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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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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 March 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ____________ to ______________
Commission file number 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 (I.R.S. Employer
incorporation or organization) Identification Number)
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[ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [X] No[ ]
As of April 30, 2003, there were outstanding 255,626,654 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
Condensed Consolidated Statements of Operations - First Quarter Ended
March 31, 2003 and 2002 4
Condensed Consolidated Balance Sheets - March 31, 2003 and December
31, 2002 5
Condensed Consolidated Statements of Changes in Stockholders' Equity -
First Quarter Ended March 31, 2003 and 2002 6
Condensed Consolidated Statements of Comprehensive Income (Loss) -
First Quarter Ended March 31, 2003 and 2002 6
Condensed Consolidated Statements of Cash Flows - First Quarter Ended
March 31,2003 and 2002 7
Notes to Condensed Consolidated Financial Statements 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 20
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 51
ITEM 4. CONTROLS AND PROCEDURES 51
PART II. OTHER INFORMATION
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ITEM 1. LEGAL PROCEEDINGS 51
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 52
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 53
Signature 54
Certifications 55
Exhibits 57
- 2 -
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
To the Board of Directors and Stockholders
The Hartford Financial Services Group, Inc.
Hartford, Connecticut
We have reviewed the accompanying condensed consolidated balance sheet of The
Hartford Financial Services Group, Inc. and subsidiaries (the "Company") as of
March 31, 2003, and the related condensed consolidated statements of operations,
changes in stockholders' equity, comprehensive income (loss) and cash flows for
the first quarters ended March 31, 2003 and 2002. These 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 condensed consolidated financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of the
Company as of December 31, 2002, and the related consolidated statements of
income, changes in stockholders' equity, comprehensive income and cash flows for
the year then ended (not presented herein); and in our report dated February 19,
2003, which includes an explanatory paragraph relating to the Company's change
in its method of accounting for goodwill and indefinite-lived intangible assets
in 2002, we expressed an unqualified opinion on those consolidated financial
statements. In our opinion, the information set forth in the accompanying
condensed consolidated balance sheet as of December 31, 2002 is fairly stated,
in all material respects, in relation to the consolidated balance sheet from
which it has been derived.
DELOITTE & TOUCHE LLP
Hartford, Connecticut
May 12, 2003
- 3 -
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FIRST QUARTER ENDED
MARCH 31,
------------------------------
(IN MILLIONS, EXCEPT FOR PER SHARE DATA) 2003 2002
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(Unaudited)
REVENUES
Earned premiums $ 2,849 $ 2,586
Fee income 617 662
Net investment income 796 706
Other revenue 122 113
Net realized capital losses (53) (7)
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TOTAL REVENUES 4,331 4,060
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BENEFITS, CLAIMS AND EXPENSES
Benefits, claims and claim adjustment expenses 5,245 2,416
Amortization of deferred policy acquisition costs and present value
of future profits 564 555
Insurance operating costs and expenses 567 534
Other expenses 180 187
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TOTAL BENEFITS, CLAIMS AND EXPENSES 6,556 3,692
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INCOME (LOSS) BEFORE INCOME TAXES (2,225) 368
Income tax expense (benefit) (830) 76
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NET INCOME (LOSS) $ (1,395) $ 292
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BASIC EARNINGS (LOSS) PER SHARE $ (5.46) $ 1.19
DILUTED EARNINGS (LOSS) PER SHARE [1] $ (5.46) $ 1.17
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Weighted average common shares outstanding 255.4 246.1
Weighted average common shares outstanding and dilutive potential
common shares [1] 255.4 249.7
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Cash dividends declared per share $ 0.27 $ 0.26
==================================================================================================================================
[1] As a result of the net loss for the quarter ended March 31, 2003,
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings
Per Share", requires the Company to use basic weighted average shares
outstanding in the calculation of first quarter 2003 diluted earnings per
share, as the inclusion of options of 0.7 would have been antidilutive to
the earnings per share calculation. In the absence of the net loss,
weighted average common shares outstanding and dilutive potential common
shares would have totaled 256.1.
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
- 4 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31,
(IN MILLIONS, EXCEPT FOR SHARE DATA) 2003 2002
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(Unaudited)
ASSETS
Investments
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Fixed maturities, available for sale, at fair value (amortized cost of $49,196 and $46,241) $ 52,126 $ 48,889
Equity securities, available for sale, at fair value (cost of $594 and $937) 619 917
Policy loans, at outstanding balance 2,876 2,934
Other investments 1,707 1,790
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Total investments 57,328 54,530
Cash and cash equivalents 655 377
Premiums receivable and agents' balances 2,712 2,611
Reinsurance recoverables 6,500 5,027
Deferred policy acquisition costs and present value of future profits 6,899 6,689
Deferred income tax 1,274 545
Goodwill 1,721 1,721
Other assets 3,500 3,397
Separate account assets 108,068 107,078
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TOTAL ASSETS $ 188,657 $ 181,975
============================================================================================================================
LIABILITIES
Reserve for future policy benefits and unpaid claims and claim adjustment expenses
Property and casualty $ 21,212 $ 17,091
Life 8,721 8,567
Other policyholder funds and benefits payable 25,251 23,956
Unearned premiums 4,291 3,989
Short-term debt 315 315
Long-term debt 2,596 2,596
Company obligated mandatorily redeemable preferred securities of subsidiary trusts holding
solely junior subordinated debentures 1,469 1,468
Other liabilities 7,292 6,181
Separate account liabilities 108,068 107,078
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TOTAL LIABILITIES 179,215 171,241
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COMMITMENTS AND CONTINGENCIES (NOTE 5)
STOCKHOLDERS' EQUITY
Common stock - 750,000,000 shares authorized, 258,386,920 and 258,184,483 shares issued,
$0.01 par value 3 3
Additional paid-in capital 2,793 2,784
Retained earnings 5,426 6,890
Treasury stock, at cost - 2,945,592 and 2,943,565 shares (37) (37)
Accumulated other comprehensive income 1,257 1,094
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TOTAL STOCKHOLDERS' EQUITY 9,442 10,734
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 188,657 $ 181,975
============================================================================================================================
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
- 5 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FIRST QUARTER ENDED
MARCH 31,
-----------------------------------------
(IN MILLIONS, EXCEPT FOR SHARE DATA) 2003 2002
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COMMON STOCK/ADDITIONAL PAID-IN CAPITAL (Unaudited)
Balance at beginning of period $ 2,787 $ 2,364
Issuance of shares under incentive and stock purchase plans 8 44
Tax benefit on employee stock options and awards 1 10
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Balance at end of period 2,796 2,418
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RETAINED EARNINGS
Balance at beginning of period 6,890 6,152
Net income (loss) (1,395) 292
Dividends declared on common stock (69) (64)
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Balance at end of period 5,426 6,380
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TREASURY STOCK, AT COST
Balance at beginning of period (37) (37)
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Balance at end of period (37) (37)
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ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Balance at beginning of period 1,094 534
Change in unrealized gain (loss) on securities, net of tax 177 (235)
Change in net loss on cash flow hedging instruments, net of tax (23) (17)
Foreign currency translation adjustments 9 (4)
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Total other comprehensive income (loss) 163 (256)
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Balance at end of period 1,257 278
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TOTAL STOCKHOLDERS' EQUITY 9,442 9,039
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OUTSTANDING SHARES (IN THOUSANDS)
Balance at beginning of period 255,241 245,536
Issuance of shares under incentive and stock purchase plans 200 1,188
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Balance at end of period 255,441 246,724
===================================================================================================================================
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
FIRST QUARTER ENDED
MARCH 31,
-----------------------------------------
(IN MILLIONS) 2003 2002
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COMPREHENSIVE INCOME (LOSS) (Unaudited)
Net income (loss) $ (1,395) $ 292
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OTHER COMPREHENSIVE INCOME (LOSS)
Change in unrealized gain (loss) on securities, net of tax 177 (235)
Change in net loss on cash-flow hedging instruments, net of tax (23) (17)
Foreign currency translation adjustments 9 (4)
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Total other comprehensive income (loss) 163 (256)
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TOTAL COMPREHENSIVE INCOME (LOSS) $ (1,232) $ 36
===================================================================================================================================
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
- 6 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FIRST QUARTER ENDED
MARCH 31,
----------------------------------
(IN MILLIONS) 2003 2002
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(Unaudited)
OPERATING ACTIVITIES
Net income (loss) $ (1,395) $ 292
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Amortization of deferred policy acquisition costs 564 555
Additions to deferred policy acquisition costs (807) (716)
Change in:
Liabilities for future policy benefits and unpaid claims and claim adjustment expenses
and unearned premiums 4,576 440
Reinsurance recoverables (1,459) 45
Receivables (95) (174)
Payables and accruals (34) (165)
Accrued and deferred income taxes (839) 96
Net realized capital (gains) losses 53 7
Depreciation and amortization 72 13
Other, net 31 (6)
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NET CASH PROVIDED BY OPERATING ACTIVITIES 667 387
================================================================================================================================
INVESTING ACTIVITIES
Purchase of investments (5,859) (3,760)
Sale of investments 3,364 2,604
Maturity of investments 931 412
Additions to property, plant and equipment (43) (31)
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NET CASH USED FOR INVESTING ACTIVITIES (1,607) (775)
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FINANCING ACTIVITIES
Short-term debt, net -- 16
Net proceeds from investment and universal life-type contracts charged against
policyholder accounts 1,279 389
Dividends paid (69) (64)
Proceeds from issuance of shares under incentive and stock purchase plans 6 45
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NET CASH PROVIDED BY FINANCING ACTIVITIES 1,216 386
================================================================================================================================
Foreign exchange rate effect on cash and cash equivalents 2 --
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Net increase (decrease) in cash and cash equivalents 278 (2)
Cash and cash equivalents - beginning of period 377 353
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CASH AND CASH EQUIVALENTS - END OF PERIOD $ 655 $ 351
================================================================================================================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
------------------------------------------------
NET CASH PAID (RECEIVED) DURING THE PERIOD FOR:
Income taxes $ (45) $ --
Interest $ 48 $ 29
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
- 7 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in millions except per share data
unless otherwise stated)
(unaudited)
NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES
(A) BASIS OF PRESENTATION
The Hartford Financial Services Group, Inc. and its consolidated subsidiaries
("The Hartford" or the "Company") provide investment products and life and
property and casualty insurance to both individual and business customers in the
United States and internationally.
The condensed consolidated financial statements have been prepared on the basis
of accounting principles generally accepted in the United States of America,
which differ materially from the accounting prescribed by various insurance
regulatory authorities. Less than majority-owned subsidiaries in which The
Hartford has at least a 20% interest are reported on the equity basis. All
intercompany transactions and balances between The Hartford, its subsidiaries
and affiliates have been eliminated.
The accompanying condensed consolidated financial statements and the condensed
notes as of March 31, 2003, and for the first quarters ended March 31, 2003 and
2002 are unaudited. These financial statements reflect all adjustments
(consisting only of normal accruals) which are, in the opinion of management,
necessary for the fair presentation of the financial position, results of
operations, and cash flows for the interim periods. These financial statements
and condensed notes should be read in conjunction with the consolidated
financial statements and notes thereto included in The Hartford's 2002 Form 10-K
Annual Report. The results of operations for the interim periods should not be
considered indicative of results to be expected for the full year.
(B) RECLASSIFICATIONS
Certain reclassifications have been made to prior year financial information to
conform to the current year classifications.
(C) USE OF ESTIMATES
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States of America, requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
The most significant estimates include those used in determining reserves;
deferred policy acquisition costs; valuation of investments and derivative
instruments; pension and other postretirement benefits; and contingencies.
(D) SIGNIFICANT ACCOUNTING POLICIES
For a description of accounting policies, see Note 1 of Notes to Consolidated
Financial Statements included in The Hartford's 2002 Form 10-K Annual Report.
(E) ADOPTION OF NEW ACCOUNTING STANDARDS
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46")
which requires an enterprise to assess if consolidation of an entity is
appropriate based upon its variable economic interests in a variable interest
entity ("VIE"). The initial determination of whether an entity is a VIE shall be
made on the date at which an enterprise becomes involved with the entity. A VIE
is an entity in which the equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. An enterprise shall consolidate a VIE if it has a
variable interest that will absorb a majority of the VIEs expected losses if
they occur, receive a majority of the entity's expected residual returns if they
occur or both. FIN 46 is effective for new VIEs established or purchased
subsequent to January 31, 2003. For VIEs entered into prior to February 1, 2003,
FIN 46 is effective for interim periods beginning after June 15, 2003. During
the quarter ended March 31, 2003, the Company did not enter into or establish
any VIEs that would require consolidation under FIN 46.
The Hartford invests in a variety of investment structures that require analysis
under FIN 46, including asset-backed securities, partnerships and certain trust
securities and is currently assessing the impact of adopting FIN 46. Based upon
a preliminary review, the adoption of FIN 46 is not expected to have a material
impact on the Company's financial condition or results of operations as there
were no material VIEs identified which would require consolidation. FIN 46
further requires the disclosure of certain information related to VIEs in which
the Company holds a significant variable interest. The Company does not believe
that it owns any such interests that require disclosure at this time.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45" or "the Interpretation"). FIN 45 requires
certain guarantees to be recorded at fair value and also requires a guarantor to
make new disclosures, even when the likelihood of making payments under the
guarantee is remote. In general, the Interpretation applies to contracts or
indemnification agreements that contingently require the guarantor to make
payments to the guaranteed party based on changes in an underlying that is
related to an asset, liability or an equity security of the guaranteed party.
The recognition provisions of FIN 45 are effective on a prospective basis for
guarantees issued or modified after December 31, 2002. The disclosure
requirements are effective for financial statements of interim and annual
periods ending after December 15, 2002. (For further discussion, see Note 1(h),
"Other Investment and Risk Management Activities-Specific Strategies", of Notes
to Consolidated Financial Statements included in The Hartford's 2002 Form 10-K
Annual Report.) Adoption of this statement did not have a material impact on the
Company's consolidated financial condition or results of operations.
- 8 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)
(E) ADOPTION OF NEW ACCOUNTING STANDARDS (CONTINUED)
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities", which addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)" ("Issue 94-3"). The
principal difference between SFAS No. 146 and Issue 94-3 is that SFAS No. 146
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred, rather than at the date
of an entity's commitment to an exit plan. SFAS No. 146 is effective for exit or
disposal activities after December 31, 2002. Adoption of SFAS No. 146 will
result in a change in the timing of when a liability is recognized if the
Company has restructuring activities after December 31, 2002. Adoption of this
statement did not have a material impact on the Company's consolidated financial
condition or results of operations.
(F) FUTURE ADOPTION OF NEW ACCOUNTING STANDARDS
In April 2003, the FASB issued guidance in Statement 133 Implementation Issue
No. B36, "Embedded Derivatives: Bifurcation of a Debt Instrument That
Incorporates Both Interest Rate Risk and Credit Risk Exposures That Are
Unrelated or Only Partially Related to the Creditworthiness of the Issuer of
That Instrument", ("DIG B36") that addresses the instances in which bifurcation
of an instrument into a debt host contract and an embedded credit derivative is
required. Specifically, one of the examples is related to the bifurcation of an
embedded derivative within a reinsurer's receivable and ceding company's payable
which arises from a modified coinsurance arrangement. DIG B36 indicates that
bifurcation is necessary in a modified coinsurance arrangement because the yield
on the receivable and payable is based on a specified proportion of the ceding
company's return on either its general account assets or a specified block of
those assets, rather than the overall creditworthiness of the ceding company.
The Company believes that the majority of its modified coinsurance and funds
withheld agreements are out of the scope of DIG B36. While the Company believes
there will be no material effect on its results of operations or financial
condition due to the implementation of this guidance, it is currently evaluating
those potential impacts. The guidance is effective for quarterly periods
beginning after September 15, 2003.
DIG B36 is also applicable to corporate issued debt securities that incorporate
credit risk exposures that are unrelated or only partially related to the
creditworthiness of the obligor. The Company is currently evaluating the impact
of DIG B36 on such corporate issued debt securities. The Company does not
believe the adoption of DIG B36 will have a material effect on the Company's
consolidated financial condition or results of operations.
(G) EXPENSING STOCK OPTIONS
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an Amendment to FASB No. 123", which
provides three optional transition methods for entities that decide to
voluntarily adopt the fair value recognition principles of SFAS No. 123,
"Accounting for Stock Issued to Employees", and modifies the disclosure
requirements of SFAS No. 123. In January 2003, the Company adopted the fair
value recognition provisions of accounting for employee stock compensation and
used the prospective transition method. Under the prospective method,
stock-based compensation expense is recognized for awards granted or modified
after the beginning of the fiscal year in which the change is made. The Company
will expense all stock-based compensation awards granted after January 1, 2003.
The fair value of stock-based awards granted during the quarter ended March 31,
2003 was $29, after-tax. The fair value of these awards will be recognized over
the awards' vesting period, generally 3 years. The expense associated with these
awards for the first quarter ending March 31, 2003, was $1, after-tax.
All stock-based awards granted or modified prior to January 1, 2003, will
continue to be valued using the intrinsic value-based provisions set forth in
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock-Issued
to Employees". Under the intrinsic value method, compensation expense is
determined on the measurement date, which is the first date on which both the
number of shares the employee is entitled to receive and the exercise price are
known. Compensation expense, if any, is measured based on the award's intrinsic
value, which is the excess of the market price of the stock over the exercise
price on the measurement date. For the first quarters ended March 31, 2003 and
2002, after-tax compensation expense related to the Company's stock-based
compensation plans, including the expense associated with the transition to SFAS
No. 123 and non-option plans, was $1. The expense, including non-option plans,
related to stock-based employee compensation included in the determination of
net income for the first quarter ended March 31, 2003 is less than that which
would have been recognized if the fair value method had been applied to all
awards since the effective date of SFAS No. 123. (For further discussion of the
Company's stock compensation plans, see Note 11 of Notes to Consolidated
Financial Statements included in The Hartford's 2002 Form 10-K Annual Report.)
The following table illustrates the effect on net income (loss) and earnings
(loss) per share as if the fair value method had been applied to all outstanding
and unvested awards in each period.
- 9 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
(G) EXPENSING STOCK OPTIONS (CONTINUED)
FIRST QUARTER ENDED
MARCH 31,
------------------------
2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Net income (loss), as reported $ (1,395) $ 292
Add: Stock-based employee compensation expense included in reported net
income (loss) , net of related tax effects [1] 1 1
Deduct: Total stock-based employee compensation expense determined under
the fair value method for all awards, net of related tax effects (9) (9)
- ------------------------------------------------------------------------------------------------------------------------------------
Pro forma net income (loss) [2] $ (1,403) $ 284
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) per share:
Basic - as reported $ (5.46) $ 1.19
Basic - pro forma [2] $ (5.49) $ 1.15
Diluted - as reported [3] $ (5.46) $ 1.17
Diluted - pro forma [2] [3] $ (5.49) $ 1.14
====================================================================================================================================
[1] Excludes the impact of non-option plans of $1 for the first quarters ended
March 31, 2003 and 2002.
[2] The pro forma disclosures are not representative of the effects on net
income (loss) and earnings (loss) per share in future periods.
[3] As a result of the net loss in the quarter ended March 31, 2003, SFAS No.
128 requires the Company to use basic weighted average shares outstanding
in the calculation of first quarter 2003 diluted earnings per share, as
the inclusion of options of 0.7 would have been antidilutive to the
earnings per share calculation. In the absence of the net loss, weighted
average common shares outstanding and dilutive potential common shares
would have totaled 256.1.
NOTE 2. GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets", and accordingly ceased all amortization of goodwill.
The 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 MARCH 31, 2003
-----------------------------
GROSS ACCUMULATED
CARRYING NET
AMORTIZED INTANGIBLE ASSETS AMOUNT AMORTIZATION
- ------------------------------------------------------------------
Present value of future profits $ 1,406 $ 298
Renewal rights 46 29
Other 9 --
- ------------------------------------------------------------------
Total $ 1,461 $ 327
==================================================================
Net amortization expense for the quarter ended March 31, 2003 was $25.
Estimated future net amortization expense for the succeeding five years is as
follows:
FOR THE YEAR ENDED DECEMBER 31,
- ------------------------------------------------------------------
2003 $ 123
2004 $ 117
2005 $ 106
2006 $ 95
2007 $ 80
==================================================================
The carrying amount of goodwill as of March 31, 2003 and December 31, 2002,
respectively, is shown below.
MARCH 31, DECEMBER 31,
2003 2002
- ------------------------------------------------------------------
Life $ 796 $ 796
Property & Casualty 153 153
Corporate 772 772
- ------------------------------------------------------------------
Total $ 1,721 $ 1,721
==================================================================
NOTE 3. DERIVATIVES AND HEDGING ACTIVITIES
The Company utilizes a variety of derivative instruments, including swaps, caps,
floors, forwards and exchange traded futures and options, through one of four
Company-approved objectives: to hedge risk arising from interest rate, price or
currency exchange rate volatility; to manage liquidity; to control transaction
costs; or to enter into income enhancement and replication transactions.
All of the Company's derivative transactions are permitted uses of derivatives
under the derivatives use plan filed and/or approved, as applicable, by the
State of Connecticut and State of New York insurance departments. The Company
does not make a market or trade in these instruments for the express purpose of
earning short-term trading profits.
For a detailed discussion of the Company's use of derivative instruments, see
Note 1(h) of Notes to Consolidated Financial Statements included in The
Hartford's 2002 Form 10-K Annual Report.
As of March 31, 2003 and December 31, 2002, the Company carried $297 and $299,
respectively, of derivative assets in other investments and $204 and $208,
respectively, of derivative liabilities in other liabilities. In addition, the
Company recognized embedded derivative liabilities related to guaranteed minimum
withdrawal benefits ("GMWB") on certain of its variable annuity
- 10 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
NOTE 3. DERIVATIVES AND HEDGING ACTIVITIES (CONTINUED)
contracts of $95 and $48 at March 31, 2003 and December 31, 2002, respectively,
in other policyholder funds. Offsetting reinsurance arrangements recognized as
derivative assets at March 31, 2003 and December 31, 2002 were $95 and $48,
respectively, and were included in reinsurance recoverables.
Cash-Flow Hedges
For the quarters ended March 31, 2003 and 2002, the Company's gross gains and
losses representing the total ineffectiveness of all cash-flow hedges were
immaterial, with the net impact reported as net realized capital gains and
losses.
Gains and losses on derivative contracts that are reclassified from accumulated
other comprehensive income ("AOCI") to current period earnings are included in
the line item in the statement of income in which the hedged item is recorded.
As of March 31, 2003 and 2002, the after-tax deferred net gains on derivative
instruments accumulated in AOCI that are expected to be reclassified to earnings
during the next twelve months are $12 and $3, respectively. This expectation is
based on the anticipated interest payments on hedged investments in fixed
maturity securities that will occur over the next twelve months, at which time
the Company will recognize the deferred net gains and losses as an adjustment to
interest income over the term of the investment cash flows. The maximum term
over which the Company is hedging its exposure to the variability of future cash
flows (for all forecasted transactions, excluding interest payments on
variable-rate debt) is twelve months. As of March 31, 2003 and December 31,
2002, the Company held derivative notional value related to strategies
categorized as cash-flow hedges of $3.1 billion and $3.2 billion, respectively.
For the quarters ended March 31, 2003 and 2002, the net reclassifications from
AOCI to earnings resulting from the discontinuance of cash-flow hedges were
immaterial.
Fair-Value Hedges
For the quarters ended March 31, 2003 and 2002, the Company's gross gains and
losses representing the total ineffectiveness of all fair-value hedges were
immaterial, with the net impact reported as net realized capital gains and
losses. All components of each derivative's gain or loss are included in the
assessment of hedge effectiveness. As of March 31, 2003 and December 31, 2002,
the Company held $786 and $800, respectively, in derivative notional value
related to strategies categorized as fair-value hedges.
Other Investment and Risk Management Activities
The Company's other investment and risk management activities primarily relate
to strategies used to reduce economic risk or enhance income, and do not receive
hedge accounting treatment. Swap agreements, interest rate cap and floor
agreements and option contracts are used to reduce economic risk. Income
enhancement and replication transactions include the use of written covered call
options, which offset embedded equity call options, total return swaps and
synthetic replication of cash market instruments. The change in the value of all
derivatives held for other investment and risk management purposes is reported
in current period earnings as net realized capital gains and losses. As of March
31, 2003 and December 31, 2002, the Company held $7.1 billion and $6.8 billion,
respectively, in derivative notional value related to strategies categorized as
Other Investment and Risk Management Activities. In addition, Hartford Life,
Inc. ("HLI") issues certain variable annuity products that contain a GMWB. The
GMWB gives the policyholder the right to make periodic surrenders that total an
amount equal to the policyholders' premium payments. This guarantee will remain
in effect if periodic surrenders do not exceed an amount equal to 7% of premium
payments each contract year. If the policyholder chooses to surrender an amount
equal to more than 7% in a contract year, then the guarantee may be reduced to
an amount less than premium payments. The GMWB represents an embedded derivative
liability in the variable annuity contract. It is carried at fair value and
reported in other policyholder funds. The fair value of the GMWB obligations are
calculated based on actuarial assumptions related to the projected benefits and
related contract charges over the lives of the contracts. Because of the dynamic
and complex nature of these cash flows, stochastic techniques under a variety of
market return scenarios and other best estimate actuarial assumptions are used.
This model involves numerous estimates and subjective judgments including those
regarding expected market rates of return and volatility.
The Company has entered into a reinsurance arrangement to offset its exposure to
the GMWB. This arrangement is recognized as a derivative asset and carried at
fair value in reinsurance recoverables. Changes in the fair value of both the
derivative assets and liabilities related to the GMWB are recorded in net
realized capital gains and losses. For further discussion of the Company's other
investment and risk management activities, see "Other Investments and Risk
Management Activities" in Note 1(h) of Notes of Consolidated Financial
Statements included in The Hartford's 2002 Form 10-K Annual Report.
- 11 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
NOTE 4. EARNINGS (LOSS) PER SHARE
The following tables present a reconciliation of net income (loss) and shares
used in calculating basic earnings (loss) per share to those used in calculating
diluted earnings (loss) per share.
MARCH 31, 2003 INCOME/(LOSS) SHARES PER SHARE AMOUNT
- ------------------------------------------------------------------------------------------------------------------------------------
BASIC LOSS PER SHARE
Net loss available to common shareholders $ (1,395) 255.4 $ (5.46)
-------------------
DILUTED LOSS PER SHARE [1]
Options -- --
-----------------------------
Net loss available to common shareholders plus assumed conversions $ (1,395) 255.4 $ (5.46)
====================================================================================================================================
[1] As a result of the net loss in the quarter ended March 31, 2003, SFAS No.
128 requires the Company to use basic weighted average shares outstanding
in the calculation of first quarter 2003 diluted earnings per share, as the
inclusion of options of 0.7 would have been antidilutive to the earnings
per share calculation. In the absence of the net loss, weighted average
common shares outstanding and dilutive potential common shares would have
totaled 256.1.
MARCH 31, 2002
- ------------------------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE
Net income available to common shareholders $ 292 246.1 $ 1.19
-------------------
DILUTED EARNINGS PER SHARE
Options -- 3.6
-----------------------------
Net income available to common shareholders plus assumed conversions $ 292 249.7 $ 1.17
====================================================================================================================================
Basic earnings (loss) per share reflects the actual weighted average number of
shares outstanding during the period. Diluted earnings (loss) per share includes
the dilutive effect of outstanding options, using the treasury stock method.
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.
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 and as an insurer defending coverage claims brought against it.
The Hartford accounts for such activity through the establishment of unpaid
claim and claim adjustment expense reserves. Subject to the discussion of the
litigation below involving Mac Arthur Company and its subsidiary, Western
MacArthur Company, both former regional distributors of asbestos products
(collectively or individually, "MacArthur"), 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 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.
The MacArthur Litigation - Hartford Accident and Indemnity Company ("Hartford
A&I"), a subsidiary of the Company, issued primary general liability policies to
MacArthur during the period 1967 to 1976. MacArthur sought coverage for
asbestos-related claims from Hartford A&I under these policies beginning in
1978. During the period between 1978 and 1987, Hartford A&I paid 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 October 3, 2000, thirteen years after it had accepted Hartford A&I's notice
of exhaustion, MacArthur filed an action against Hartford A&I and another
insurer in the U.S. District Court for the Eastern District of New York,
seeking, for the first time, additional coverage for asbestos bodily injury
claims under the Hartford A&I primary policies on the theory that Hartford A&I
had exhausted only its products aggregate limit of liability, not separate
limits MacArthur alleges to be available for non-products liability. The
complaint sought a declaration of coverage and unquantified damages. On March
28, 2003, the District Court dismissed this action without prejudice on
MacArthur's motion.
- 12 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
NOTE 5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
(A) LITIGATION (CONTINUED)
On June 3, 2002, The St. Paul Companies, Inc. ("St. Paul") announced a
settlement of a coverage action brought by MacArthur against United States
Fidelity and Guaranty Company ("USF&G"), a subsidiary of St. Paul. Under the
settlement, St. Paul agreed to pay a total of $975 to resolve its asbestos
liability to MacArthur in conjunction with a proposed bankruptcy petition and
pre-packaged plan of reorganization to be filed by MacArthur. USF&G provided at
least twelve 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.
On October 7, 2002, MacArthur filed an action in the Superior Court in Alameda
County, California, against Hartford A&I and two other insurers. As in the
now-dismissed New York action, 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.
In its October 7, 2002 complaint, MacArthur alleges that it has approximately
$1.8 billion of unpaid asbestos liability judgments against it to date. The
ultimate amount of MacArthur's alleged non-products asbestos liability,
including any unresolved current claims and future demands, is currently
unknown.
On November 22, 2002, MacArthur filed a bankruptcy petition and proposed plan of
reorganization, which seeks to implement the terms of its settlement with St.
Paul. MacArthur's bankruptcy filings indicate that it will seek to have the full
amount of its current and future asbestos liability estimated in an amount
substantially more than the amount of the alleged unpaid judgments in
conjunction with plan confirmation. If such an estimation is made, MacArthur
intends to ask the Alameda County court to enter judgment against the insurers
for the amount of its total liability, including unliquidated claims and future
demands, less the estimated amount ultimately paid by St. Paul. Hartford A&I has
filed an adversary complaint in the MacArthur bankruptcy seeking a declaratory
judgment that any estimation made in the bankruptcy proceedings is not an
adjudication of MacArthur's asbestos liability for purposes of insurance
coverage.
Hartford A&I intends to defend the MacArthur action vigorously. In the opinion
of management, the ultimate outcome is highly uncertain for many reasons. It is
not yet known, for example, 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.
Bancorp Services, LLC - 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, LLC ("ICMG"). The judge
dismissed the patent infringement claim on summary judgment. The jury's award
was based on the last two claims. On August 28, 2002, the Court entered an order
awarding Bancorp prejudgment interest on the breach of contract claim in the
amount of $16.
HLIC and ICMG have appealed the judgment on the trade secret and breach of
contract claims. Bancorp has cross-appealed the pretrial dismissal of its patent
infringement claim. The Company's management, based on the advice of its legal
counsel, believes that there is a substantial likelihood that the judgment will
not survive at its current amount. Based on the advice of legal counsel
regarding the potential outcomes of this litigation, the Company recorded an $11
after-tax charge for this matter in the first quarter of 2002 to increase
litigation reserves. Should HLIC and ICMG not succeed in eliminating or reducing
the judgment, a significant additional expense would be recorded in the future.
Reinsurance Arbitration - On March 16, 2003, a final decision and award was
issued in the previously disclosed arbitration between subsidiaries of The
Hartford and one of their primary reinsurers relating to policies with
guaranteed death benefits written from 1994 to 1999. The arbitration involved
alleged breaches under the reinsurance treaties. Under the terms of the final
decision and award, the reinsurer's reinsurance obligations to The Hartford's
subsidiaries were unchanged and not limited or reduced in any manner. The award
was confirmed by the Connecticut Superior Court on May 5, 2003.
(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 bodily
injuries asserted by those who came in contact with asbestos or products
containing asbestos. Environmental claims relate primarily to pollution and the
related clean-up costs.
The Hartford wrote several different categories of insurance coverage to which
asbestos and environmental claims may apply. First, The Hartford wrote direct
policies as a primary liability insurance carrier. Second, The Hartford wrote
direct excess insurance policies providing additional coverage for insureds that
exhausted their underlying liability insurance coverage. Third, The Hartford
acted as a reinsurer assuming a portion of risks previously assumed by other
insurers writing primary, excess and reinsurance coverages. Fourth, The Hartford
participated as a London Market company that wrote both direct insurance and
assumed reinsurance business.
With regard to both environmental and particularly asbestos claims, significant
uncertainty limits the ability of insurers and reinsurers to estimate the
ultimate reserves necessary for unpaid losses and related settlement expenses.
Traditional reserving techniques cannot reasonably estimate the ultimate cost of
these
- 13 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
NOTE 5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
(B) ASBESTOS AND ENVIRONMENTAL CLAIMS (CONTINUED)
claims, particularly during periods where theories of law are in flux. As a
result of the factors discussed in the following paragraphs, the degree of
variability of reserve estimates for these exposures is significantly greater
than for other, more traditional exposures. In particular, The Hartford believes
there is a high degree of uncertainty inherent in the estimation of asbestos
loss reserves.
In the case of the reserves for asbestos exposures, factors contributing to the
high degree of uncertainty include inadequate development patterns, plaintiffs'
expanding theories of liability, the risks inherent in major litigation and
inconsistent emerging legal doctrines. Courts have reached inconsistent
conclusions as to when losses are deemed to have occurred and which policies
provide coverage; what types of losses are covered; whether there is an insurer
obligation to defend; how policy limits are applied; whether particular claims
are product/completed operation claims subject to an aggregate limit; and how
policy exclusions and conditions are applied and interpreted. Furthermore,
insurers in general, including The Hartford, have recently experienced an
increase in the number of asbestos-related claims due to, among other things,
more intensive advertising by lawyers seeking asbestos claimants, plaintiffs'
increased focus on new and previously peripheral defendants, and an increase in
the number of insureds seeking bankruptcy protection as a result of
asbestos-related liabilities. Plaintiffs and insureds have sought to use
bankruptcy proceedings, including "pre-packaged" bankruptcies, to accelerate and
increase loss payments by insurers. In addition, some policyholders have begun
to assert new classes of claims for so-called "non-product" coverages to which
an aggregate limit of liability may not apply. Recently, many insurers,
including the Hartford, also have been sued directly by asbestos claimants
asserting that insurers had a duty to protect the public from the dangers of
asbestos. Management believes these issues are not likely to be resolved in the
near future.
In the case of the reserves for environmental exposures, factors contributing to
the high degree of uncertainty include court decisions that have interpreted the
insurance coverage to be broader than originally intended; inconsistent
decisions, especially across jurisdictions; and uncertainty as to the monetary
amount being sought by the claimant from the insured.
Further uncertainties include the effect of the recent acceleration in the rate
of bankruptcy filings by asbestos defendants on the rate and amount of The
Hartford's asbestos claims payments; a further increase or decrease in asbestos
and environmental claims which cannot now be anticipated; whether some
policyholders' liabilities will reach the umbrella or excess layer of their
coverage; the resolution or adjudication of some disputes pertaining to the
amount of available coverage for asbestos claims in a manner inconsistent with
The Hartford's previous assessment of these claims; the number and outcome of
direct actions against The Hartford; and unanticipated developments pertaining
to The Hartford's ability to recover reinsurance for asbestos and environmental
claims. It is also not possible to predict changes in the legal and legislative
environment and their impact on the future development of asbestos and
environmental claims. In particular, recently there has been a variety of
potential federal legislative changes concerning asbestos litigation under
discussion among business, labor, plaintiffs' lawyer groups, and Congressional
leaders. Whether any such legislation will be enacted and, if so, what its
effect will be on The Hartford's aggregate asbestos liabilities is unknown.
Additionally, the reporting pattern for excess insurance and reinsurance claims
is much longer than direct claims. In many instances, it takes months or years
to determine that the policyholder's own obligations have been met and how the
reinsurance in question may apply to such claims. The delay in reporting excess
and reinsurance claims and exposures adds to the uncertainty of estimating the
related reserves.
Given the factors and emerging trends described above, The Hartford believes the
actuarial tools and other techniques it employs to estimate the ultimate cost of
claims for more traditional kinds of insurance exposure are less precise in
estimating reserves for its asbestos and environmental exposures. The Hartford
regularly evaluates new information in assessing its potential asbestos
exposures.
In the first quarter of 2003, The Hartford conducted a detailed study of its
asbestos exposures. Based on the results of the study, the Company strengthened
its gross and net asbestos reserves by $3.9 billion and $2.6 billion,
respectively. The Company believes that its current asbestos reserves are
reasonable and appropriate. However, analyses of future developments could cause
The Hartford to change its estimates of its asbestos and environmental reserves
and the effect of these changes could be material to the Company's consolidated
operating results, financial condition and liquidity.
As of March 31, 2003 and December 31, 2002, the Company reported $3.7 billion
and $1.1 billion of net asbestos and $559 and $591 of net environmental
reserves, respectively. Because of the significant uncertainties previously
described, principally those related to asbestos, the ultimate liabilities may
exceed the currently recorded reserves. Any such additional liability (or any
range of additional amounts) cannot be reasonably estimated now but could be
material to The Hartford's future consolidated operating results, financial
condition and liquidity. Consistent with the Company's longstanding reserving
practices, The Hartford will continue to regularly review and monitor these
reserves and, where future circumstances indicate, make appropriate adjustments
to the reserves.
(C) TAX MATTERS
The Hartford's federal income tax returns are routinely audited by the Internal
Revenue Service ("IRS"). The Company is currently under audit for the 1998-2001
tax years. No material issues have been raised to date by the IRS. Management
believes that adequate provision has been made in the financial statements for
any potential assessments that may result from tax examinations and other tax
related matters.
- 14 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
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 HLI that the Company did not already own, as well
as capital that has not been contributed to the Company's insurance subsidiaries
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, interest sensitive whole life and term life insurance. Group Benefits
sells group insurance products, including group life and group disability
insurance as well as other products, including stop loss and supplementary
medical 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 Japan and Latin America; realized
capital gains and losses; as well as corporate items not directly allocated to
any of its reportable operating segments, principally interest expense; and
intersegment eliminations.
Property & Casualty is organized into five reportable operating segments: the
North American underwriting segments of Business Insurance, Personal Lines,
Specialty Commercial and Reinsurance; and the Other Operations segment, which
includes substantially all of the Company's asbestos and environmental
exposures. "North American" includes the combined underwriting results of the
Business Insurance, Personal Lines, Specialty Commercial and Reinsurance
underwriting segments along with income and expense items not directly allocated
to these segments, such as net investment income, net realized capital gains and
losses, other expenses including interest and income taxes.
Business Insurance provides standard commercial insurance coverage to small
commercial and middle market commercial business primarily throughout the United
States. This segment offers workers' compensation, property, automobile,
liability, umbrella and marine coverages. Commercial risk management products
and services are also provided.
Personal Lines provides automobile, homeowners' and home-based business
coverages to the members of AARP through a direct marketing operation; to
individuals who prefer local agent involvement through a network of independent
agents in the standard personal lines market; and through the Omni Insurance
Group in the non-standard automobile market. Personal Lines also operates a
member contact center for health insurance products offered through AARP's
Health Care Options.
The Specialty Commercial segment offers a variety of customized insurance
products and risk management services. Specialty Commercial provides standard
commercial insurance products including workers' compensation, automobile and
liability coverages to large-sized companies. Specialty Commercial also provides
bond, professional liability, specialty casualty and agricultural coverages, as
well as core property and excess and surplus lines coverages not normally
written by standard lines insurers. Alternative markets, within Specialty
Commercial, provides insurance products and services primarily to captive
insurance companies, pools and self-insurance groups. In addition, Specialty
Commercial provides third party administrator services for claims
administration, integrated benefits, loss control and performance measurement
through Specialty Risk Services, a subsidiary of the Company.
The Reinsurance segment assumes reinsurance in North America and primarily
writes treaty reinsurance through professional reinsurance brokers covering
various property, casualty, property catastrophe, marine and alternative risk
transfer ("ART") products. ART includes non-traditional reinsurance products
such as multi-year property catastrophe treaties, aggregate of excess of loss
agreements and quota share treaties with single event caps. International
property catastrophe, marine and ART are also written outside of North America
through a London contact office. On May 12, 2003, the Company announced plans to
exit the assumed reinsurance 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 measure of profit or loss used by The Hartford's management in evaluating
the performance of its Life segments is net income. However, the North American
underwriting segments 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.
Certain transactions between segments occur during the year that primarily
relate to tax settlements, insurance coverage, expense reimbursements, services
provided, security transfers and capital contributions. In addition, certain
reinsurance stop loss agreements exist between the segments which specify that
one segment will reimburse another for losses incurred in excess of a
predetermined limit. Also, one segment may purchase group annuity contracts from
another to fund pension costs and claim annuities to settle casualty claims. In
addition, certain intersegment transactions occur in Life. These transactions
include interest income on allocated surplus and the allocation of certain net
realized capital gains and losses through net investment income utilizing the
duration of the segment's investment portfolios. During the first quarter of
2003, $750 of securities were sold by the Property & Casualty operation to the
- 15 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
NOTE 6. SEGMENT INFORMATION (CONTINUED)
Life operation. An additional $1.0 billion of securities were sold in April
2003. For segment reporting, the net gain on this sale was deferred by the
Property & Casualty operation and will be reported as realized when the
underlying securities are sold by the Life operation. On December 1, 2002, The
Hartford entered into a contract with a subsidiary, Fencourt Reinsurance
Company, Ltd. ("Fencourt"), whereby Fencourt will provide reinsurance for the
Property & Casualty operations. The financial results of this reinsurance
program, net of retrocessions to unrelated reinsurers, will be included in the
Specialty Commercial segment.
The following tables present revenues and net income (loss). Underwriting
results are presented for the Business Insurance, Personal Lines, Specialty
Commercial and Reinsurance segments, while net income is presented for all other
segments, along with Life and Property & Casualty, including North American.
REVENUES
FIRST QUARTER ENDED
MARCH 31,
-----------------------------
2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Life
Investment Products $ 773 $ 810
Individual Life 244 232
Group Benefits 667 644
COLI 127 160
Other [1] (25) (10)
- ------------------------------------------------------------------------------------------------------------------------------------
Total Life 1,786 1,836
- ------------------------------------------------------------------------------------------------------------------------------------
Property & Casualty
North American
Earned premiums and other revenue
Business Insurance 880 732
Personal Lines 800 747
Specialty Commercial 422 290
Reinsurance 151 171
- ------------------------------------------------------------------------------------------------------------------------------------
Total North American earned premiums and other revenue 2,253 1,940
Net investment income 243 217
Net realized capital gains (losses) (15) 7
- ------------------------------------------------------------------------------------------------------------------------------------
Total North American 2,481 2,164
Other Operations 60 56
- ------------------------------------------------------------------------------------------------------------------------------------
Total Property & Casualty 2,541 2,220
- ------------------------------------------------------------------------------------------------------------------------------------
Corporate 4 4
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES $ 4,331 $ 4,060
====================================================================================================================================
[1] Amounts include net realized capital losses of $(48), and $(15) for the
first quarter ended March 31, 2003 and 2002, respectively.
- 16 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
NOTE 6. SEGMENT INFORMATION (CONTINUED)
NET INCOME (LOSS) FIRST QUARTER ENDED
MARCH 31,
------------------------------
2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Life
Investment Products $ 98 $ 117
Individual Life 32 31
Group Benefits 34 28
COLI 10 --
Other (48) (6)
- ------------------------------------------------------------------------------------------------------------------------------------
Total Life 126 170
- ------------------------------------------------------------------------------------------------------------------------------------
Property & Casualty
North American
Underwriting results
Business Insurance (12) 4
Personal Lines 52 (11)
Specialty Commercial -- (10)
Reinsurance (19) (4)
- ------------------------------------------------------------------------------------------------------------------------------------
Total North American underwriting results 21 (21)
Net servicing and other income [1] 3 2
Net investment income 243 217
Other expenses (45) (51)
Net realized capital gains (losses) (15) 7
Income tax (expense) (39) (27)
- ------------------------------------------------------------------------------------------------------------------------------------
Total North American 168 127
Other Operations (1,681) 1
- ------------------------------------------------------------------------------------------------------------------------------------
Total Property & Casualty (1,513) 128
- ------------------------------------------------------------------------------------------------------------------------------------
Corporate (8) (6)
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ (1,395) $ 292
====================================================================================================================================
[1] Net of expenses related to service business.
NOTE 7. DEBT
(A) SHELF REGISTRATIONS
On March 19, 2003, The Hartford filed with the SEC a shelf registration
statement (Registration No. 333-103915) for the potential offering and sale of
debt and equity securities in an aggregate amount of up to $1.3 billion. On
April 10, 2003, The Hartford amended the registration statement (as amended, the
"Registration Statement"), to allow for the offering and sale of up to
approximately $2.6 billion in debt and equity securities. Specifically, the
Registration Statement allows for the following types of securities to be
offered: (i) debt securities, preferred stock, common stock, depositary shares,
warrants, stock purchase contracts, stock purchase units and junior subordinated
deferrable interest debentures of the Company, and (ii) preferred securities of
any of one or more capital trusts organized by The Hartford ("The Hartford
Trusts"). The Company may enter into guarantees with respect to the preferred
securities of any of The Hartford Trusts. The Registration Statement became
effective on April 10, 2003. As of that date, The Hartford had no remaining
availability under its previously filed shelf registration statement
(Registration No. 333-88762).
- 17 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
NOTE 7. DEBT (CONTINUED)
(B) SHORT-TERM DEBT
OUTSTANDING
-------------------------------
EFFECTIVE EXPIRATION MAXIMUM MARCH 31, DECEMBER 31,
DESCRIPTION DATE DATE AVAILABLE 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Commercial Paper
The Hartford 11/10/86 N/A $ 2,000 $ 315 $ 315
HLI 2/7/97 N/A 250 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total commercial paper $ 2,250 $ 315 $ 315
Revolving Credit Facility
5-year revolving credit facility 6/20/01 6/20/06 $ 1,000 $ -- $ --
3-year revolving credit facility 12/31/02 12/31/05 490 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total revolving credit facility $ 1,490 $ -- $ --
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM DEBT $ 3,740 $ 315 $ 315
====================================================================================================================================
On December 31, 2002, the Company and HLI entered into a joint three-year
Competitive Advance and Revolving Credit Facility with 12 participating banks to
enable the Company and HLI to borrow an aggregate amount of up to $490. As of
March 31, 2003 and December 31, 2002, there were no outstanding borrowings under
this facility.
On February 26, 2003, the Company entered into a Second Amended and Restated
Five-Year Competitive Advance and Revolving Credit Facility with 11
participating banks to amend and restate the Company's ability to borrow an
aggregate amount of up to $1,000. As of March 31, 2003 and December 31, 2002,
there were no outstanding borrowings under this facility.
(C) INTEREST EXPENSE
The following table presents interest expense incurred related to debt and trust
preferred securities for first quarter ended March 2003 and 2002, respectively.
FIRST QUARTER ENDED
MARCH 31,
----------------------------
2003 2002
- -----------------------------------------------------------------
Short-term debt $ 1 $ 1
Long-term debt (including current
maturities of long-term debt) 43 42
Company obligated mandatorily
redeemable preferred securities of
subsidiary trusts holding solely
junior subordinated debentures 22 23
- -----------------------------------------------------------------
TOTAL INTEREST EXPENSE $ 66 $ 66
=================================================================
- 18 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
NOTE 8. ACCUMULATED OTHER COMPREHENSIVE INCOME
Comprehensive income is defined as all changes in stockholders' equity, except
those arising from transactions with stockholders. Comprehensive income includes
net income (loss) and other comprehensive income (loss), which for the Company
consists of changes in unrealized appreciation or depreciation of investments
carried at market value, changes in gains or losses on cash-flow hedging
instruments, changes in foreign currency translation gains or losses and changes
in the Company's minimum pension liability.
The components of AOCI or loss were as follows:
UNREALIZED NET GAIN ON FOREIGN MINIMUM
GAIN (LOSS) CASH-FLOW CURRENCY PENSION
ON HEDGING CUMULATIVE LIABILITY ACCUMULATED OTHER
SECURITIES, INSTRUMENTS, TRANSLATION ADJUSTMENT, COMPREHENSIVE
FOR THE FIRST QUARTER ENDED MARCH 31, 2003 NET OF TAX NET OF TAX ADJUSTMENTS NET OF TAX INCOME (LOSS)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, BEGINNING OF PERIOD $1,444 $128 $(95) $(383) $1,094
Unrealized gain (loss) on securities [1] [2] 177 -- -- -- 177
Foreign currency translation adjustments -- -- 9 -- 9
Net loss on cash-flow hedging instruments [1] [3] -- (23) -- -- (23)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, END OF PERIOD $1,621 $105 $(86) $(383) $1,257
====================================================================================================================================
FOR THE FIRST QUARTER ENDED MARCH 31, 2002
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, BEGINNING OF PERIOD $606 $63 $(116) $(19) $534
Unrealized gain (loss) on securities [1] [2] (235) -- -- -- (235)
Foreign currency translation adjustments -- -- (4) -- (4)
Net loss on cash-flow hedging instruments [1] [3] -- (17) -- -- (17)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, END OF PERIOD $371 $46 $(120) $(19) $278
====================================================================================================================================
[1] Unrealized gain (loss) on securities is net of tax and other items of $131
and $(127) for the first quarter ended March 31, 2003 and 2002,
respectively. Net gain on cash-flow hedging instruments is net of tax
(benefit) of $(12) and $(9) for the first quarter ended March 31, 2003 and
2002, respectively.
[2] Net of reclassification adjustment for gains (losses) realized in net
income of $(31) and $0 for the first quarter ended March 31, 2003 and
2002, respectively.
[3] Net of amortization adjustment of $9 and $1 to net investment income for
the first quarter ended March 31, 2003 and 2002, respectively.
NOTE 9. SUBSEQUENT EVENTS
On May 12, 2003, the Company announced the results of the first quarter 2003
detailed study of asbestos exposures. Based on the results of the study, the
Company strengthened its net asbestos reserves by $2.6 billion in the first
quarter ended March 31, 2003. Accordingly, the Company plans to raise capital,
which may include concurrent offerings of equity and equity-linked securities
and debt securities.
In addition, the Company announced plans to exit the assumed reinsurance
business. The Company has also announced several expense reduction initiatives,
which are intended to result in lower operating costs. These expense initiatives
include centralizing redundant operations to leverage spending and lower costs,
eliminating non-essential functions and reducing overall consumption and costs
of spending for various administrative expenses including travel, conferences
and outside consultants. During 2003 and 2004, the Company expects these
initiatives to result in a reduction in the Company's workforce by approximately
4%. The Company expects to incur severance costs associated with these
reductions ranging from $25 to $35, after-tax, during the second quarter of
2003.
- 19 -
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 March 31, 2003, compared with December 31, 2002, and its
results of operations for the first quarter ended March 31, 2003, compared to
the equivalent 2002 period. This discussion should be read in conjunction with
the MD&A in The Hartford's 2002 Form 10-K Annual Report.
Certain of the statements contained herein are forward-looking statements. These
forward-looking statements are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995 and include estimates and
assumptions related to economic, competitive and legislative developments. These
forward-looking statements are subject to change and uncertainty which are, in
many instances, beyond the Company's control and have been made based upon
management's expectations and beliefs concerning future developments and their
potential effect upon the Company. There can be no assurance that future
developments will be in accordance with management's expectations or that the
effect of future developments on 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 Mac
Arthur 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 uncertain impact on the Company of
various tax reduction proposals being considered by Congress that relate to the
lowering of the capital gains rate and the application of that rate to dividend
distributions or the exclusion of some or all of such distributions from gross
income; the response of reinsurance companies under reinsurance contracts, the
impact of increasing reinsurance rates and the availability and adequacy of
reinsurance to protect the Company against losses; the 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.
- --------------------------------------------------------------------------------
INDEX
- --------------------------------------------------------------------------------
Recent Developments 20
Critical Accounting Estimates 21
Consolidated Results of Operations: Operating Summary 22
Life 25
Investment Products 26
Individual Life 27
Group Benefits 27
Corporate Owned Life Insurance ("COLI") 28
Property & Casualty 28
Business Insurance 30
Personal Lines 31
Specialty Commercial 32
Reinsurance 33
Other Operations (Including Asbestos and
Environmental Claims 33
Investments 37
Capital Markets Risk Management 40
Capital Resources and Liquidity 48
Accounting Standards 51
- --------------------------------------------------------------------------------
RECENT DEVELOPMENTS
- --------------------------------------------------------------------------------
On May 12, 2003, the Company announced the completion of its ground-up study of
asbestos-related exposures. Based on the results of the study, the Company
strengthened its gross and net asbestos reserves by $3.9 billion and $2.6
billion, respectively. The asbestos reserve strengthening resulted in a $1.7
billion after-tax charge to net income in the first quarter of 2003.
In connection with the announcement of the asbestos study, the Company announced
that it intends to issue $1.6 billion of equity and equity-linked securities and
$250 of debt securities to replace the surplus lost as a result of the asbestos
reserve strengthening. To enhance capital further, the Company intends to exit
certain higher-risk asset classes (equities and certain limited partnerships) in
its investment portfolio and to realize a small percentage of its unrealized
capital gains. The Company expects to complete the majority of the steps in its
capital plan, including raising the external capital, by the end of the second
quarter of 2003.
The Company also announced that it will exit the assumed property-casualty
reinsurance business. The Company is in negotiations with a third party for the
possible sale of most of the business. However, regardless of whether a
transaction is completed, the Company will cease writing new business in the
assumed property-casualty reinsurance market no later than June 30, 2003. The
Company also announced the initiation of a cost
- 20 -
reduction program. As a significant part of the program, 850 employees will lose
their jobs by the end of the second quarter of 2003 and 650 vacant positions
were eliminated. The job cuts will come primarily from the Company's
property-casualty businesses and, to a lesser extent, from the consolidation of
some corporate services. The Company expects to incur a related after-tax
severance charge of $25 to $35 in the second quarter of 2003.
- --------------------------------------------------------------------------------
CRITICAL ACCOUNTING ESTIMATES
- --------------------------------------------------------------------------------
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States of America, requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
The Company has identified the following estimates as critical in that they
involve a higher degree of judgment and are subject to a significant degree of
variability: reserves; valuation of investments and derivative instruments;
deferred policy acquisition costs; pension and other postretirement benefits;
and contingencies. In developing these estimates management makes subjective and
complex judgments that are inherently uncertain and subject to material change
as facts and circumstances develop. Although variability is inherent in these
estimates, management believes the amounts provided are appropriate based upon
the facts available upon compilation of the financial statements.
RESERVES
ASBESTOS AND ENVIRONMENTAL CLAIMS
In the first quarter of 2003, The Hartford conducted a detailed study of its
asbestos exposures. The Company undertook the study consistent with its practice
of regularly updating its reserve estimates as new information becomes
available. As a result of the study, the Company strengthened its gross and net
asbestos reserves by, $3.9 billion and $2.6 billion, respectively, during the
quarter ended March 31, 2003.
The process of estimating asbestos reserves remains subject to a wide variety of
uncertainties, which are detailed in Note 5(b) of Notes to Condensed
Consolidated Financial Statements. Due to these uncertainties, further
developments could cause The Hartford to change its estimates of asbestos
reserves and the effect of these changes could be material to the Company's
consolidated operating results, financial condition and liquidity.
DEFERRED POLICY 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. These deferred costs, together with the present value of future profits
of acquired business, are recorded as an asset commonly referred to as deferred
policy acquisition costs and present value of future profits ("DAC"). At March
31, 2003 and December 31, 2002, the carrying value of the Company's Life
operations' DAC was $5.9 billion and $5.8 billion, respectively. For statutory
accounting purposes, such costs are expensed as incurred.
DAC related to traditional policies are amortized over the premium-paying period
in proportion to the present value of annual expected premium income. DAC
related to investment contracts and universal life-type contracts are deferred
and amortized using the retrospective deposit method. Under the retrospective
deposit method, acquisition costs are amortized in proportion to the present
value of the estimated gross profits ("EGPs") arising principally from projected
investment, mortality and expense margins and surrender charges. The
attributable portion of the DAC amortization is allocated to realized gains and
losses on investments. The DAC balance is also adjusted through other
comprehensive income by an amount that represents the amortization of deferred
policy acquisition costs that would have been required as a charge or credit to
operations had unrealized gains and losses on investments been realized. Actual
gross profits can vary from management's estimates, resulting in increases or
decreases in the rate of amortization.
The Company regularly evaluates its EGPs to determine if actual experience or
other evidence suggests that earlier estimates should be revised. In the event
that the Company were to revise its EGPs, the cumulative DAC amortization would
be adjusted to reflect such revised EGPs in the period the revision was
determined to be necessary. Several assumptions considered to be significant in
the development of EGPs include separate account fund performance, surrender and
lapse rates, estimated interest spread and estimated mortality. The separate
account fund performance assumption is critical to the development of the EGPs
related to the Company's