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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 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 001-12749
HARTFORD LIFE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 06-1470915
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 HOPMEADOW STREET, SIMSBURY, CONNECTICUT 06089
(Address of principal executive offices)
(860) 547-5000
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
7.2% Trust Preferred Securities, Series A, issued by Hartford Life Capital I
7.625% Trust Preferred Securities, Series B, issued by Hartford Life Capital II
Securities registered pursuant to Section 12(g) of the Act:
6.90% Notes due June 15, 2004
7.10% Notes due June 15, 2007
7.65% Debentures due June 15, 2027
7.375% Senior Notes due March 1, 2031
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 Exchange Act Rule 12b-2). Yes [ ] No[X]
The aggregate market value of the shares of Common Stock held by non-affiliates
of the registrant as of June 30, 2003 was $0, because all of the outstanding
shares of Common Stock were owned by Hartford Holdings, Inc., a direct wholly
owned subsidiary of The Hartford Financial Services Group, Inc.
As of February 20, 2004, there were outstanding 1,000 shares of Common Stock,
$0.01 par value per share, of the registrant.
The registrant meets the conditions set forth in General Instruction (I) (1) (a)
and (b) of Form 10-K and is therefore filing this Form with the reduced
disclosure format.
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CONTENTS
ITEM DESCRIPTION PAGE
PART I 1 Business of Hartford Life* 3
2 Properties* 11
3 Legal Proceedings 12
4 **
PART II 5 Market for Hartford Life's Common Stock and Related Stockholder Matters 12
6 **
7 Management's Discussion and Analysis of Financial Condition and
Results of Operations* 13
7A Quantitative and Qualitative Disclosures About Market Risk 49
8 Financial Statements and Supplementary Data 49
9 Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure 49
9A Controls and Procedures 49
PART III 10 **
11 **
12 **
13 **
14 Principal Accounting Fees and Services 50
PART IV 15 Exhibits, Financial Statement Schedules, and Reports on Form 8-K 50
Signatures II-1
Exhibits Index II-2
* Item prepared in accordance with General Instruction I (2) of Form 10-K
** Item omitted in accordance with General Instruction I (2) of Form 10-K
2
PART I
ITEM 1. BUSINESS OF HARTFORD LIFE
(DOLLAR AMOUNTS IN MILLIONS, EXCEPT FOR SHARE DATA, UNLESS OTHERWISE STATED)
GENERAL
Hartford Life, Inc. and its subsidiaries ("Hartford Life" or the "Company"), an
indirect subsidiary of The Hartford Financial Services Group, Inc. ("The
Hartford"), is headquartered in Simsbury, Connecticut and is a leading financial
services and insurance organization. Hartford Life provides (i) investment
products, including variable annuities, fixed market value adjusted ("MVA")
annuities, mutual funds and retirement plan services for the savings and
retirement needs of over 1.5 million customers, (ii) life insurance for wealth
protection, accumulation and transfer needs for approximately 735,000 customers,
(iii) group benefits products such as group life and group disability insurance
for the benefit of millions of individuals and (iv) corporate owned life
insurance, which includes life insurance policies purchased by a company on the
lives of its employees. The Company is one of the largest sellers of individual
variable annuities, variable universal life insurance and group disability
insurance in the United States. The Company's strong position in each of its
core businesses provides an opportunity to increase the sale of the Company's
products and services as individuals increasingly save and plan for retirement,
protect themselves and their families against the financial uncertainties
associated with disability or death and engage in estate planning. In an effort
to advance the Company's strategy of growing its businesses, The Hartford
acquired the group life and accident, and short-term and long-term disability
businesses of CNA Financial Corporation on December 31, 2003, and the individual
life insurance, annuity and mutual fund businesses of Fortis on April 2, 2001.
(For additional information, see the Capital Resources and Liquidity section of
the Management's Discussion and Analysis ("MD&A") section and Note 17 of Notes
to Consolidated Financial Statements). In addition, Hartford Life's Japanese
operation achieved $3.7 billion, $1.4 billion and $462 in variable annuity sales
for the years ended December 31, 2003, 2002 and 2001, respectively. The growth
in sales was the primary reason for the increased account values related to
Japan, which grew to more than $6.2 billion as of December 31, 2003 up from $1.7
billion at December 31, 2002.
Hartford Life is among the largest consolidated life insurance groups in the
United States based on statutory assets as of December 31, 2003. In the past
year, the Company's total assets under management, which include $22.5 billion
of third-party assets invested in the Company's mutual funds and 529 College
Savings Plans, increased 27% to $210.1 billion at December 31, 2003 from $165.1
billion at December 31, 2002. Hartford Life generated revenues of $8.1 billion,
$6.9 billion and $7.4 billion in 2003, 2002 and 2001, respectively.
Additionally, the Company generated net income of $769, $557 and $685 in 2003,
2002 and 2001, respectively.
CUSTOMER SERVICE, TECHNOLOGY AND ECONOMIES OF SCALE
The Company maintains advantageous economies of scale and operating efficiencies
due to its growth, attention to expense and claims management and commitment to
customer service and technology. These advantages allow the Company to
competitively price its products for its distribution network and policyholders.
In addition, the Company utilizes computer technology to enhance communications
within the Company and throughout its distribution network in order to improve
the Company's efficiency in marketing, selling and servicing its products and,
as a result, provides high-quality customer service. In recognition of
excellence in customer service for variable annuities, Hartford Life was awarded
the 2003 Annuity Service Award by DALBAR Inc., a recognized independent
financial services research organization, for the eighth consecutive year.
Hartford Life is the only company to receive this prestigious award in every
year of the award's existence. Also, in 2003 the Company earned its first DALBAR
Awards for Mutual Fund and Retirement Plan Service which recognize Hartford Life
as the No. 1 service provider of mutual funds and retirement plans in the
industry. Additionally, the Company's Individual Life segment won its third
consecutive DALBAR award for service of life insurance customers and its second
DALBAR Intermediary Service Award in 2003.
RISK MANAGEMENT
The Company's product designs, prudent underwriting standards and risk
management techniques are structured to protect it against disintermediation
risk, greater than expected mortality and morbidity experience and, for certain
product features, specifically the guaranteed minimum death benefit ("GMDB") and
guaranteed minimum withdrawal benefit ("GMWB") offered with variable annuity
products, equity market volatility. As of December 31, 2003, the Company had
limited exposure to disintermediation risk on approximately 96% of its domestic
life insurance and annuity liabilities through the use of non-guaranteed
separate accounts, MVA features, policy loans, surrender charges and
non-surrenderability provisions. The Company effectively utilizes prudent
underwriting to select and price insurance risks and regularly monitors
mortality and morbidity assumptions to determine if experience remains
consistent with these assumptions and to ensure that its product pricing remains
appropriate. The Company also enforces disciplined claims management to protect
itself against greater than expected morbidity experience. The Company uses
reinsurance structures and has modified benefit features to mitigate the
mortality exposure associated with guaranteed minimum death benefits. The
Company also uses reinsurance in combination with derivative instruments to
minimize the volatility associated with the GMWB liability.
3
REPORTING SEGMENTS
Hartford Life, headquartered in Simsbury, Connecticut, is organized into four
reportable operating segments: Investment Products, Individual Life, Group
Benefits and Corporate Owned Life Insurance ("COLI"). The Company includes in
"Other" corporate items not directly allocable to any of its reportable
operating segments, principally interest expense, as well as its international
operations, which are primarily located in Japan and Brazil, realized capital
gains and losses and intersegment eliminations. The following is a description
of each segment, including a discussion of principal products, methods of
distribution and competitive environments. Additional information on Hartford
Life's segments may be found in the MD&A and Note 16 of Notes to Consolidated
Financial Statements.
Investment Products
The Investment Products segment focuses, through the sale of individual variable
and fixed annuities, mutual funds, retirement plan services and other investment
products, on the savings and retirement needs of the growing number of
individuals who are preparing for retirement or who have already retired. This
segment's assets under management grew to $146.5 billion at December 31, 2003
from $110.2 billion at December 31, 2002. Investment Products generated revenues
of $3.8 billion, $3.1 billion and $3.3 billion in 2003, 2002 and 2001,
respectively, of which individual annuities accounted for $1.8 billion for 2003
and $1.5 billion for 2002 and 2001. Net income in the Investment Products
segment was $510, $432 and $463 in 2003, 2002 and 2001, respectively.
The Company sells both variable and fixed individual annuity products through a
wide distribution network of national and regional broker-dealer organizations,
banks and other financial institutions and independent financial advisors. The
Company is a market leader in the annuity industry with sales of $16.5 billion,
$11.6 billion and $10.0 billion in 2003, 2002 and 2001, respectively. The
Company was the largest seller of individual retail variable annuities in the
United States with sales of $15.7 billion, $10.3 billion and $9.0 billion in
2003, 2002 and 2001, respectively. In addition, the Company continues to be the
largest seller of individual retail variable annuities through banks in the
United States.
The Company's total account value related to individual annuity products was
$97.7 billion as of December 31, 2003. Of this total account value, $86.5
billion, or 89%, related to individual variable annuity products and $11.2
billion, or 11%, related primarily to fixed MVA annuity products. In 2002, the
Company's total account value related to individual annuity products was $74.9
billion. Of this total account value, $64.3 billion, or 86%, related to
individual variable annuity products and $10.6 billion, or 14%, related
primarily to fixed MVA annuity products.
In addition to its leading position in individual annuities, Hartford Life
continues to emerge as a significant participant in the mutual fund business. In
2003 The Hartford mutual funds reached $20 billion in assets faster than any
other retail-oriented mutual fund family in history, according to Strategic
Insight. As of December 31, 2003, retail mutual fund assets were $20.3 billion.
The Company is also among the top providers of retirement products and services,
including asset management and plan administration sold to small and medium size
corporations pursuant to Section 401(k) of the Internal Revenue Code of 1986, as
amended (referred to as "401(k)") and to municipalities pursuant to Section 457
and 403(b) of the Internal Revenue Code of 1986, as amended (referred to as
"Section 457" and "403(b)", respectively). The Company also provides structured
settlement contracts, terminal funding products and other investment products
such as guaranteed investment contracts ("GICs"). In 2002, the Company began
selling a 529 college savings product.
Principal Products
Individual Variable Annuities -- Hartford Life earns fees, based on
policyholders' account values, for managing variable annuity assets and
maintaining policyholder accounts. The Company uses specified portions of the
periodic deposits paid by a customer to purchase units in one or more mutual
funds as directed by the customer, who then assumes the investment performance
risks and rewards. As a result, variable annuities permit policyholders to
choose aggressive or conservative investment strategies, as they deem
appropriate, without affecting the composition and quality of assets in the
Company's general account. These products offer the policyholder a variety of
equity and fixed income options, as well as the ability to earn a guaranteed
rate of interest in the general account of the Company. The Company offers an
enhanced guaranteed rate of interest for a specified period of time (no longer
than twelve months) if the policyholder elects to dollar-cost average funds from
the Company's general account into one or more non-guaranteed separate accounts.
Additionally, the Investment Products segment sells variable annuity contracts
that offer various guaranteed death benefits. For certain guaranteed death
benefits, The Hartford pays the greater of (1) the account value at death; (2)
the sum of all premium payments less prior withdrawals; or (3) the maximum
anniversary value of the contract, plus any premium payments since the contract
anniversary, minus any withdrawals following the contract anniversary.
Policyholders may make deposits of varying amounts at regular or irregular
intervals and the value of these assets fluctuates in accordance with the
investment performance of the funds selected by the policyholder. To encourage
persistency, many of the Company's individual variable annuities are subject to
withdrawal restrictions and surrender charges. Surrender charges range up to
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8% of the contract's deposits less withdrawals, and reduce to zero on a sliding
scale, usually within seven years from the deposit date. Individual variable
annuity account values of $86.5 billion as of December 31, 2003, have grown from
$64.3 billion as of December 31, 2002, due to strong net cash flow, resulting
from high levels of sales, low levels of surrenders and equity market
appreciation. Approximately 90% and 88% of the individual variable annuity
account values were held in non-guaranteed separate accounts as of December 31,
2003 and 2002, respectively.
In August 2002, the Company introduced Principal First, a new guaranteed
withdrawal benefit rider which is sold in conjunction with the Company's
variable annuity contracts. The Principal First rider provides the policyholder
with a guaranteed remaining balance ("GRB") if the account value is reduced to
zero through a combination of market declines and withdrawals. The GRB is
generally equal to premiums less withdrawals. However, annual withdrawals that
exceed 7% of the premiums paid may reduce the GRB by an amount greater than the
withdrawals and may also impact the guaranteed annual withdrawal amount that
subsequently applies after the excess annual withdrawals occur. The policyholder
also has the option, after a specified time period, to reset the GRB to the
then-current account value, if greater.
The assets underlying the Company's variable annuities are managed both
internally and by independent money managers, while the Company provides all
policy administration services. The Company utilizes a select group of money
managers, such as Wellington Management Company, LLP ("Wellington"); Hartford
Investment Management Company ("Hartford Investment Management"), a wholly-owned
subsidiary of The Hartford; Putnam Financial Services, Inc. ("Putnam"); American
Funds; MFS Investment Management ("MFS"); Franklin Templeton Group; and AIM
Investments ("AIM"). All have an interest in the continued growth in sales of
the Company's products and enhance the marketability of the Company's annuities
and the strength of its product offerings. Hartford Leaders, which is a
multi-manager variable annuity that combines the product manufacturing,
wholesaling and service capabilities of the Company with the investment
management expertise of four of the nation's most successful investment
management organizations: American Funds, Franklin Templeton Group, AIM and MFS,
has emerged as the industry leader in terms of retail sales. In addition, the
Director variable annuity, which is managed in part by Wellington, ranks second
in the industry in terms of retail sales.
Fixed MVA Annuities -- Fixed MVA annuities are fixed rate annuity contracts
which guarantee a specific sum of money to be paid in the future, either as a
lump sum or as monthly income. In the event that a policyholder surrenders a
policy prior to the end of the guarantee period, the MVA feature increases or
decreases the cash surrender value of the annuity in respect of any interest
rate decreases or increases, respectively, thereby protecting the Company from
losses due to higher interest rates at the time of surrender. The amount of
payment will not fluctuate due to adverse changes in the Company's investment
return, mortality experience or expenses. The Company's primary fixed MVA
annuities have terms varying from one to ten years with an average term of
approximately four years. Account values of fixed MVA annuities were $11.2
billion and $10.6 billion as of December 31, 2003 and 2002, respectively.
Mutual Funds -- In September 1996, Hartford Life launched a family of retail
mutual funds for which the Company provides investment management and
administrative services. The fund family has grown significantly from 8 funds at
inception to the current offering of 34 funds, including the addition of the
Hartford Equity Income Fund introduced in 2003. The Company's funds are managed
by Wellington and Hartford Investment Management. The Company has entered into
agreements with over 960 financial services firms to distribute these mutual
funds.
The Company charges fees to the shareholders of the mutual funds, which are
recorded as revenue by the Company. Investors can purchase shares in the mutual
funds, all of which are registered with the Securities and Exchange Commission,
in accordance with the Investment Company Act of 1940. The mutual funds are
owned by the shareholders of those funds and not by the Company. As such, the
mutual fund assets and liabilities, as well as related investment returns, are
not reflected in the Company's consolidated financial statements. Total retail
mutual fund assets under management were $20.3 billion and $14.1 billion as of
December 31, 2003 and 2002, respectively.
Governmental -- The Company sells retirement plan products and services to
municipalities under Section 457 plans. The Company offers a number of different
investment products, including variable annuities and fixed products, to the
employees in Section 457 plans. Generally, with the variable products, the
Company manages the fixed income funds and certain other outside money managers
act as advisors to the equity funds offered in Section 457 plans administered by
the Company. As of December 31, 2003, the Company administered over 3,000 plans
under Section 457 and 403(b). Total governmental assets under management were
$9.7 billion and $7.9 billion as of December 31, 2003 and 2002, respectively.
Corporate -- The Company sells retirement plan products and services to
corporations under Section 401(k) plans targeting the small and medium case
markets. The Company believes these markets are under-penetrated in comparison
to the large case market. As of December 31, 2003, the Company administered over
4,100 Section 401(k) plans. Total corporate assets under management were $5.2
billion and $3.4 billion as of December 31, 2003 and 2002, respectively.
Institutional Investment Products -- The Company sells the following
institutional investment products; structured settlements, GICs and other short
term funding agreements, institutional mutual funds and other annuity contracts
for special purposes such as funding of
5
terminated defined benefit pension plans. Structured settlement contracts
provide for periodic payments to an injured person or survivor for a generally
determinable number of years, typically in settlement of a claim under a
liability policy in lieu of a lump sum settlement. The Company's structured
settlements are sold through The Hartford's Property & Casualty insurance
operations as well as specialty brokers. Total institutional investment products
assets under management were $13.1 billion and $9.9 billion as of December 31,
2003 and 2002, respectively. The increase in the institutional investment
products assets under management was the result of strong sales totaling $3.4
billion, $2.0 billion and $2.6 billion for the years ended December 31, 2003,
2002 and 2001, respectively.
Section 529 Plans - Hartford Life introduced a tax advantaged college savings
product ("529 plan") in March 2002 called SMART 529. SMART 529 is a
state-sponsored education savings program established by the State of West
Virginia which offers an easy way for both residents of West Virginia and
out-of-state participants to plan for a college education. In 1996, Congress
created a tax-advantaged college savings program as part of Section 529 of the
Internal Revenue Code (the "Code"). The 529 Plan is an investment plan operated
by a state, designed to help families save for future college costs. On January
1, 2002, 529 Plans became federal tax-exempt for qualified withdrawals. In July
2003, the Company began selling a multi-manager 529 product.
SMART 529 is designed to be flexible by allowing investors to choose from a wide
variety of investment portfolios to match their risk preference to help
investors accumulate savings for college. An individual can open a SMART 529
account for anyone, at any age. The SMART 529 product complements the Company's
existing offering of investment products (mutual funds, variable annuities,
401(k), 457 and 403(b) plans). It also leverages the Company's capabilities in
distribution, service and fund performance. Total 529 Plan assets under
management were $259 and $87 as of December 31, 2003 and 2002, respectively.
Marketing and Distribution
The Investment Products distribution network is based on management's strategy
of utilizing multiple and competing distribution channels to achieve the
broadest distribution to reach target customers. The success of the Company's
marketing and distribution system depends on its product offerings, fund
performance, successful utilization of wholesaling organizations, quality of
customer service, and relationships with national and regional broker-dealer
firms, banks and other financial institutions, and independent financial
advisors (through which the sale of the Company's retail investment products to
customers is consummated).
Hartford Life maintains a distribution network of approximately 1,500
broker-dealers and approximately 500 banks. As of December 31, 2003, the Company
was selling products through the 25 largest retail banks in the United States.
The Company periodically negotiates provisions and terms of its relationships
with unaffiliated parties, and there can be no assurance that such terms will
remain acceptable to the Company or such third parties. The Company's primary
wholesaler of its individual annuities and mutual funds is its wholly-owned
subsidiary, PLANCO Financial Services, Inc. and its affiliate, PLANCO,
Incorporated (collectively "PLANCO"). PLANCO is one of the nation's largest
wholesalers of individual annuities and has played a significant role in The
Hartford's growth over the past decade. As a wholesaler, PLANCO distributes the
Company's fixed and variable annuities, mutual funds, 401(k) plans and 529 Plans
by providing sales support to registered representatives, financial planners and
broker-dealers at brokerage firms and banks across the United States. Owning
PLANCO secures an important distribution channel for the Company and gives the
Company a wholesale distribution platform which it can expand in terms of both
the number of individuals wholesaling its products and the portfolio of products
which they wholesale. In addition, the Company uses internal personnel with
extensive experience in the Section 457 market, as well as access to the Section
401(k) market, to sell its products and services in the retirement plan and
institutional markets.
Competition
The Investment Products segment competes with numerous other insurance companies
as well as certain banks, securities brokerage firms, independent financial
advisors and other financial intermediaries marketing annuities, mutual funds
and other retirement-oriented products. Product sales are affected by
competitive factors such as investment performance ratings, product design,
visibility in the marketplace, financial strength ratings, distribution
capabilities, levels of charges and credited rates, reputation and customer
service.
6
Regulatory Developments
Recently, there has been a significant increase in federal and state regulatory
activity relating to financial services companies, particularly mutual funds
companies. These regulatory inquiries have focused on a number of mutual fund
issues. The Company, like many others in the financial services industry, has
received requests for information from the Securities and Exchange Commission
and a subpoena from the New York Attorney General's Office, in each case
requesting documentation and other information regarding various mutual fund
regulatory issues. The Company continues to cooperate fully with these
regulatory agencies in responding to these requests. In addition,
representatives from the SEC's Office of Compliance Inspections and
Examinations recently concluded an on-site compliance examination of the
Company's variable annuity and mutual fund operations.
The Company's mutual funds are available for purchase by the separate accounts
of different variable life insurance policies, variable annuity products, and
funding agreements, and they are offered directly to certain qualified
retirement plans. Although existing products contain transfer restrictions
between subaccounts, some products, particularly older variable annuity
products, do not contain restrictions on the frequency of transfers. In
addition, as a result of the settlement of litigation against the Company with
respect to certain owners of older variable annuity products, the Company's
ability to restrict transfers by these owners is limited.
A number of companies recently have announced settlements of enforcement
actions with various regulatory agencies, primarily the Securities and Exchange
Commission and the New York Attorney General's Office. No such action has been
initiated against the Company. It is possible that one or more regulatory
agencies may pursue action against the Company in the future.
INDIVIDUAL LIFE
The Individual Life segment provides life insurance solutions to a wide array of
partners to solve the wealth protection, accumulation and transfer needs of
their affluent, emerging affluent and business insurance clients. The individual
life business acquired from Fortis in 2001 added significant scale to the
Company's Individual Life segment, contributing to a significant increase in
life insurance in force in that year. As of December 31, 2003, life insurance in
force increased 3% to $130.8 billion, from $126.7 billion as of December 31,
2002. Account values increased 15% to $8.7 billion as of December 31, 2003 from
$7.6 billion as of December 31, 2002. Revenues were $982, $958 and $890 for the
years ended December 31, 2003, 2002 and 2001, respectively. Net income in the
Individual Life segment was $145, $133 and $121 for the years ended December 31,
2003, 2002 and 2001, respectively.
Principal Products
Hartford Life holds a significant market share in the variable universal life
product market and is the number one seller of variable life insurance,
according to the Tillinghast Value Survey. In 2003, the Company's sales of
individual life insurance were 54% variable universal life, 41% universal life
and other, and 5% term life insurance.
Variable Universal Life -- Variable universal life provides life insurance with
a return linked to an underlying investment portfolio and the Company allows
policyholders to determine their asset mix among a variety of underlying mutual
funds. As the return on the investment portfolio increases or decreases, the
surrender value of the variable universal life policy will increase or decrease,
and, under certain policyholder options or market conditions, the death benefit
may also increase or decrease. The Company's second-to-die products are
distinguished from other products in that two lives are insured rather than one,
and the policy proceeds are paid upon the death of both insureds. Second-to-die
policies are frequently used in estate planning for a married couple. Variable
universal life account values were $4.7 billion and $3.6 billion as of December
31, 2003 and 2002, respectively.
Universal Life and Interest Sensitive Whole Life -- Universal life and interest
sensitive whole life insurance coverages provide life insurance with adjustable
rates of return based on current interest rates. Universal life provides
policyholders with flexibility in the timing and amount of premium payments and
the amount of the death benefit, provided there are sufficient policy funds to
cover all policy charges for the coming period. The Company also sells
second-to-die universal life insurance policies similar to the variable
universal life insurance product offered. Universal life and interest sensitive
whole life account values were $3.3 and $3.1 billion as of December 31, 2003 and
2002, respectively.
Marketing and Distribution
Consistent with the Company's strategy to access multiple distribution outlets,
the Individual Life distribution organization has been developed to penetrate a
multitude of retail sales channels. These include independent life insurance
sales professionals; agents of other companies; national, regional and
independent broker-dealers; banks, financial planners, certified public
accountants and property and casualty insurance organizations. The primary
organization used to wholesale Hartford Life's products to these outlets is a
group of highly qualified life insurance professionals with specialized training
in sophisticated life insurance sales. These individuals
7
are generally employees of the Company who are managed through a regional sales
office system. Additional distribution is provided through Woodbury Financial
Services, a subsidiary retail broker dealer and other marketing relationships.
Competition
The Individual Life segment competes with approximately 1,200 life insurance
companies in the United States, as well as other financial intermediaries
marketing insurance products. Competitive factors related to this segment are
primarily the breadth and quality of life insurance products offered, pricing,
relationships with third-party distributors, effectiveness of wholesaling
support, pricing and availability of reinsurance, and the quality of
underwriting and customer service.
GROUP BENEFITS
The Group Benefits segment sells group life and group disability insurance, as
well as other products, including medical stop loss, accidental death and
dismemberment, travel accident and other special risk coverage to employers and
associations. The Company also offers disability underwriting, administration,
claims processing services and reinsurance to other insurers and self-funded
employer plans. Generally, policies sold in this segment are term insurance.
This allows the Company to adjust the rates or terms of its policies in order to
minimize the adverse effect of various market trends, including declining
interest rates and other factors. Typically policies are sold with one, two or
three year rate guarantees depending upon the product. In the disability market,
the Company focuses on strong risk and claims management to derive a competitive
advantage. The Group Benefits segment generated revenues of $2.6 billion for the
years ended December 31, 2003 and 2002, and $2.5 billion for the year ended
December 31, 2001, of which group disability insurance accounted for $1.1
billion in each of the three years and group life insurance accounted for $935,
$887 and $763, respectively. The Company held group disability reserves of $4.0
billion and $2.5 billion and group life reserves of $1.2 billion and $765, as of
December 31, 2003 and 2002, respectively. Net income in the Group Benefits
segment was $148, $128 and $106 for the years ended December 31, 2003, 2002 and
2001, respectively.
As previously mentioned, Hartford Life acquired the group life and accident, and
short-term and long-term disability businesses of CNA Financial Corporation on
December 31, 2003. This acquisition will increase the scale of the Company's
group life and disability operations, expand the Company's distribution and
enhance the Company's capability to deliver outstanding products and services.
Principal Products
Group Disability -- Hartford Life is one of the largest participants in the
"large case" market of the group disability insurance business. The large case
market, as defined by the Company, generally consists of group disability
policies covering over 500 employees in a particular company. The Company is
continuing its focus on the "small case" and "medium case" group markets,
emphasizing name recognition and reputation as well as the Company's managed
disability approach to claims and administration. The Company's efforts in the
group disability market focus on early intervention, return-to-work programs and
successful rehabilitation. Over the last several years, the focus of new
disability products introduced is to provide incentives for employees to return
to independence. The Company also works with disability claimants to improve the
receipt rate of Social Security offsets (i.e., reducing payment of benefits by
the amount of Social Security payments received).
The Company's short-term disability benefit plans provide a weekly benefit
amount (typically 60% to 70% of the employee's earned income up to a specified
maximum benefit) to insured employees when they are unable to work due to an
accident or illness. Long-term disability insurance provides a monthly benefit
for those extended periods of time not covered by a short-term disability
benefit plan when insured employees are unable to work due to disability.
Employees may receive total or partial disability benefits. Most of these
policies begin providing benefits following a 90 or 180 day waiting period and
generally continue providing benefits until the employee is no longer disabled
or until the employee reaches age 65. Long-term disability benefits are paid
monthly and are limited to a portion, generally 50-70%, of the employee's earned
income up to a specified maximum benefit.
Group Life -- Group term life insurance provides term coverage to employees and
their dependents for a specified period and has no accumulation of cash values.
The Company offers options for its basic group life insurance coverage,
including portability of coverage and a living benefit option, whereby
terminally ill policyholders can receive death benefits prior to their deaths.
In addition, the Company offers premium waiver and accidental death and
dismemberment coverages to employee groups.
Other -- Hartford Life provides excess of loss medical coverage (known as stop
loss insurance) to employers who self-fund their medical plans and pay claims
using the services of a third party administrator. The Company also provides
travel accident, hospital indemnity and other coverages (including group life
and disability) primarily to individual membership of various associations, as
well as employee groups. A significant Medicare supplement customer of the
company had been the members of the Retired Officers Association, an
organization consisting of retired military officers. Congress passed
legislation, effective in the fourth quarter of 2001, whereby retired military
officers age 65 and older will receive full medical insurance, eliminating the
need for Medicare supplement insurance. This legislation reduced the Company's
Military Medicare supplement premium revenue to zero after 2001.
Marketing and Distribution
8
The Company uses an experienced group of Company employees, managed through a
regional sales office system, to distribute its group insurance products and
services through a variety of distribution outlets, including brokers,
consultants, third-party administrators and trade associations. The Company
intends to continue to expand the system over the coming years in areas that
offer the highest growth potential.
Competition
The Group Benefits business remains highly competitive. Competitive factors
primarily affecting Group Benefits are the variety and quality of products and
services offered, the price quoted for coverage and services, the Company's
relationships with its third-party distributors, and the quality of customer
service. Group Benefits competes with numerous other insurance companies and
other financial intermediaries marketing insurance products. However, many of
these businesses have relatively high barriers to entry and there have been very
few new entrants over the past few years.
CORPORATE OWNED LIFE INSURANCE ("COLI")
Hartford Life is a leader in the COLI market, which includes life insurance
policies purchased by a company on the lives of its employees, with the company
or a trust sponsored by the company named as the beneficiary under the policy.
Until the passage of Health Insurance Portability and Accountability Act of 1996
("HIPAA"), the Company sold two principal types of COLI, leveraged and variable
products. Leveraged COLI is a fixed premium life insurance policy owned by a
company or a trust sponsored by a company. HIPAA phased out the deductibility of
interest on policy loans under leveraged COLI at the end of 1998, virtually
eliminating all future sales of leveraged COLI. Variable COLI continues to be a
product used by employers to fund non-qualified benefits or other
post-employment benefit liabilities.
Variable COLI account values were $21.0 billion and $19.7 billion as of December
31, 2003 and 2002, respectively. Leveraged COLI account values decreased to $2.5
billion as of December 31, 2003 from $3.3 billion as of December 31, 2002,
primarily due to surrender activity. COLI generated revenues of $483, $592 and
$719 for the years ended December 31, 2003, 2002 and 2001, respectively and net
(loss) income of $(1), $32 and $37 for the years ended December 31, 2003, 2002
and 2001, respectively.
RESERVES
In accordance with applicable insurance regulations under which the Company
operates, life insurance subsidiaries of Hartford Life establish and carry as
liabilities actuarially determined reserves which are calculated to meet the
Company's future obligations. Reserves for life insurance and disability
contracts are based on actuarially recognized methods using prescribed morbidity
and mortality tables in general use in the United States, which are modified to
reflect the Company's actual experience when appropriate. These reserves are
computed at amounts that, with additions from estimated premiums to be received
and with interest on such reserves compounded annually at certain assumed rates,
are expected to be sufficient to meet the Company's policy obligations at their
maturities or in the event of an insured's disability or death. Reserves also
include unearned premiums, premium deposits, claims incurred but not reported
and claims reported but not yet paid. Reserves for assumed reinsurance are
computed in a manner that is comparable to direct insurance reserves. Additional
information on Hartford Life reserves may be found in the Critical Accounting
Estimates section of the MD&A under "Reserves".
CEDED REINSURANCE
In accordance with normal industry practice, the Company is involved in both the
cession and assumption of insurance with other insurance and reinsurance
companies. As of December 31, 2003, the largest amount of life insurance
retained on any one life by any one of the life operations was approximately
$2.5. In addition, the Company has reinsured the majority of the minimum death
benefit guarantees and the guaranteed minimum withdrawal benefits offered in
connection with its variable annuity contracts. The majority of variable annuity
contracts issued since August 2002 include a guaranteed minimum withdrawal
benefit ("GMWB") rider. The GMWB represents an embedded derivative in the
variable annuity contract that is required to be reported separately from the
host variable annuity contract. Beginning July 7, 2003, substantially all new
contracts with the GMWB were not covered by reinsurance as the Company had
exceeded the limit in the existing reinsurance agreement prior to that date. As
of December 31, 2003, approximately $11 billion or 64% of variable annuity
account value with GMWB was reinsured. Ceded reinsurance does not relieve the
Company of its primary liability and, as such, failure of reinsurers to honor
their obligations could result in losses to the Company. The Company also
assumes reinsurance from other insurers. The Company evaluates the financial
condition of its reinsurers and monitors concentrations of credit risk. For the
years ended December 31, 2003, 2002 and 2001, the Company did not make any
significant changes in the terms under which reinsurance is ceded to other
insurers except for the Company's recapture of a block of business previously
reinsured with an unaffiliated reinsurer. For further discussion see Note 12 in
"Notes to Consolidated Financial Statements".
INVESTMENT OPERATIONS
9
An important element of the financial results of Hartford Life is return on
invested assets. The investment portfolios are managed based on the underlying
characteristics and nature of each operation's respective liabilities and within
established risk parameters.
The investment portfolios of the Company are managed by Hartford Investment
Management. Hartford Investment Management is responsible for monitoring and
managing the asset/liability profile, establishing investment objectives and
guidelines and determining, within specified risk tolerances and investment
guidelines, the appropriate asset allocation, duration, convexity and other
characteristics of the portfolios. Security selection and monitoring are
performed by asset class specialists working within dedicated portfolio
management teams.
The primary investment objective of the Company's general account and guaranteed
separate accounts is to maximize after-tax returns consistent with acceptable
risk parameters, including the management of the interest rate sensitivity of
invested assets and the generation of sufficient liquidity, relative to that of
policyholder and corporate obligations.
For a further discussion of Hartford Life's approach to managing risks,
including derivative utilization, see the Investments and Capital Markets Risk
Management sections, of the MD&A, as well as Note 2 of Notes to Consolidated
Financial Statements.
REGULATION AND PREMIUM RATES
Although there has been some deregulation with respect to large commercial
insurers in recent years, insurance companies, for the most part, are still
subject to comprehensive and detailed regulation and supervision throughout the
United States. The extent of such regulation varies, but generally has its
source in statutes which delegate regulatory, supervisory and administrative
powers to state insurance departments. Such powers relate to, among other
things, the standards of solvency that must be met and maintained; the licensing
of insurers and their agents; the nature of and limitations on investments;
establishing premium rates; claim handling and trade practices; restrictions on
the size of risks which may be insured under a single policy; deposits of
securities for the benefit of policyholders; approval of policy forms; periodic
examinations of the affairs of companies; annual and other reports required to
be filed on the financial condition of companies or for other purposes; fixing
maximum interest rates on life insurance policy loans and minimum rates for
accumulation of surrender values; and the adequacy of reserves and other
necessary provisions for unearned premiums, unpaid claims and claim adjustment
expenses and other liabilities, both reported and unreported.
Most states have enacted legislation that regulates insurance holding company
systems such as The Company. This legislation provides that each insurance
company in the system is required to register with the insurance department of
its state of domicile and furnish information concerning the operations of
companies within the holding company system which may materially affect the
operations, management or financial condition of the insurers within the system.
All transactions within a holding company system affecting insurers must be fair
and equitable. Notice to the insurance departments is required prior to the
consummation of transactions affecting the ownership or control of an insurer
and of certain material transactions between an insurer and any entity in its
holding company system. In addition, certain of such transactions cannot be
consummated without the applicable insurance department's prior approval.
The extent of insurance regulation on business outside the United States varies
significantly among the countries in which the Company operates. Some countries
have minimal regulatory requirements, while others regulate insurers
extensively. Foreign insurers in many countries are faced with greater
restrictions than domestic competitors domiciled in that particular
jurisdiction. The Company's international operations are comprised of insurers
licensed in their respective countries and, therefore, are subject to the
generally less restrictive domestic insurance regulations.
RATINGS
Reference is made to the Capital Resources and Liquidity section of the MD&A
under "Ratings".
RISK-BASED CAPITAL
Reference is made to the Capital Resources and Liquidity section of the MD&A
under "Risk-Based Capital".
LEGISLATIVE AND REGULATORY INITIATIVES
Reference is made to the Regulatory Matters and Contingencies section of the
MD&A under "Legislative and Regulatory Initiatives".
10
INSOLVENCY FUND
Reference is made to the Regulatory Matters and Contingencies section of the
MD&A under "Guaranty Fund".
NAIC PROPOSALS
Reference is made to the Regulatory Matters and Contingencies section of the
MD&A under "NAIC Codification".
DEPENDENCE ON CERTAIN THIRD PARTY RELATIONSHIPS
Reference is made to the Regulatory Matters and Contingencies section of the
MD&A under "Dependence on Certain Third Party Relationships".
EMPLOYEES
The Company had approximately 7,500 employees at December 31, 2003.
ITEM 2. PROPERTIES
The Company's principal executive offices are located in Simsbury, Connecticut.
The Company's home office complex consists of approximately 655 thousand square
feet, and is leased from a third party by Hartford Fire Insurance Company
(Hartford Fire), a direct subsidiary of The Hartford. This lease expires in the
year 2009. Expenses associated with these offices are allocated on a direct
basis to The Company by Hartford Fire. The Company believes its properties and
facilities are suitable and adequate for current operations.
11
ITEM 3. LEGAL PROCEEDINGS
The Company is or may become involved in various kinds of legal actions, some of
which assert claims for substantial amounts. These actions may include, among
others, putative state and federal class actions seeking certification of a
state or national class. The Company also is involved in individual actions in
which punitive damages are sought, such as claims alleging bad faith in the
handling of insurance claims. Management expects that the ultimate liability, if
any, with respect to such lawsuits, after consideration of provisions made for
potential losses and costs of defense, will not be material to the consolidated
financial condition of the Company. Nonetheless, given the large or
indeterminate amounts sought in certain of these actions, and the inherent
unpredictability of litigation, 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.
Bancorp Services, LLC - In the third quarter of 2003, Hartford Life Insurance
Company ("HLIC") and its affiliate International Corporate Marketing Group, LLC
("ICMG") settled their intellectual property dispute with Bancorp Services, LLC
("Bancorp"). The dispute concerned, among other things, Bancorp's claims for
alleged patent infringement, breach of a confidentiality agreement, and
misappropriation of trade secrets related to certain stable value
corporate-owned life insurance products. The dispute was the subject of
litigation in the United States District Court for the Eastern District of
Missouri, in which Bancorp obtained in 2002 a judgment exceeding $134 against
HLIC and ICMG after a jury trial on the trade secret and breach of contract
claims, and HLIC and ICMG obtained summary judgment on the patent infringement
claim. Based on the advice of legal counsel following entry of the judgment, the
Company recorded an $11 after-tax charge in the first quarter of 2002 to
increase litigation reserves. Both components of the judgment were appealed.
Under the terms of the settlement, The Hartford will pay a minimum of $70 and a
maximum of $80, depending on the outcome of the patent appeal, to resolve all
disputes between the parties. The appeal from the trade secret and breach of
contract judgment will be dismissed. The settlement resulted in the recording of
an additional charge of $40 after-tax in the third quarter of 2003, reflecting
the maximum amount payable under the settlement. In November of 2003, the
Company paid the initial $70 of the settlement.
Reinsurance Arbitration - On March 16, 2003, a final decision and award was
issued in the previously disclosed reinsurance 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.
PART II
ITEM 5. MARKET FOR HARTFORD LIFE'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
All of the Company's outstanding shares are ultimately owned by The Hartford. As
of February 20, 2004, the Company had issued and outstanding 1,000 shares of
Common Stock at $0.01 par value per share. There is no established public
trading market for the Company's Common Stock.
For a discussion regarding the Company's payment of dividends, and the
restrictions related thereto, see the Capital Resources and Liquidity section of
the MD&A under "Dividends" and "Liquidity Requirements."
12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(Dollar amounts in millions, unless otherwise stated)
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") addresses the financial condition of Hartford Life, Inc. and
its subsidiaries ("Hartford Life" or the "Company") as of December 31, 2003,
compared with December 31, 2002, and its results of operations for the three
years ended December 31, 2003, 2002 and 2001. This discussion should be read in
conjunction with the Consolidated Financial Statements and related Notes
beginning on page F-1.
Certain of the statements contained herein are forward-looking statements. These
forward-looking statements are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995 and include estimates and
assumptions related to economic, competitive and legislative developments. These
forward-looking statements are subject to change and uncertainty which are, in
many instances, beyond the Company's control and have been made based upon
management's expectations and beliefs concerning future developments and their
potential effect upon the Company. There can be no assurance that future
developments will be in accordance with management's expectations or that the
effect of future developments on the Company will be those anticipated by
management. Actual results could differ materially from those expected by the
Company, depending on the outcome of various factors. These factors include: the
uncertain effect on the Company of the Jobs and Growth Tax Relief Reconciliation
Act of 2003, in particular the reduction in tax rates on long-term capital gains
and most dividend distributions; the response of reinsurance companies under
reinsurance contracts, the impact of increasing reinsurance rates and the
availability and adequacy of reinsurance to protect the Company against losses;
the inability to effectively mitigate the impact of equity market volatility on
the Company's financial position and results of operations arising from
obligations under annuity product guarantees; the possibility of more
unfavorable loss experience than anticipated; the possibility of general
economic and business conditions that are less favorable than anticipated; the
effect of changes in interest rates, the stock markets or other financial
markets; stronger than anticipated competitive activity; unfavorable
legislative, regulatory or judicial developments; the Company's ability to
distribute its products through distribution channels, both current and future;
the uncertain effects of emerging claim and coverage issues; the effect of
assessments and other surcharges for guaranty funds; a downgrade in the
Company's claims-paying, financial strength or credit ratings; the ability of
the Company's subsidiaries to pay dividends to the Company; and other factors
described in such forward-looking statements.
Certain reclassifications have been made to prior year financial information to
conform to the current year presentation.
INDEX
Critical Accounting Estimates 13
Consolidated Results of Operations: Operating Summary 18
Investment Products 20
Individual Life 22
Group Benefits 23
Corporate Owned Life Insurance (COLI) 24
Investments 25
Investment Credit Risk 29
Capital Markets Risk Management 36
Capital Resources and Liquidity 42
Effect of Inflation 47
Impact of New Accounting Standards 47
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States, requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
The Company has identified the following estimates as critical in that they
involve a higher degree of judgment and are subject to a significant degree of
variability: deferred policy acquisition costs and present value of future
profits; valuation of investments; valuation of derivative instruments; reserves
and contingencies. In developing these estimates management makes subjective and
complex judgments that are inherently uncertain and subject to material change
as facts and circumstances develop. Although variability is inherent in these
estimates, management believes the amounts provided are appropriate based upon
the facts available upon compilation of the financial statements.
DEFERRED POLICY ACQUISITION COSTS AND PRESENT VALUE OF FUTURE PROFITS
Policy acquisition costs, which include commissions and certain other expenses
that vary with and are primarily associated with acquiring business, are
deferred and amortized over the estimated lives of the contracts, usually 20
years. These deferred costs, together with the present value of future profits
of acquired business, are recorded as an asset commonly referred to as deferred
policy
13
acquisition costs and present value of future profits ("DAC"). At December 31,
2003 and 2002, the carrying value of the Company's DAC was $6.6 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 estimated gross profits ("EGPs"), arising principally from projected
investment, mortality and expense margins and surrender charges. The
attributable portion of the DAC amortization is allocated to realized gains and
losses on investments. The DAC balance is also adjusted through other
comprehensive income by an amount that represents the amortization of deferred
policy acquisition costs that would have been required as a charge or credit to
operations had unrealized gains and losses on investments been realized. Actual
gross profits can vary from management's estimates, resulting in increases or
decreases in the rate of amortization.
The Company regularly evaluates its EGPs to determine if actual experience or
other evidence suggests that earlier estimates should be revised. In the event
that the Company were to revise its EGPs, the cumulative DAC amortization would
be adjusted to reflect such revised EGPs in the period the revision was
determined to be necessary. Several assumptions considered to be significant in
the development of EGPs include separate account fund performance, surrender and
lapse rates, estimated interest spread and estimated mortality. The separate
account fund performance assumption is critical to the development of the EGPs
related to the Company's variable annuity and to a lesser extent, variable
universal life insurance businesses. The average annual long-term rate of
assumed separate account fund performance (before mortality and expense charges)
used in estimating gross profits for the variable annuity and variable universal
life business was 9% for the years ended December 31, 2003 and 2002. For other
products including fixed annuities and other universal life-type contracts, the
average assumed investment yield ranged from 5% to 8.5% for both years ended
December 31, 2003 and 2002.
The Company has developed sophisticated modeling capabilities to evaluate its
DAC asset, which allowed it to run a large number of stochastically determined
scenarios of separate account fund performance. These scenarios were then
utilized to calculate a statistically significant range of reasonable estimates
of EGPs. This range was then compared to the present value of EGPs currently
utilized in the DAC amortization model. As of December 31, 2003, the present
value of the EGPs utilized in the DAC amortization model fall within a
reasonable range of statistically calculated present value of EGPs. As a result,
the Company does not believe there is sufficient evidence to suggest that a
revision to the EGPs (and therefore, a revision to the DAC) as of December 31,
2003 is necessary; however, if in the future the EGPs utilized in the DAC
amortization model were to exceed the margin of the reasonable range of
statistically calculated EGPs, a revision could be necessary. Furthermore, the
Company has estimated that the present value of the EGPs is likely to remain
within a reasonable range if overall separate account returns decline by 15% or
less for 2004, and if certain other assumptions that are implicit in the
computations of the EGPs are achieved.
Additionally, the Company continues to perform analyses with respect to the
potential impact of a revision to future EGPs. If such a revision to EGPs were
deemed necessary, the Company would adjust, as appropriate, all of its
assumptions for products accounted for in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 97, "Accounting and Reporting by Insurance
Enterprises for Certain Long-Duration Contracts and for Realized Gains and
Losses from the Sale of Investments", and reproject its future EGPs based on
current account values at the end of the quarter in which a revision is deemed
to be necessary. To illustrate the effects of this process, assume the Company
had concluded that a revision of the Company's EGPs was required at December 31,
2003. If the Company assumed a 9% average long-term rate of growth from December
31, 2003 forward along with other appropriate assumption changes in determining
the revised EGPs, the Company estimates the cumulative increase to amortization
would be approximately $65-$75, after-tax. If instead the Company were to assume
a long-term growth rate of 8% in determining the revised EGPs, the adjustment
would be approximately $80-$95, after-tax. Assuming that such an adjustment were
to have been required, the Company anticipates that there would have been
immaterial impacts on its DAC amortization for the 2004 and 2005 years exclusive
of the adjustment, and that there would have been positive earnings effects in
later years. Any such adjustment would not affect statutory income or surplus,
due to the prescribed accounting for such amounts that is discussed above.
Aside from absolute levels and timing of market performance assumptions,
additional factors that will influence this determination include the degree of
volatility in separate account fund performance and shifts in asset allocation
within the separate account made by policyholders. The overall return generated
by the separate account is dependent on several factors, including the relative
mix of the underlying sub-accounts among bond funds and equity funds as well as
equity sector weightings. The Company's overall separate account fund
performance has been reasonably correlated to the overall performance of the S&P
500 Index (which closed at 1,112 on December 31, 2003), although no assurance
can be provided that this correlation will continue in the future.
The overall recoverability of the DAC asset is dependent on the future
profitability of the business. The Company tests the aggregate recoverability of
the DAC asset by comparing the amounts deferred to the present value of total
EGPs. In addition, the Company routinely stress tests its DAC asset for
recoverability against severe declines in its separate account assets, which
could occur if the equity markets experienced another significant sell-off, as
the majority of policyholders' funds in the separate accounts is invested in the
equity market. As of December 31, 2003, the Company believed variable annuity
separate account assets could fall by at least 40% before portions of its DAC
asset would be unrecoverable.
14
VALUATION OF INVESTMENTS AND DERIVATIVE INSTRUMENTS
The Company's investments in both fixed maturities, which include bonds,
redeemable preferred stock and commercial paper; and equity securities, which
include common and non-redeemable preferred stocks, are classified as
"available-for-sale" as defined in Statement of Financial Accounting Standards
("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity
Securities". Accordingly, these securities are carried at fair value with the
after-tax difference from amortized cost, as adjusted for the effect of
deducting the life and pension policyholders' share of the immediate
participation guaranteed contracts and certain life and annuity deferred policy
acquisition costs, reflected in stockholder's equity as a component of
accumulated other comprehensive income ("AOCI"). Policy loans are carried at
outstanding balance, which approximates fair value. Other investments primarily
consist of limited partnership interests, derivatives and mortgage loans. The
limited partnerships are accounted for under the equity method and accordingly
the partnership earnings are included in net investment income. Derivatives are
carried at fair value and mortgage loans on real estate are recorded at the
outstanding principal balance adjusted for amortization of premiums or discounts
and net of valuation allowances, if any.
Valuation of Fixed Maturities
The fair value for fixed maturity securities is largely determined by one of
three primary pricing methods: independent third party pricing services,
independent broker quotations or pricing matrices, which use data provided by
external sources. With the exception of short-term securities for which
amortized cost is predominantly used to approximate fair value, security pricing
is applied using a hierarchy or "waterfall" approach whereby prices are first
sought from independent pricing services with the remaining unpriced securities
submitted to brokers for prices or lastly priced via a pricing matrix.
Prices from independent pricing services are often unavailable for securities
that are rarely traded or are traded only in privately negotiated transactions.
As a result, a significant percentage of the Company's asset-backed and
commercial mortgage-backed securities are priced via broker quotations. A
pricing matrix is used to price securities for which the Company is unable to
obtain either a price from a third party service or an independent broker
quotation. The pricing matrix begins with current treasury rates and uses credit
spreads and issuer-specific yield adjustments received from an independent third
party source to determine the market price for the security. The credit spreads
incorporate the issuer's credit rating as assigned by a nationally recognized
rating agency and a risk premium, if warranted, due to the issuer's industry and
security's time to maturity. The issuer-specific yield adjustments, which can be
positive or negative, are updated twice annually, as of June 30 and December 31,
by an independent third-party source and are intended to adjust security prices
for issuer-specific factors. The matrix-priced securities at December 31, 2003
and 2002, primarily consisted of non-144A private placements and have an average
duration of 4.4 and 4.6, respectively.
The following table identifies the fair value of fixed maturity securities by
pricing source as of December 31, 2003 and 2002:
2003 2002
------------------------------------ ------------------------------------
General and Guaranteed Percentage General and Guaranteed Percentage
Separate Account Fixed of Total Separate Account Fixed of Total
Maturities at Fair Value Fair Value Maturities at Fair Value Fair Value
------------------------ ---------- ------------------------ ----------
Priced via independent market quotations $ 40,122 81.5% $ 31,422 77.7%
Priced via broker quotations 3,273 6.7% 4,949 12.2%
Priced via matrices 3,445 7.0% 2,898 7.2%
Priced via other methods 301 0.6% 171 0.4%
Short-term investments [1] 2,056 4.2% 1,022 2.5%
----------- ----- ------------ -----
TOTAL $ 49,197 100.0% $ 40,462 100.0%
=========== ===== ============ =====
Total general accounts $ 37,462 76.1% $ 29,377 72.6%
Total guaranteed separate accounts $ 11,735 23.9% $ 11,085 27.4%
=========== ===== ============ =====
[1] Short-term investments are valued at amortized cost, which approximates
fair value.
The fair value of a financial instrument is the amount at which the instrument
could be exchanged in a current transaction between willing parties, other than
in a forced or liquidation sale. As such, the estimated fair value of a
financial instrument may differ significantly from the amount that could be
realized if the security were sold immediately.
Other-Than-Temporary Impairments
One of the significant estimations inherent in the valuation of investments is
the evaluation of other-than-temporary impairments. The evaluation of
impairments is a quantitative and qualitative process, which is subject to risks
and uncertainties and is intended to determine whether declines in the fair
value of investments should be recognized in current period earnings. The risks
and uncertainties include changes in general economic conditions, the issuer's
financial condition or near term recovery prospects and the effects of changes
in interest rates. The Company's accounting policy requires that a decline in
the value of a security below its amortized cost basis be assessed to determine
if the decline is other-than-temporary. If so, the security is deemed to be
other-than-
15
temporarily impaired, and a charge is recorded in net realized
capital losses equal to the difference between the fair value and amortized cost
basis of the security. The fair value of the other-than-temporarily impaired
investment becomes its new cost basis. The Company has a security monitoring
process overseen by a committee of investment and accounting professionals that
identifies securities that, due to certain characteristics, as described below,
are subjected to an enhanced analysis on a quarterly basis.
Securities not subject to Emerging Issues Task Force ("EITF") Issue No. 99-20,
"Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets" ("non-EITF Issue No. 99-20
securities"), that are depressed by twenty percent or more for six months are
presumed to be other-than-temporarily impaired unless the depression is the
result of rising interest rates or significant objective verifiable evidence
supports that the security price is temporarily depressed and is expected to
recover within a reasonable period of time. Non-EITF Issue No. 99-20 securities
depressed less than twenty percent or depressed twenty percent or more but for
less than six months are also reviewed to determine if an other-than-temporary
impairment is present. The primary factors considered in evaluating whether a
decline in value for non-EITF Issue No. 99-20 securities is other-than-temporary
include: (a) the length of time and the extent to which the fair value has been
less than cost, (b) the financial condition, credit rating and near-term
prospects of the issuer, (c) whether the debtor is current on contractually
obligated interest and principal payments and (d) the intent and ability of the
Company to retain the investment for a period of time sufficient to allow for
recovery.
For certain securitized financial assets with contractual cash flows (including
asset-backed securities), EITF Issue No. 99-20 requires the Company to
periodically update its best estimate of cash flows over the life of the
security. If the fair value of a securitized financial asset is less than its
carrying amount and there has been a decrease in the present value of the
estimated cash flows since the last revised estimate, considering both timing
and amount, then an other-than-temporary impairment charge is recognized.
Projections of expected future cash flows may change based upon new information
regarding the performance of the underlying collateral.
For securities expected to be sold, an other-than-temporary impairment charge is
recognized if the Company does not expect the fair value of a security to
recover to amortized cost prior to the expected date of sale. Once an impairment
charge has been recorded, the Company continues to review the
other-than-temporarily impaired securities for additional other-than-temporary
impairments.
Valuation of Derivative Instruments
Derivative instruments are reported at fair value based upon either independent
market quotations for exchange traded derivative contracts, independent third
party pricing sources or pricing valuation models which utilize independent
third party data as inputs. Valuation of derivatives underlying the GMWB
investment product is discussed below.
Valuation of Guaranteed Minimum Withdrawal Benefit Embedded Derivatives
An embedded derivative instrument is reported at fair value based upon
internally established valuations that are consistent with external valuation
models, quotations furnished by dealers in such instrument or market quotations.
The Company has calculated the fair value of the guaranteed minimum withdrawal
benefit ("GMWB") embedded derivative liability based on actuarial assumptions
related to the projected cash flows, including benefits and related contract
charges, over the lives of the contracts, incorporating expectations concerning
policyholder behavior. Because of the dynamic and complex nature of these cash
flows, stochastic techniques under a variety of market return scenarios and
other best estimate assumptions are used. Estimating these cash flows involves
numerous estimates and subjective judgments including those regarding expected
market rates of return, market volatility, correlations of market returns and
discount rates. At each valuation date, the Company assumes expected returns
based on risk-free rates as represented by the current LIBOR forward curve
rates; market volatility assumptions for each underlying index is based on a
blend of observed market "implied volatility" data and annualized standard
deviations of monthly returns using the most recent 20 years of observed market
performance; correlations of market returns across underlying indices is based
on actual observed market returns and relationships over the ten years preceding
the valuation date; and current risk-free spot rates as represented by the
current LIBOR spot curve is used to determine the present value of expected
future cash flows produced in the stochastic projection process.
RESERVES
The Company's insurance subsidiaries establish and carry as liabilities
actuarially determined reserves which are calculated to meet Hartford Life's
future obligations. Reserves for life insurance and disability contracts are
based on actuarially recognized methods using prescribed morbidity and mortality
tables in general use in the United States, which are modified to reflect The
Company's actual experience when appropriate. These reserves are computed at
amounts that, with additions from estimated premiums to be received and with
interest on such reserves compounded annually at certain assumed rates, are
expected to be sufficient to meet the Company's policy obligations at their
maturities or in the event of an insured's death. Changes in or deviations from
the assumptions used for mortality, morbidity, expected future premiums and
interest can significantly affect the Company's reserve levels and related
future operations. Reserves also include unearned premiums, premium deposits,
claims incurred but not reported ("IBNR") and claims reported but not yet paid.
Reserves for assumed reinsurance are computed in a manner that is comparable to
direct insurance reserves.
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
16
services to be performed over future periods, and any amounts previously
assessed against policyholders that are refundable on termination of the
contract.
For investment contracts, policyholder liabilities are equal to the accumulated
policy account values, which consist of an accumulation of deposit payments plus
credited interest, less withdrawals and amounts assessed through the end of the
period. Certain investment contracts include provisions whereby a guaranteed
minimum death benefit is provided in the event that the contractholder's account
value at death is below the guaranteed value. Although the Company reinsures the
majority of the death benefit guarantees associated with its in-force block of
business, declines in the equity market may increase the Company's net exposure
to death benefits under these contracts. In addition, these contracts contain
various provisions for determining the amount of the death benefit guaranteed
following the withdrawal of a portion of the account value by the policyholder.
Partial withdrawals under certain of these contracts may not result in a
reduction in the guaranteed minimum death benefit in proportion to the account
value surrendered. The Company records the death benefit costs, net of
reinsurance, as they are incurred. See Impact of New Accounting Standards
section for a discussion of the Company's adoption of Statement of Position
03-1, "Accounting and Reporting by Insurance Enterprises for Certain
Nontraditional Long-Duration Contracts and for Separate Accounts" (the "SOP") in
2004 and the recording of a liability for GMDB in accordance with the provisions
of the SOP.
For the Company's group disability policies, the level of reserves is based on a
variety of factors including particular diagnoses, termination rates and benefit
levels.
ACCOUNTING FOR CONTINGENCIES
Management follows the requirements of SFAS No. 5 "Accounting for
Contingencies". This statement requires management to evaluate each contingent
matter separately. The evaluation is a two-step process, including: determining
a likelihood of loss, and, if a loss is likely, developing a potential range of
loss. Management establishes reserves for these contingencies at its "best
estimate", or, if no one number within the range of possible losses is more
likely than any other, the Company records an estimated reserve at the low end
of the range of losses. The majority of contingencies currently being evaluated
by the Company relate to litigation and tax matters, which are inherently
difficult to evaluate and subject to significant changes.
CONSOLIDATED RESULTS OF OPERATIONS
EXECUTIVE OVERVIEW
The Company provides investment and retirement products such as variable and
fixed annuities, mutual funds and retirement plan services and other
institutional products; individual and corporate owned life insurance; and,
group benefit products, such as group life and group disability insurance.
The Company derives its revenues principally from: (a) fee income, including
asset management fees, on separate account and mutual fund assets and mortality
and expense fees, as well as cost of insurance charges; (b) fully insured
premiums; (c) certain other fees; and (d) net investment income on general
account assets. Asset management fees and mortality and expense fees are
primarily generated from separate account assets, which are deposited with the
Company through the sale of variable annuity and variable universal life
products and from mutual funds. Cost of insurance charges are assessed on the
net amount at risk for investment-oriented life insurance products. Premium
revenues are derived primarily from the sale of group life and group disability
insurance products.
The Company's expenses essentially consist of interest credited to policyholders
on general account liabilities, insurance benefits provided, dividends to
policyholders, costs of selling and servicing the various products offered by
the Company, and other general business expenses.
The Company's profitability in its variable annuity, mutual fund and to a lesser
extent, variable universal life businesses depends largely on the amount of its
assets under management on which it earns fees and the level of fees charged.
Changes in assets under management are comprised of two main factors: net flows,
which measure the success of the Company's asset gathering and retention efforts
(sales and other deposits less surrenders) and the market return of the funds,
which is heavily influenced by the return on the equity markets. The
profitability of the Company's fixed annuities depends largely on its ability to
earn target spreads between earned investment rates on its general account
assets and interest credited to policyholders. Profitability is also influenced
by operating expense management including the benefits of economies of scale in
its variable annuity businesses in particular. In addition, the size and
persistency of gross profits from these businesses is an important driver of
earnings as it affects the amortization of the deferred policy acquisition
costs.
The Company's profitability in its individual life insurance and group benefits
businesses depends largely on the size of its in force block, the adequacy of
product pricing and underwriting discipline, and the efficiency of its claims
and expense management.
17
OPERATING SUMMARY
2003 VS. 2002
2002 VS. 2001
---- --------
2003 2002 2001 CHANGE CHANGE
---- ---- ---- ------ ------
Fee income $ 2,760 $ 2,577 $ 2,633 7% (2%)
Earned premiums 3,086 2,697 2,975 14% (9%)
Net investment income 2,041 1,849 1,782 10% 4%
Other revenue 131 120 128 9% (6%)
Net realized capital gains (losses) 40 (308) (136) NM (126%)
--------- -------- -------- --- ----
TOTAL REVENUES 8,058 6,935 7,382 16% (6%)
--------- -------- -------- --- ----
Benefits, claims and claim adjustment expenses 4,616 4,158 4,444 11% (6%)
Insurance operating costs and expenses 1,535 1,438 1,390 7% 3%
Amortization of deferred policy acquisition costs
and present value of future profits 769 628 642 22% (2%)
Interest expense 117 112 104 4% 8%
Goodwill amortization -- -- 24 -- (100%)
Other expenses 72 32 13 125% 146%
--------- -------- -------- --- ----
TOTAL BENEFITS, CLAIMS AND EXPENSES 7,109 6,368 6,617 12% (4%)
--------- -------- -------- --- ----
INCOME BEFORE INCOME TAX EXPENSE AND
CUMULATIVE EFFECT OF ACCOUNTING
CHANGES 949 567 765 67% (26%)
Income tax expense 180 10 54 NM (81%)
--------- -------- -------- --- ----
Cumulative effect of accounting changes, net of
tax[1] -- -- (26) -- (100%)
--------- -------- -------- --- ----
NET INCOME $ 769 $ 557 $ 685 38% (19%)
========= ======== ======== === ====
[1] For the year ended December 31, 2001, represents the cumulative impact of
the Company's adoption of SFAS No. 133 of $(23) and EITF Issue 99-20 of
$(3).
The Company is organized into four reportable operating segments: Investment
Products, Individual Life, Group Benefits and Corporate Owned Life Insurance
("COLI"). The Company also includes in an Other category its international
operations, which are primarily located in Japan and Brazil; realized capital
gains and losses; as well as corporate items not directly allocable to any of
its reportable operating segments, principally interest expense; and
intersegment eliminations. The Company defines the following as "NM" or not
meaningful: increases or decreases greater than 200%, or changes from a net gain
to a net loss position, or vice versa.
On December 31, 2003, the Company acquired CNA Financial Corporation's group
life and accident, and short-term and long-term disability businesses for $485
in cash. The purchase price paid on December 31, 2003, was based on a September
30, 2003 valuation of the business acquired. During the first quarter of 2004,
the purchase price will be adjusted to reflect a December 31, 2003 valuation of
the business acquired. The Company currently estimates that adjustment to the
purchase price to be an increase of $51 which primarily reflects the increase in
the surplus of the business acquired in the fourth quarter of 2003. As a result
of the acquisition being effective on December 31, 2003, there were no income
statement effects recorded for the year ended December 31, 2003. On April 2,
2001, the Company acquired the United States individual life insurance, annuity
and mutual fund businesses of Fortis. This transaction was accounted for as a
purchase and, as such, the revenues and expenses generated by this business from
April 2, 2001 forward are included in the Company's consolidated results of
operations. (For further discussion see Note 17 of Notes to Consolidated
Financial Statements).
18
2003 COMPARED TO 2002 -- Revenues increased as a result of realized gains in
2003 as compared to realized losses in 2002. (See the Investments section for
further discussion of investment results and related realized capital losses.)
Also contributing to the increased revenues were higher earned premiums and net
investment income in the Investment Products segment as compared to the prior
year. The increase in earned premiums in Investment Products is attributed to
higher sales in the institutional investment products business, specifically, in
the terminal funding and structured settlement businesses. Additionally, net
investment income increased due to higher general account assets in the
individual annuity business and growth in assets in the institutional
investments business. Fee income in the Investment Products segment was higher
in 2003 compared to a year ago, as a result of higher average account values,
specifically in individual annuities and mutual fund businesses, due primarily
to stronger variable annuity sales. The Individual Life segment reported an
increase in revenues in 2003 compared to a year ago driven by increases in fees
and cost of insurance as life insurance inforce grew and aged, and variable
universal life account values increased 30% due primarily to the growth in the
equity markets. In addition, Group Benefits experienced an increase in revenues
driven by increases in net investment income and earned premiums in 2003 as
compared to a year ago. Partially offsetting these increases were lower fee
income and net investment income in the COLI segment. The decrease in COLI net
investment income for 2003 was primarily due to lower average leveraged COLI
account values as a result of surrender activity. In addition, COLI had lower
fee income due in part to lower sales in 2003, as compared to the prior year.
Benefits, claims and expenses increased primarily due to increases in the
Investment Products segment associated with the growth in the individual annuity
and institutional investments businesses discussed above. Partially offsetting
this increase was a decrease in interest credited expenses in COLI related to
the decline in leverage COLI account values. For the year ended December 31,
2003, COLI other expenses increased due to a $40 after-tax charge, associated
with the settlement for the Bancorp Services, LLC ("Bancorp") litigation. (For
further discussion of the Bancorp litigation, see Note 14 of Notes to
Consolidated Financial Statements.)
Net income increased for the year ended December 31, 2003 due primarily to the
growth in the Investment Products segment and a decrease in net realized capital
losses compared to a year ago. Additionally, Group Benefits net income increased
due principally to more favorable claims experience as compared to the prior
year and continued expense management. Individual Life experienced earnings
growth in 2003 due to increases in fee income, favorable mortality and growth in
the in force business. Partially offsetting these increases was a decrease in
COLI net income of $(33) for the year ended December 31, 2003, as compared to
the prior year period. This decrease includes the effects of a year over year
increase of $29 in the charge for the Bancorp litigation. In addition, there was
an $8 after-tax impact recorded in the first quarter of 2002 related to
favorable development on the Company's estimated September 11 exposure.
The effective tax rate increased in 2003 when compared with 2002 as a result of
higher earnings and lower dividends received deduction ("DRD") related tax
items. The tax provision recorded during 2003, reflects a benefit of $30,
consisting primarily of a change in estimate of the DRD tax benefit reported
during 2002. The change in estimate was the result of actual 2002 investment
performance on the related separate accounts being unexpectedly out of pattern
with past performance, which had been the basis for the estimate. This compares
with a tax benefit of $76 recorded in 2002. (See Note 14 of Notes Consolidated
Financial Statements.) The total DRD benefit related to the 2003 tax year for
the year ended December 31, 2003 was $87 as compared to $63 for the year ended
December 31, 2002.
2002 COMPARED TO 2001 -- Revenues decreased, primarily driven by an increase in
realized capital losses in 2002 as compared to the prior year. (See the
Investments section for further discussion of investment results and related
realized capital losses.) Additionally, COLI experienced a decline in revenues,
as a result of the decrease in leveraged COLI account values as compared to a
year ago, which was partially offset by revenue growth across the other
operating segments. Revenues related to the Investment Products segment
decreased, as a result of lower earned premiums in the institutional investment
product business and a decline in revenues within the individual annuity
operation. Lower assets under management due to the decline in the equity
markets are the principal driver of declining revenues for the individual
annuity operation. The Group Benefits Division experienced an increase in
revenues, as a result of strong sales to new customers and solid persistency
within the in-force block of business. Additionally, Individual Life revenues
increased, as a result of increased life insurance inforce and the Fortis
acquisition.
Total benefits, claims and expenses decreased due primarily to the revenue
changes described above. Expenses decreased in the Investment Products segment,
principally due to a lower change in reserve as a result of the lower earned
premiums discussed above and a $31 increase in death benefits related to the
individual annuity operation, as a result of depressed contractholder account
values driven by the lower equity markets. In addition, 2002 expenses include
$11, after-tax, of accrued expenses recorded within the COLI segment related to
the Bancorp litigation. (For a discussion of the Bancorp litigation, see Note 14
of Notes to Consolidated Financial Statements.) Also included in 2002 expenses
was an after-tax benefit of $8, recorded within "Other", associated with
favorable development related to the estimated September 11 exposure.
Net income decreased, due primarily to lower income in Other as a result of
higher realized capital losses and lower income in the Investment Products
segment as a result of the lower equity markets. These declines were partially
offset by increases in Group Benefits Division as a result of business growth
and stable loss ratios and Individual Life primarily due to the Fortis
acquisition. In addition, the Company recorded, in 2002, an $11 after-tax
expense associated with the Bancorp Litigation and recognized an $8 after-
19
tax benefit due to favorable development related to September 11. In 2001, the
Company recorded a $20 after-tax loss related to September 11.
SEGMENT RESULTS
Below is a summary of net income (loss) by segment.
2003 2002 2001
---- ---- ----
Investment Products $ 510 $ 432 $ 463
Individual Life 145 133 121
Group Benefits 148 128 106
Corporate Owned Life Insurance (1) 32 37
Other (33) (168) (42)
------- ------ ------
NET INCOME $ 769 $ 557 $ 685
------- ------ ------
A description of each segment as well as an analysis of the operating results
summarized above is included on the following pages.
INVESTMENT PRODUCTS
OPERATING SUMMARY
2003 VS. 2002 VS.
2002 2001
2003 2002 2001 CHANGE CHANGE
---- ---- ---- ------ ------
Fee income and other $ 1,744 $ 1,631 $ 1,724 7% (5%)
Earned premiums 764 397 729 92% (46%)
Net investment income 1,273 1,070 884 19% 21%
Net realized capital gains 27 9 2 NM NM
-------- -------- -------- -- ---
TOTAL REVENUES 3,808 3,107 3,339 23% (7%)
-------- -------- -------- -- ---
Benefits, claims and claim adjustment expenses 1,993 1,454 1,652 37% (12%)
Insurance operating costs and other expenses 652 648 608 1% 7%
Amortization of deferred policy acquisition costs and
present value of future profits 542 444 461 22% (4%)
-------- -------- -------- -- ---
TOTAL BENEFITS, CLAIMS AND EXPENSES 3,187 2,546 2,721 25% (6%)
-------- -------- -------- -- ---
INCOME BEFORE INCOME TAX EXPENSE 621 561 618 11% (9%)
Income tax expense 111 129 155 (14%) (17%)
-------- -------- -------- -- ---
NET INCOME $ 510 $ 432 $ 463 18% (7%)
======== ======== ======== == ===
Individual variable annuity account values $ 86,501 $ 64,343 $ 74,581 34% (15%)
Other individual annuity account values 11,215 10,565 9,572 6% 10%
Other investment products account values 26,279 19,921 19,322 32% 3%
-------- -------- -------- -- ---
TOTAL ACCOUNT VALUES 123,995 94,829 103,475 31% (8%)
Mutual fund assets under management 22,462 15,321 16,809 47% 9%
-------- -------- -------- -- ---
TOTAL ASSETS UNDER MANAGEMENT $146,457 $110,150 $120,284 33% (8%)
======== ======== ======== == ===
The Investment Products segment focuses on the savings and retirement needs of
the growing number of individuals who are preparing for retirement, or have
already retired, through the sale of individual variable and fixed annuities,
mutual funds, retirement plan services and other investment products. The
Company is both a leading writer of individual variable annuities and a top
seller of individual variable annuities through banks in the United States.
2003 COMPARED TO 2002 -- Revenues in the Investment Products segment increased
primarily driven by higher earned premiums and higher net investment income. The
increase in earned premiums is due to higher sales of terminal funding and
structured settlement products in the institutional investment products
business. Net investment income increased due to higher general account assets.
General account assets for the individual annuity business were $9.4 billion as
of December 31, 2003, an increase of approximately $800 or 9% from 2002, due
primarily to an increase in individual annuity sales, with the majority of those
new sales electing to use the dollar cost averaging ("DCA") feature. The DCA
feature allows policyholders to earn a credited interest rate in the general
account for a defined period of time as their invested assets are systematically
invested into the separate account funds. Additionally, net
20
investment income related to other investment products increased as a result of
the growth in average assets over the last twelve months in the institutional
investment business, where related general account assets under management
increased $2.4 billion, since December 31, 2002, to $10.4 billion as of December
31, 2003. Assets under management is an internal performance measure used by the
Company since a significant portion of the Company's revenue is based upon asset
values. These revenues increase or decrease with a rise or fall, respectively,
in the level of average assets under management. Fee income in the Investment
Products segment was higher in 2003 compared to a year ago, as a result of
higher average account values, specifically in individual annuities and mutual
fund businesses, due primarily to stronger variable annuity sales and the higher
equity market values compared to the prior year.
Total benefits, claims and expenses increased primarily due to higher terminal
funding and structured settlement sales in the institutional investment business
causing an increase in reserve levels and increased interest credited in the
individual annuity operation as a result of higher general account asset levels.
Additionally, amortization of deferred policy acquisition costs related to the
individual annuity business increased due to higher gross profits.
Net income was higher driven by an increase in revenues in the individual
annuity and other investment product operations as a result of the strong net
flows and growth in the equity markets during 2003 and strong expense
management. In addition, net income increased in 2003 compared to 2002 due to
the favorable impact of $21, resulting from the Company's previously discussed
change in estimate of the DRD tax benefit reported during 2002. The change in
estimate was the result of 2002 actual investment performance on the related
separate accounts being unexpectedly out of pattern with past performance, which
had been the basis for the estimate. The total DRD benefit related to the 2003
tax year for the year ended December 31, 2003 was $81 as compared to $59 for the
year ended December 31, 2002.
2002 COMPARED TO 2001 - Revenues in the Investment Products segment decreased,
primarily due to lower earned premiums in the institutional investment products
business and lower fee income related to the individual annuity operation as
average account values decreased from $85.7 billion to $79.5 billion compared to
prior year, primarily due to the lower equity markets. Partially offsetting
these declines was an increase in net investment income, primarily driven by
growth in the institutional investment product business, where related assets
under management increased $669, or 7%, to $9.7 billion as of December 31, 2002.
Total benefits, claims and expenses decreased, due primarily to a lower change
in reserve as a result of the lower earned premiums discussed above.
Additionally, there was a decrease in amortization of policy acquisition costs
related to the individual annuity business, which declined as a result of lower
gross profits, driven by the decrease in fee income and the increase in death
benefit costs. Partially offsetting these decreases were increases of $84, or
11%, in interest credited on general account assets, $61, or 6%, in commissions
and wholesaling expenses, and $31 in individual annuity death benefit costs due
to the lower equity markets. The increase in operating expenses was primarily
driven by the mutual fund business.
Net income decreased, driven by the lower equity markets resulting in the
decline in revenues in the individual annuity operation and increases in the
death benefit costs incurred by the individual annuity operation.
OUTLOOK
Management believes the market for retirement products continues to expand as
individuals increasingly save and plan for retirement. Demographic trends
suggest that as the "baby boom" generation matures, a significant portion of the
United States population will allocate a greater percentage of their disposable
incomes to saving for their retirement years due to uncertainty surrounding the
Social Security system and increases in average life expectancy. In addition,
the Company believes that it has developed and implemented strategies to
maintain and enhance its position as a market leader in the financial services
industry. This was demonstrated by record individual annuity sales in 2003 of
$16.5 billion (a 42% increase) compared to $11.6 billion and $10.0 billion in
2002 and 2001, respectively. Significantly contributing to the growth in sales
was the introduction of Principal First, a guaranteed minimum withdrawal benefit
rider, which was developed in response to our customers' needs. However, the
competition is increasing in this market and as a result, the Company may not be
able to sustain the level of sales attained in 2003. Based on VARDS, the Company
had 12.6% market share as of December 31, 2003 as compared to 9.4% at December
31, 2002. Additionally, in 2003 The Hartford mutual funds reached $20 billion in
assets faster than any other retail-oriented mutual fund family in history,
according to Strategic Insight.
The growth and profitability of the individual annuity and mutual fund
businesses is dependent to a large degree on the performance of the equity
markets. In periods of favorable equity market performance, the Company may
experience stronger sales and higher net cash flows, which will increase assets
under management and thus increase fee income earned on those assets. In
addition, higher equity market levels will generally reduce certain costs to the
Company of individual annuities, such as GMDB and GMWB benefits. Conversely
though, weak equity markets may dampen sales activity and increase surrender
activity causing declines in assets under management and lower fee income. Such
declines in the equity markets will also increase the cost to the Company of
GMDB and GMWB benefits associated with individual annuities. The Company
attempts to mitigate some of the volatility associated with the GMDB and GMWB
benefits using reinsurance or other risk management strategies, such as hedging.
Future net income for the Company will be affected by the effectiveness of the
risk management strategies the Company has implemented to mitigate the net
21
income volatility associated with the GMDB and GMWB benefits of variable annuity
contracts. For spread based products sold in the Investment Products segment,
the future growth will depend on the ability to earn targeted returns on new
business, given competition and the future interest rate environment.
INDIVIDUAL LIFE
OPERATING SUMMARY
2003 VS. 2002 VS.
2002 2001
---- ----
2003 2002 2001 CHANGE CHANGE
---- ---- ---- ------ ------
Fee income and other $ 747 $ 705 $ 643 6% 10%
Earned premiums (20) (8) 4 (150%) NM
Net investment income 256 262 244 (2%) 8%
Net realized capital losses (1) (1) (1) - -
--------- --------- --------- ---- --
TOTAL REVENUES 982 958 890 3% 8%
--------- --------- --------- ---- --
Benefits, claims and claim adjustment expenses 436 443 385 (2%) 15%
Amortization of deferred policy acquisition costs 176 160 168 10% (5%)
Insurance operating costs and other expenses 161 159 159 1% -
--------- --------- --------- ---- --
TOTAL BENEFITS, CLAIMS AND EXPENSES 773 762 712 1% 7%
--------- --------- --------- ---- --
INCOME BEFORE INCOME TAX EXPENSE 209 196 178 7% 10%
Income tax expense 64 63 57 2% 10%
--------- --------- --------- ---- --
NET INCOME $ 145 $ 133 $ 121 9% 10%
========= ========= ========= ==== ==
Variable universal life account values $ 4,725 $ 3,648 $ 3,993 30% (9%)
--------- --------- --------- ---- --
TOTAL ACCOUNT VALUES $ 8,726 $ 7,557 $ 7,868 15% (4%)
--------- --------- --------- ---- --
Variable universal life insurance in force $ 67,031 $ 66,715 $ 61,617 - 8%
--------- --------- --------- ---- --
TOTAL LIFE INSURANCE IN FORCE $ 130,798 $ 126,680 $ 120,269 3% 5%
--------- --------- --------- ---- --
The Individual Life segment provides life insurance solutions to a wide array of
partners to solve the wealth protection, accumulation and transfer needs of
their affluent, emerging affluent and business insurance clients.
2003 COMPARED TO 2002 - Revenues in the Individual Life segment increased
primarily driven by increases in fees and cost of insurance charges as life
insurance in force grew and aged, and variable universal life account values
increased 30%, driven by the growth in the equity markets in 2003. These
increases were partially offset by lower earned premiums and net investment
income in 2003. The decrease in net investment income was due primarily to lower
investment yields. Earned premiums, which include premiums for ceded
reinsurance, decreased primarily due to increased use of reinsurance.
Total benefits, claims and expenses increased, principally driven by an increase
in amortization of deferred policy acquisition costs. These increases were
partially offset by a decrease in benefit costs in 2003 as compared to 2002 due
to favorable mortality rates compared to the prior year.
Net income increased due to increases in fee income and unusually favorable
mortality. Additionally, net income for the year ended December 31, 2003
includes the favorable impact of $2 DRD benefit resulting from the Company's
previously discussed change in estimate of the DRD tax benefit reported during
2002. The total DRD benefit related to the 2003 tax year for the year ended
December 31, 2003 was $4 as compared to $3 for the year ended December 31, 2002.
2002 COMPARED TO 2001 - Revenues in the Individual Life segment increased,
primarily driven by business growth including the impact of the Fortis
transaction. Total benefits, claims, and expenses increased, driven by the
growth in the business including the impact of the Fortis acquisition. In
addition, mortality rates for 2002 increased as compared to the prior year, but
were in line with management's expectations. Individual Life's earnings
increased for the year ended December 31, 2002, principally due to the
contribution to earnings from the Fortis transaction. The increase in net income
was also impacted by an after-tax loss of $3 related to September 11 in the
third quarter of 2001.
OUTLOOK
The Individual Life segment benefited from unusually favorable mortality during
the fourth quarter. It is not anticipated that similar experience would be
likely to continue. Individual life sales grew to $196 in 2003 from $173 in 2002
with the successful introduction of new universal life and whole life products.
Improved equity markets should help increase variable universal life sales. The
Company also continues to introduce new and enhanced products, which are
expected to increase sales. However, the Company continues to face uncertainty
surrounding estate tax legislation and aggressive competition from life
insurance providers. The Company is actively
22
pursuing broader distribution opportunities to fuel growth, including our
Pinnacle Partners marketing initiative, and anticipates growth at Woodbury
Financial Services.
GROUP BENEFITS
OPERATING SUMMARY
2003 VS. 2002 VS.
2002 2001
---- ----
2003 2002 2001 CHANGE CHANGE
---- ---- ---- ------ ------
Earned premiums and other $ 2,362 $ 2,327 $ 2,259 2% 3%
Net investment income 264 258 255 2% 1%
Net realized capital losses (2) (3) (7) 33% 57%
------- ------- ------- -- ----
TOTAL REVENUES 2,624 2,582 2,507 2% 3%
------- ------- ------- -- ----
Benefits, claims and claim adjustment expenses 1,862 1,878 1,874 (1%) -
Insurance operating costs and other expenses 571 541 498 6% 9%
------- ------- ------- -- ----
TOTAL BENEFITS, CLAIMS AND EXPENSES 2,433 2,419 2,372 1% 2%
------- ------- ------- -- ----
INCOME BEFORE INCOME TAX EXPENSE 191 163 135 17% 21%
Income tax expense 43 35 29 23% 21%
------- ------- ------- -- ----
NET INCOME $ 148 $ 128 $ 106 16% 21%
======= ======= ======= == ====
Fully insured - ongoing premiums $ 2,302 $ 2,295 $ 2,014 - 14%
Buyout premiums 40 13 97 NM (87%)
Military Medicare supplement - - 131 -- (100%)
Other 20 19 17 5% 12%