the generally older policies
and liabilities managed in the Other Operations segment. The Hartford's
experience has been that while this group of policies has over time produced
significantly higher claims and losses than were initially contemplated at
inception, the areas of active claim activity have shifted over time based on
changes in plaintiff focus and the overall litigation environment. A significant
portion of the claim reserves of the Other Operations segment relates to
exposure to the insurance businesses of other insurers or reinsurers ("whole
account" exposure). Many of these whole account exposures arise from reinsurance
agreements previously written by The Hartford. The Hartford's net exposure in
these arrangements has increased for a variety of reasons, including, but not
limited to, situations where The Hartford has commuted previous retrocessions of
such business. Due to the reporting practices of cedants to their reinsurers,
determination of the nature of the individual risks involved in these whole
account exposures (such as asbestos, environmental, or other exposures) requires
various assumptions and estimates, which are subject to variability and
uncertainty.
Consistent with the reports of other insurers, The Hartford has been
experiencing an increase in the number of new asbestos claims by policyholders
not previously identified as potentially significant claimants, including
installers or handlers of asbestos-containing products. In addition, new classes
of claims are beginning to arise whereby some asbestos-related defendants are
asserting that their asbestos-related claims fall within so-called non-products
liability coverage contained within their policies rather than products
liability coverage and that the claimed non-products coverage is not subject to
any aggregate limit. (An example of these non-products claims is presented in
the MacArthur litigation discussed in (d) below.)
On May 14, 2002, The Hartford announced its participation, along with several
dozen other insurance carriers, in a settlement in principle with its insured,
PPG Industries ("PPG"), of litigation arising from asbestos exposures involving
Pittsburgh Corning Corporation ("Pittsburgh Corning"), which is 50% owned by
PPG. The structure of the settlement will allow The Hartford to make fixed
payments to a settlement trust over a 20-year period beginning in 2004 and
allows The Hartford to prepay its obligations at any time at a fixed discount
rate of 5.5%. The settlement is subject to a number of contingencies, including
the negotiation of a definitive agreement among the parties and approval of the
bankruptcy court supervising the reorganization of Pittsburgh Corning. The
Hartford estimated the settlement amount to be approximately $130 (non
tax-effected) on a discounted basis and net of anticipated reinsurance
recoveries. The settlement was covered by existing asbestos reserves, and as a
result, did not have a material impact on The Company's consolidated financial
condition or results of operations.
As of September 30, 2002, the Company reported $1,133 and $642 of net Asbestos
and Environmental reserves, respectively. Based on currently known facts and the
Company's methodologies for estimating asbestos and environmental reserves, The
Hartford believes that the level of recorded reserves at September 30, 2002 is
reasonable and appropriate. Because of the significant uncertainties described
in this Note 5, principally those related to asbestos, the ultimate liabilities
may exceed the currently recorded reserves. Any such additional liability (or
any range of additional amounts) cannot be reasonably estimated now but could be
material to The Hartford's future consolidated operating results and financial
condition. Consistent with the Company's longstanding reserving practices, The
Hartford will continue to regularly review and monitor these reserves and, where
future circumstances indicate, make appropriate adjustments to the reserves.
(C) TAX MATTERS
The Company's Federal income tax returns are routinely audited by the Internal
Revenue Service ("IRS"). Throughout the audit of the 1996-1997 years, the
Company and the IRS have been engaged in an ongoing dispute regarding what
portion of the separate account dividends-received deduction ("DRD") is
deductible by the Company. During 2001 the Company continued its discussions
with the IRS. As part of the Company's due diligence with respect to this issue,
the Company closely monitored the activities of the IRS with respect to other
taxpayers on this issue and consulted with outside tax counsel and advisors on
the merits of the Company's separate account DRD. The due diligence was
completed during the third quarter of 2001 and the Company concluded that it was
probable that a greater portion of the separate account DRD claimed on its filed
returns would be realized. Based on the Company's assessment of the probable
outcome, the Company concluded an additional $130 tax benefit was appropriate to
record in the third quarter of 2001, relating to the tax years 1996-2000.
Additionally, the Company increased its estimate of the separate account DRD
recognized with respect to tax year 2001 from $44 to $60.
- 13 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
(C) TAX MATTERS (CONTINUED)
Earlier in 2002, the Company and its IRS agent requested advice from the
National Office of the IRS with respect to certain aspects of the computation of
the separate account DRD that had been claimed by the Company for the 1996-1997
audit period. During September 2002 the IRS National Office issued a ruling that
confirmed that the Company had properly computed the items in question in the
separate account DRD claimed on its 1996-1997 tax returns. Additionally, during
the third quarter, the Company reached agreement with the IRS on all other
issues with respect to the 1996-1997 tax years. The Company recorded a benefit
of $76 during the third quarter of 2002, primarily relating to the tax treatment
of such issues for the 1996-1997 tax years, as well as appropriate carryover
adjustments to the 1998-2002 years. The Company will continue to monitor further
developments surrounding the computation of the separate account DRD, as well as
other items, and will adjust its estimate of the probable outcome of these
issues as developments warrant. Management believes that adequate provision has
been made in the financial statements for any potential assessments that may
result from tax examinations and other tax-related matters for all open tax
years.
(D) SUBSEQUENT EVENTS
On October 7, 2002, an action was filed in the Superior Court in Alameda County,
California, against Hartford Accident & Indemnity Company ("Hartford A&I"), a
subsidiary of the Company, and two other insurers. The principal plaintiffs are
MacArthur Company and its subsidiary, Western MacArthur Company, both former
regional distributors of asbestos products (collectively or individually,
"MacArthur"). MacArthur seeks a declaration of coverage and damages for asbestos
bodily-injury claims. Five asbestos claimants who allegedly have obtained
default judgments against MacArthur also are joined as plaintiffs; they seek to
recover the amount of their default judgments and additional damages directly
from the defendant insurers and assert a right to an accelerated trial.
Hartford A&I issued primary general liability policies to MacArthur during the
period 1967-76. MacArthur sought coverage for asbestos-related claims from
Hartford A&I under these policies beginning in 1978. During the period 1978 to
1987, Hartford A&I paid out its full aggregate limits under these policies plus
defense costs. In 1987, Hartford A&I notified MacArthur that its available
limits under these policies had been exhausted, and MacArthur ceased submitting
claims to Hartford A&I under these policies.
On June 3, 2002, The St. Paul Companies, Inc. ("St. Paul") announced a
settlement of a coverage action brought by MacArthur against United States
Fidelity and Guaranty Company ("USF&G"), a subsidiary of St. Paul. Under the
settlement, St. Paul agreed to pay a total of $975 to resolve its asbestos
liability to MacArthur in conjunction with a proposed bankruptcy petition and
pre-packaged plan of reorganization that MacArthur is to file. USF&G provided at
least 12 years of primary general liability coverage to MacArthur, but, unlike
Hartford A&I, had denied coverage and had refused to pay for defense or
indemnity.
In its October 7, 2002 complaint, MacArthur alleges that it has approximately
$1.8 billion of unpaid asbestos liability judgments against it to date.
MacArthur seeks additional coverage from Hartford A&I on the theory that
Hartford A&I has exhausted only its products aggregate limit of liability, not
separate limits MacArthur alleges to be available for non-products liability.
The ultimate amount of MacArthur's alleged non-products asbestos liability,
including any unresolved current and future claims, is currently unknown.
MacArthur indicates in its complaint that it will seek to have the full amount
of its current and future asbestos liability estimated in its anticipated
bankruptcy proceeding. If such an estimation is made, MacArthur intends to seek
a judgment against the defendants for the amount of its total liability,
including estimated claims, less the amount ultimately paid by St. Paul.
Hartford A&I intends to defend the MacArthur action vigorously. Based on the
information currently available, management believes that Hartford A&I's
liability, if any, to MacArthur will not be finally resolved for at least a year
and most probably not for several years. In the opinion of management, the
ultimate outcome is highly uncertain for many reasons. It is not yet known, for
example, in which venue Hartford A&I's liability, if any, will be determined;
whether Hartford A&I's defenses based on MacArthur's long delay in asserting
claims for further coverage will be successful; how other significant coverage
defenses will be decided; or the extent to which the claims and default
judgments against MacArthur involve injury outside of the products and completed
operations hazard definitions of the policies. In the opinion of management, an
adverse outcome could have a material adverse effect on the Company's results of
operations, financial condition and liquidity.
NOTE 6. SEGMENT INFORMATION
The Hartford is organized into two major operations: Life and Property &
Casualty. Within these operations, The Hartford conducts business principally in
nine operating segments. Additionally, the capital raising and purchase
accounting adjustment activities related to the June 27, 2000 acquisition of all
of the outstanding shares of Hartford Life, Inc. ("HLI") that the Company did
not already own ("The HLI Repurchase") are included in Corporate.
Life is organized into four reportable operating segments: Investment Products,
Individual Life, Group Benefits and Corporate Owned Life Insurance ("COLI").
Investment Products offers individual variable and fixed annuities, mutual
funds, retirement plan services and other investment products. Individual Life
sells a variety of life insurance products, including variable life, universal
life and term life insurance. Group Benefits sells group insurance products,
including group life and group disability insurance as well as other products,
including stop loss and supplementary medical coverages to employers and
employer sponsored plans, accidental death and dismemberment, travel accident
and other special risk coverages to employers and associations. COLI primarily
offers variable products used by employers to fund non-qualified benefits or
other postemployment benefit obligations as well as leveraged COLI. Life also
includes in an Other category its international operations, which are primarily
located in Latin America and Japan, as well as corporate
- 14 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6. SEGMENT INFORMATION (CONTINUED)
items not directly allocable to any of its reportable operating segments,
principally interest expense.
In January 2002, Property & Casualty integrated its Affinity Personal Lines and
Personal Insurance segments, now reported as Personal Lines. As a result,
Property & Casualty is now organized into five reportable operating segments:
the North American underwriting segments of Business Insurance, Personal Lines,
Specialty Commercial and Reinsurance (collectively, "North American"); and the
Other Operations segment, which includes substantially all of the Company's
asbestos and environmental exposures.
Business Insurance provides standard commercial insurance coverage to small
commercial and middle market insureds. This segment also provides commercial
risk management products and services to small and mid-sized members of affinity
groups in addition to marine coverage. Personal Lines provides automobile,
homeowners' and home-based business coverages to the members of AARP through a
direct marketing operation; to individuals who prefer local agent involvement
through a network of independent agents in the standard personal lines market;
and through the Omni Insurance Group in the non-standard automobile market.
Personal Lines also operates a member contact center for health insurance
products offered through AARP's Health Care Options. The Specialty Commercial
segment offers a variety of customized insurance products and risk management
services. Specialty Commercial provides standard commercial insurance products
including workers' compensation, automobile and liability coverages to
large-sized companies. Specialty Commercial also provides bond, professional
liability, specialty casualty and agricultural coverages, as well as core
property and excess and surplus lines coverages not normally written by standard
lines insurers. In addition, Specialty Commercial provides third party
administrator services for claims administration, integrated benefits, loss
control and performance measurement through Specialty Risk Services. The
Reinsurance segment assumes reinsurance mainly in North America and primarily
writes treaty reinsurance through professional reinsurance brokers covering
various property, casualty, specialty and marine classes of business. The Other
Operations segment consists of certain property and casualty insurance
operations of The Hartford which have discontinued writing new business and
includes substantially all of the Company's asbestos and environmental
exposures. The Other Operations segment results also include activity for the
Company's international property and casualty businesses up until their dates of
sale, and for 2002 include the activity in the exited international lines of
HartRe as a result of its restructuring in October 2001. (For further discussion
of this restructuring, see Note 9.)
The measure of profit or loss used by The Hartford's management in evaluating
performance is operating income, except for its North American underwriting
segments, which are evaluated by The Hartford's management primarily based upon
underwriting results. Underwriting results represent premiums earned less
incurred claims, claim adjustment expenses and underwriting expenses. "Operating
income" is defined as after-tax operational results excluding, as applicable,
net realized capital gains or losses, the cumulative effect of accounting
changes and certain other items. While not considered segments, the Company also
reports and evaluates operating income results for Life, Property & Casualty and
North American. Property & Casualty includes operating income for North American
and the Other Operations segment. North American includes the combined
underwriting results of the North American underwriting segments along with
income and expense items not directly allocable to these segments, such as net
investment income.
Certain transactions between segments occur during the year that primarily
relate to tax settlements, insurance coverage, expense reimbursements, services
provided and capital contributions. Certain reinsurance stop loss agreements
exist between the segments which specify that one segment will reimburse another
for losses incurred in excess of a predetermined limit. Also, one segment may
purchase group annuity contracts from another to fund pension costs and claim
annuities to settle casualty claims. In addition to the above transactions,
certain intersegment transactions occur in Life. These transactions include
interest income on allocated surplus and the allocation of net realized capital
gains and losses through net invested income utilizing the duration of the
segment's investment portfolios.
The following tables present revenues and operating income (loss). Underwriting
results are presented for the Business Insurance, Personal Lines, Specialty
Commercial and Reinsurance segments, while operating income is presented for all
other segments, along with Life and Property & Casualty, including North
American.
- 15 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6. SEGMENT INFORMATION (CONTINUED)
REVENUES
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------------------------------------
2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Life
Investment Products $ 637 $ 622 $ 1,946 $ 1,869
Individual Life 239 236 720 639
Group Benefits 645 617 1,943 1,871
COLI 145 171 451 536
Other (125) (41) (252) (25)
- ------------------------------------------------------------------------------------------------------------------------------------
Total Life 1,541 1,605 4,808 4,890
- ------------------------------------------------------------------------------------------------------------------------------------
Property & Casualty
North American
Earned premiums and other revenue
Business Insurance 795 680 2,293 1,940
Personal Lines 789 732 2,308 2,157
Specialty Commercial 414 334 1,037 922
Reinsurance 178 220 521 699
Ceded premiums related to September 11 -- (114) -- (114)
- ------------------------------------------------------------------------------------------------------------------------------------
Total North American earned premiums and other revenue 2,176 1,852 6,159 5,604
Net investment income 225 227 676 679
Net realized capital losses (28) (4) (49) (28)
- ------------------------------------------------------------------------------------------------------------------------------------
Total North American 2,373 2,075 6,786 6,255
Other Operations 42 38 138 133
- ------------------------------------------------------------------------------------------------------------------------------------
Total Property & Casualty 2,415 2,113 6,924 6,388
- ------------------------------------------------------------------------------------------------------------------------------------
Corporate 5 4 14 13
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES $ 3,961 $ 3,722 $ 11,746 $ 11,291
====================================================================================================================================
- 16 -
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 6. SEGMENT INFORMATION (CONTINUED)
OPERATING INCOME THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------------------------------------
2002 2001 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Life
Investment Products $ 100 $ 116 $ 335 $ 344
Individual Life 33 30 99 86
Group Benefits 34 26 92 76
COLI 10 8 20 27
Other 55 102 40 86
- ------------------------------------------------------------------------------------------------------------------------------------
Total Life 232 282 586 619
- ------------------------------------------------------------------------------------------------------------------------------------
Property & Casualty
North American
Underwriting results
Business Insurance 21 6 17 (7)
Personal Lines (13) (17) (48) (44)
Specialty Commercial 3 (18) 1 (56)
Reinsurance (4) (47) (17) (109)
- ------------------------------------------------------------------------------------------------------------------------------------
Underwriting results excluding September 11 7 (76) (47) (216)
September 11 -- (647) -- (647)
- ------------------------------------------------------------------------------------------------------------------------------------
Total North American underwriting results 7 (723) (47) (863)
Net servicing and other income [1] 4 5 7 17
Net investment income 225 227 676 679
Other expenses (75) (50) (184) (153)
Income tax (expense) benefit (23) 222 (73) 209
- ------------------------------------------------------------------------------------------------------------------------------------
Total North American 138 (319) 379 (111)
Other Operations 1 -- 2 2
- ------------------------------------------------------------------------------------------------------------------------------------
Total Property & Casualty 139 (319) 381 (109)
- ------------------------------------------------------------------------------------------------------------------------------------
Corporate (6) (15) (18) (47)
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME (LOSS) 365 (52) 949 463
Cumulative effect of accounting changes, net of tax -- -- -- (34)
Net realized capital losses, after-tax (100) (51) (207) (66)
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ 265 $ (103) $ 742 $ 363
====================================================================================================================================
[1] Net of expenses related to service business.
NOTE 7. DEBT
On September 13, 2002 The Hartford issued 6.6 million 6% equity units at a price
of $50.00 per unit and received net proceeds of $319.
Each equity unit offered initially consists of a corporate unit with a stated
amount of $50.00 per unit. Each corporate unit consists of one purchase contract
for the sale of a certain number of shares of the Company's stock and fifty
dollars principal amount of senior notes due November 16, 2008.
The corporate unit may be converted by the holder into a treasury unit
consisting of the purchase contract and a 5% undivided beneficial interest in a
zero-coupon U.S. Treasury security with a principal amount of one thousand
dollars that matures on November 15, 2006. The holder of an equity unit owns the
underlying senior notes or treasury portfolio but has pledged the senior notes
or treasury portfolio to the Company to secure the holder's obligations under
the purchase contract.
The purchase contract obligates the holder to purchase, and obligates The
Hartford to sell, on November 16, 2006, for fifty dollars, a variable number of
newly issued common shares of The Hartford. The number of The Hartford's shares
to be issued will be determined at the time the purchase contracts are settled
based upon the then current applicable market value of The Hartford's common
stock. If the applicable market value of The Hartford's common stock is equal to
or less than $47.25, then the Company will deliver 1.0582 shares to the holder
of the equity unit, or an aggregate of 7.0 million shares. If the applicable
market value of The Hartford's common stock is greater than $47.25 but less than
$57.645, then the Company will deliver the number of shares equal to fifty
dollars divided by the then current applicable market value of The Hartford's
common stock to the holder. Finally, if the applicable market value of The
Hartford's common
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTE 7. DEBT (CONTINUED)
stock is equal to or greater than $57.645, then the Company will deliver 0.8674
shares to the holder, or an aggregate of 5.7 million shares. Accordingly, upon
settlement of the purchase contracts on November 16, 2006, The Hartford will
receive proceeds of approximately $330 and will deliver between 5.7 million and
7.0 million common shares in the aggregate. The proceeds will be credited to
stockholders' equity and allocated between the common stock and additional
paid-in-capital accounts. The Hartford will make quarterly contract adjustment
payments to the equity unit holders at a rate of 1.90% of the stated amount per
year until the purchase contract is settled.
Each corporate unit also includes fifty dollars principal amount of senior notes
that will mature on November 16, 2008. The aggregate maturity value of the
senior notes is $330. The notes are pledged by the holders to secure their
obligations under the purchase contracts. The Hartford will make quarterly
interest payments to the holders of the notes initially at an annual rate of
4.10%. On August 11, 2006, the notes will be remarketed. At that time, The
Hartford's remarketing agent will have the ability to reset the interest rate on
the notes in order to generate sufficient remarketing proceeds to satisfy the
holder's obligation under the purchase contract. In the event of an unsuccessful
remarketing, the Company will exercise its rights as a secured party to obtain
and extinguish the notes.
The total distributions payable on the equity units are at an annual rate of
6.0%, consisting of interest (4.10%) and contract adjustment payments (1.90%).
The corporate units are listed on the New York Stock Exchange under the symbol
"HIG PrA".
The present value of the contract adjustment payments of $24 was accrued upon
the issuance of the equity units as a charge to additional paid-in capital and
are included in other liabilities in the accompanying consolidated balance sheet
as of September 30, 2002. Subsequent contract adjustment payments will be
allocated between this liability account and interest expense based on a
constant rate calculation over the life of the transaction. Additional paid-in
capital as of September 30, 2002, also reflected a charge of $9 representing a
portion of the equity unit issuance costs that was allocated to the purchase
contracts.
The equity units have been reflected in the diluted earnings per share
calculation using the treasury stock method, which would be used for the equity
units at any time before the settlement of the purchase contracts. Under the
treasury stock method, the number of shares of common stock used in calculating
diluted earnings per share is increased by the excess, if any, of the number of
shares issuable upon settlement of the purchase contracts over the number of
shares that could be purchased by The Hartford in the market, at the average
market price during the period, using the proceeds received upon settlement. The
Company anticipates that there will be no dilutive effect on its earnings per
share related to the equity units, except during periods when the average market
price of a share of the Company's common stock is above the threshold
appreciation price of $57.645. Because the average market price of The
Hartford's common stock during the quarter ended September 30, 2002, was below
this threshold appreciation price, the shares issuable under the purchase
contract component of the equity units have not been included in the diluted
earnings per share calculation.
On August 29, 2002 The Hartford issued 4.7% senior notes due September 1, 2007
and received net proceeds of $298. Interest on the notes is payable
semi-annually on March 1 and September 1, commencing on March 1, 2003. The
Company used the proceeds to repay senior notes that matured on November 1,
2002.
NOTE 8. STOCKHOLDERS' EQUITY
On September 13, 2002, The Hartford issued approximately 7.3 million shares of
common stock pursuant to an underwritten offering at a price of $47.25 per share
and received net proceeds of $330. Also on September 13, 2002, The Hartford
issued 6.6 million 6% equity units. Each equity unit contains a purchase
contract obligating the holder to purchase and The Hartford to sell, a variable
number of newly-issued shares of The Hartford's common stock. Upon settlement of
the purchase contracts on November 16, 2006, The Hartford will receive proceeds
of approximately $330 and will deliver between 5.7 million and 7.0 million
shares in the aggregate. (For further discussion of this issuance, see Note 7.)
At the Company's annual meeting of shareholders held on April 18, 2002,
shareholders approved an amendment to Section (a) Article Fourth of the Amended
and Restated Certificate of Incorporation to increase the aggregate authorized
number of shares of common stock from 400 million to 750 million.
NOTE 9. RESTRUCTURING
During the fourth quarter of 2001, the Company approved and implemented plans
for restructuring the operations of both HartRe and The Hartford Bank, FSB ("The
Hartford Bank"). HartRe announced a restructuring of its entire international
and domestic operations, with the purpose of centralizing the underwriting
organization in Hartford, Connecticut. Also, the Boards of Directors for both
The Hartford Bank and The Hartford Financial Services Group, Inc. approved The
Hartford Bank's dissolution plan. Both plans will be completed during 2002.
As a result of these restructuring plans, the Company recorded a 2001 pre-tax
charge and accrual of approximately $16. This amount included $8 in
employee-related costs, $5 in occupancy-related costs and the remaining $3 in
other restructuring costs.
The 79 employees terminated under these restructuring plans primarily relate to
all levels of the underwriting and claims areas. The occupancy-related costs
represent the remaining lease liabilities for both the domestic and
international offices of HartRe to be closed pursuant to the restructuring plan.
As of September 30, 2002, the Company has paid approximately $5 in
employee-related restructuring costs, $1 in occupancy related costs and $1 in
other restructuring costs.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Dollar amounts in millions except share data unless otherwise stated)
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") addresses the financial condition of The Hartford Financial
Services Group, Inc. and its subsidiaries (collectively, "The Hartford" or the
"Company") as of September 30, 2002, compared with December 31, 2001, and its
results of operations for the third quarter and nine months ended September 30,
2002, compared with the equivalent 2001 periods. This discussion should be read
in conjunction with the MD&A in The Hartford's 2001 Form 10-K Annual Report.
Certain of the statements contained herein (other than statements of historical
fact) are forward-looking statements. These forward-looking statements are made
pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995 and include estimates and assumptions related to economic,
competitive and legislative developments. These forward-looking statements are
subject to change and uncertainty which are, in many instances, beyond the
Company's control and have been made based upon management's expectations and
beliefs concerning future developments and their potential effect upon the
Company. There can be no assurance that future developments will be in
accordance with management's expectations or that the effect of future
developments on The Hartford will be those anticipated by management. Actual
results could differ materially from those expected by the Company, depending on
the outcome of various factors. These factors include: the difficulty in
predicting the Company's potential exposure for asbestos and environmental
claims and related litigation, in particular, significant uncertainty with
regard to the outcome of the Company's current dispute with MacArthur Company
and its subsidiary, Western MacArthur Company (collectively or individually,
"MacArthur"); the uncertain nature of damage theories and loss amounts and the
development of additional facts related to the September 11 terrorist attack
("September 11"); the response of reinsurance companies under reinsurance
contracts, the impact of increasing reinsurance rates, and the adequacy of
reinsurance to protect the Company against losses; the possibility of more
unfavorable loss experience than anticipated; the possibility of general
economic and business conditions that are less favorable than anticipated; the
incidence and severity of catastrophes, both natural and man-made; the effect of
changes in interest rates, the stock markets or other financial markets;
stronger than anticipated competitive activity; unfavorable legislative,
regulatory or judicial developments; the Company's ability to distribute its
products through distribution channels, both current and future; the uncertain
effects of emerging claim and coverage issues; the effect of assessments and
other surcharges for guaranty funds and second-injury funds and other mandatory
pooling arrangements; a downgrade in the Company's claims-paying, financial
strength or credit ratings; the ability of the Company's subsidiaries to pay
dividends to the Company; and other factors described in such forward-looking
statements.
Certain reclassifications have been made to prior year financial information to
conform to the current year presentation.
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INDEX
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Critical Accounting Policies 19
Consolidated Results of Operations: Operating Summary 22
Life 24
Investment Products 26
Individual Life 26
Group Benefits 27
Corporate Owned Life Insurance ("COLI") 27
Property & Casualty 28
Business Insurance 29
Personal Lines 29
Specialty Commercial 30
Reinsurance 31
Other Operations (Including Asbestos and
Environmental Claims) 31
Investments 34
Capital Markets Risk Management 36
Capital Resources and Liquidity 39
Accounting Standards 42
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CRITICAL ACCOUNTING POLICIES
- --------------------------------------------------------------------------------
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States, requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
The Company has identified the following policies as critical accounting
policies because they involve a higher degree of judgment. In applying these
policies management makes subjective and complex judgments that frequently
require estimates about matters that are inherently uncertain. Although
variability is inherent in these estimates, management believes the amounts
provided are appropriate based upon the facts available at the time.
DEFERRED ACQUISITION COSTS
LIFE
Policy acquisition costs, which include commissions and certain other expenses
that vary with and are primarily associated with acquiring business, are
deferred and amortized over the estimated lives of the contracts, usually 20
years.
Deferred policy acquisition costs ("DAC") related to investment contracts and
universal life-type contracts are deferred and amortized using the retrospective
deposit method. Under the retrospective deposit method, acquisition costs are
amortized in proportion to the present value of expected gross profits from
- 19 -
investment, mortality and expense margins and surrender charges. Actual gross
profits vary from management's estimates, resulting in increases or decreases in
the rate of amortization. Management periodically reviews these estimates and
evaluates the recoverability of the deferred acquisition cost asset. When
appropriate, management revises its assumptions on the estimated gross profits
of these contracts and the cumulative amortization for the books of business are
re-estimated and adjusted by a cumulative charge or credit to income. The
average long-term rate of assumed investment yield used in estimating expected
gross profits related to variable annuity and variable life business was 9.0% at
September 30, 2002, and for all other products including fixed annuities and
other universal life-type contracts the average assumed investment yield ranged
from 5.0% - 8.5%.
Deferred policy acquisition costs related to traditional policies are amortized
over the premium-paying period of the related policies in proportion to the
ratio of the present value of annual expected premium income to the present
value of total expected premium income. Adjustments are made each year to
recognize actual experience as compared to assumed experience for the current
period.
To date, our experience has generally been comparable to the assumptions used in
determining DAC amortization. However, if the Company was to experience a
material adverse deviation in certain critical assumptions, including surrender
rates, mortality experience, or investment performance, there could be a
negative effect on the Company's consolidated results of operations or financial
condition.
PROPERTY & CASUALTY
The Property & Casualty operations also incur costs related to the acquisition
of new and renewal insurance policies. These costs include agent and broker
commissions, premium taxes and certain other underwriting expenses. These costs
are deferred and amortized over policy terms. Estimates of the present value of
future revenues, including net investment income and tax benefits, are compared
to estimates of the present value of future costs, including amortization of
policy acquisition costs, to determine if the deferred acquisition costs are
recoverable, and if not, they are charged to expense. For the third quarter and
nine months ended September 30, 2002 and 2001 no material amounts of deferred
acquisition costs were charged to expense based on the results of these
estimates of recoverability.
RESERVES
LIFE
In accordance with applicable insurance regulations under which Life operates,
life insurance subsidiaries of The Hartford establish and carry as liabilities
actuarially determined reserves which are calculated to meet The Hartford's
future obligations. Reserves for life insurance and disability contracts are
based on actuarially recognized methods using prescribed morbidity and mortality
tables in general use in the United States, which are modified to reflect The
Hartford's actual experience when appropriate. These reserves are computed at
amounts that, with additions from estimated premiums to be received and with
interest on such reserves compounded annually at certain assumed rates, are
expected to be sufficient to meet The Hartford's policy obligations at their
maturities or in the event of an insured's death. Reserves also include unearned
premiums, premium deposits, claims incurred but not reported ("IBNR") and claims
reported but not yet paid. Reserves for assumed reinsurance are computed in a
manner that is comparable to direct insurance reserves.
The liability for policy benefits for universal life-type contracts and
interest-sensitive whole life policies is equal to the balance that accrues to
the benefit of policyholders, including credited interest, amounts that have
been assessed to compensate the Company for services to be performed over future
periods, and any amounts previously assessed against policyholders that are
refundable on termination of the contract. Certain contracts include provisions
whereby a guaranteed minimum death benefit is provided in the event that the
contractholder's account value at death is below the guaranteed value. Although
the Company reinsures the majority of the death benefit guarantees associated
with its in-force block of business, declines in the equity market may increase
the Company's net exposure to death benefits under these contracts. The Company
records the death benefit costs, net of reinsurance, as they are incurred. For
investment contracts, policyholder liabilities are equal to the accumulated
policy account values, which consist of an accumulation of deposit payments plus
credited interest, less withdrawals and amounts assessed through the end of the
period. For the Company's group disability policies, the level of reserves is
based on a variety of factors including particular diagnoses, termination rates
and benefit levels.
The persistency of The Hartford's annuity and other interest-sensitive life
insurance reserves is enhanced by policy restrictions on the withdrawal of
funds. Withdrawals in excess of allowable penalty-free amounts are assessed a
surrender charge during a penalty period, which is usually at least seven years.
This surrender charge is initially a percentage of either the accumulation value
or considerations received, which varies by product, and generally decreases
gradually during the penalty period. Surrender charges are set at levels to
protect The Hartford from loss on early terminations and to reduce the
likelihood of policyholders terminating their policies during periods of
increasing interest rates, thereby lengthening the effective duration of policy
liabilities and improving the Company's ability to maintain profitability on
such policies.
PROPERTY & CASUALTY
The Hartford establishes property and casualty reserves to provide for the
estimated costs of paying claims made by policyholders or against policyholders.
These reserves include estimates for both claims that have been reported and
those that have been incurred but not reported, and include estimates of