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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended June 30, 2004
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)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No[ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act)
Yes [ ] No[X]
As of July 31, 2004 there were outstanding 1,000 shares of Common Stock,
$0.01 par value per share, of the registrant, all of which were directly
owned by Hartford Holdings, Inc., a direct wholly owned subsidiary of The
Hartford Financial Services Group, Inc.
The registrant meets the conditions set forth in General Instruction H (1)
(a) and (b) of Form 10-Q and is therefore filing this form with the reduced
disclosure format.
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1
INDEX
PAGE
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Report of Independent Registered Public Accounting Firm 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Condensed Consolidated Statements of Income - Second Quarter
and Six Months ended June 30, 2004 and 2003 4
Condensed Consolidated Balance Sheets - June 30, 2004
and December 31, 2003 5
Condensed Consolidated Statements of Changes in
Stockholder's Equity - Six Months Ended June 30, 2004 and 2003 6
Condensed Consolidated Statements of Cash Flows - Six Months
Ended June 30, 2004 and 2003 7
Notes to Condensed Consolidated Financial Statements 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 20
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 40
ITEM 4. CONTROLS AND PROCEDURES 40
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 40
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 40
Signature 41
Certifications 44
2
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholder
Hartford Life, Inc.
Hartford, Connecticut
We have reviewed the accompanying condensed consolidated balance sheet of
Hartford Life, Inc. and subsidiaries (the "Company") as of June 30, 2004, and
the related condensed consolidated statements of income for the second quarter
and six months ended June 30, 2004 and 2003, and changes in stockholder's
equity, and cash flows for the six months ended June 30, 2004 and 2003. These
interim financial statements are the responsibility of the Company's management.
We conducted our review in accordance with standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with standards
of the Public Company Accounting Oversight Board (United States), the objective
of which is the expression of an opinion regarding the financial statements
taken as a whole. According, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to such condensed consolidated interim financial statements for them to
be in conformity with accounting principles generally accepted in the United
States of America.
We have previously audited, in accordance with standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheet of
the Company as of December 31, 2003 and the related consolidated statements of
income, changes in stockholder's equity, and cash flows for the year then ended
(not presented herein); and in our report dated February 25, 2004, we expressed
an unqualified opinion on those consolidated financial statements. In our
opinion, the information set forth in the accompanying condensed consolidated
balance sheet as of December 31, 2003 is fairly stated, in all material
respects, in relation to the consolidated balance sheet from which it has been
derived.
DELOITTE & TOUCHE LLP
Hartford, Connecticut
August 11, 2004
3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HARTFORD LIFE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
SECOND QUARTER SIX MONTHS
ENDED ENDED
JUNE 30, JUNE 30,
(In millions) (Unaudited) 2004 2003 2004 2003
- ---------------------------------------------------------------------------------------------------------
REVENUES
Fee income and other $ 790 $ 693 $ 1,576 $ 1,337
Earned premiums 970 706 1,965 1,389
Net investment income 858 504 2,059 1,007
Net realized capital gains 26 59 102 15
- ---------------------------------------------------------------------------------------------------------
TOTAL REVENUES 2,644 1,962 5,702 3,748
- ---------------------------------------------------------------------------------------------------------
BENEFITS, CLAIMS AND EXPENSES
Benefits, claims and claim adjustment expenses 1,531 1,086 3,408 2,169
Insurance expenses and other 506 373 1,020 713
Amortization of deferred policy acquisition costs and present
value of future profits 233 175 466 338
Dividends to policyholders 8 25 21 40
Interest expense 22 29 57 58
- ---------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 2,300 1,688 4,972 3,318
- ---------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAX EXPENSE AND CUMULATIVE EFFECT OF
ACCOUNTING CHANGE 344 274 730 430
Income tax expense 89 31 194 61
- ---------------------------------------------------------------------------------------------------------
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE 255 243 536 369
Cumulative effect of accounting change, net of tax - - (23) -
- ---------------------------------------------------------------------------------------------------------
NET INCOME $ 255 $ 243 $ 513 $ 369
- ---------------------------------------------------------------------------------------------------------
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
4
HARTFORD LIFE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
JUNE 30, DECEMBER 31,
(In millions, except for share data) 2004 2003
- --------------------------------------------------------------------------------------------------------
(Unaudited)
ASSETS
Investments
Fixed maturities, available-for-sale, at fair value (amortized cost of
$46,445 and $35,569) $ 47,807 $ 37,462
Equity securities, available-for-sale, at fair value (cost of $377 and $335) 383 357
Equity securities, held for trading, at fair value 8,995 -
Policy loans, at outstanding balance 2,650 2,512
Other investments 1,229 823
- -------------------------------------------------------------------------------------------------------
Total investments 61,064 41,154
Cash 509 265
Premiums receivable and agents' balances 379 335
Reinsurance recoverables 665 604
Deferred policy acquisition costs and present value of future profits 7,073 6,623
Deferred income taxes (444) (486)
Goodwill 796 796
Other assets 1,665 1,668
Separate account assets 130,840 136,633
- -------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 202,547 $ 187,592
=======================================================================================================
LIABILITIES
Reserve for future policy benefits $ 11,753 $ 11,411
Other policyholder funds 46,606 26,186
Short-term debt - 505
Long-term debt 1,050 1,300
Other liabilities 4,556 4,498
Separate account liabilities 130,840 136,633
- -------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 194,805 180,533
=======================================================================================================
Commitments and Contingent Liabilities, Note 4
STOCKHOLDER'S EQUITY
Common Stock - 1,000 shares authorized, issued and outstanding;
par value $0.01 - -
Capital surplus 3,094 2,489
Accumulated other comprehensive income
Net unrealized capital gains on securities, net of tax
Foreign currency translation adjustments
567 903
(44) (43)
Total accumulated other comprehensive income 523 860
Retained earnings 4,125 3,710
- -------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDER'S EQUITY 7,742 7,059
=======================================================================================================
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $ 202,547 $ 187,592
=======================================================================================================
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
5
HARTFORD LIFE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
SIX MONTHS ENDED JUNE 30, 2004
ACCUMULATED OTHER COMPREHENSIVE INCOME
------------------------------------------
NET NET GAIN
UNREALIZED (LOSS) ON
CAPITAL CASH FLOW FOREIGN
GAINS ON HEDGING CURRENCY TOTAL
COMMON CAPITAL SECURITIES, NET INSTRUMENTS, TRANSLATION RETAINED STOCKHOLDER'S
(In millions) (Unaudited) STOCK SURPLUS OF TAX NET OF TAX ADJUSTMENTS EARNINGS EQUITY
- ------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2003 $ - $ 2,489 $ 928 $ (25) $ (43) $ 3,710 $ 7,059
Comprehensive income
Net income 513 513
-------------
Other comprehensive income, net of
tax (1)
Cumulative effect of accounting
change 292 292
Net change in unrealized capital
gains (loss) on securities (2) (575) (575)
Net loss on cash flow hedging
instruments (53) (53)
-------------
Cumulative translation adjustments (1) (1)
-------------
Total other comprehensive income (337)
-------------
Total comprehensive income 176
-------------
Dividends declared (98) (98)
Capital contributions from parent 605 605
- ------------------------------------------------------------------------------------------------------------------------------
BALANCE, JUNE 30, 2004 $ - $ 3,094 $ 645 $ (78) $ (44) $ 4,125 $ 7,742
==============================================================================================================================
SIX MONTHS ENDED JUNE 30, 2003
ACCUMULATED OTHER COMPREHENSIVE INCOME
----------------------------------------------
NET NET GAIN
UNREALIZED (LOSS) ON
CAPITAL CASH FLOW FOREIGN
GAINS ON HEDGING CURRENCY TOTAL
COMMON CAPITAL SECURITIES, NET INSTRUMENTS, TRANSLATION RETAINED STOCKHOLDER'S
(In millions) (Unaudited) STOCK SURPLUS OF TAX NET OF TAX ADJUSTMENTS EARNINGS EQUITY
- ------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2002 $ - $ 1,970 $ 621 $ 126 $ (39) $ 3,010 $ 5,688
Comprehensive income
Net income 369 369
-------------
Other comprehensive income, net of
tax (1)
Net change in unrealized capital 510 510
gains on securities (2)
Net loss on cash flow hedging
instruments (36) (36)
-------------
Cumulative translation adjustments 1 1
-------------
Total other comprehensive income 475
-------------
Total comprehensive income 844
-------------
Dividends declared (35) (35)
- ------------------------------------------------------------------------------------------------------------------------------
BALANCE, JUNE 30, 2003 $ - $ 1,970 $ 1,131 $ 90 $ (38) $ 3,344 $ 6,497
==============================================================================================================================
(1) Unrealized (loss) gain on securities is net of tax (benefit) provision and
other items of $(310) and $275 for the six months ended June 30, 2004 and
2003, respectively. Net (loss) on cash flow hedging instruments is net of
tax (benefit) of $(29) and $(19) for the six months ended June 30, 2004
and 2003. There is no tax effect on cumulative translation adjustments.
(2) Net of reclassification adjustment for gains (losses) realized in net
income of $44 and $(17) for the six months ended June 30, 2004 and 2003,
respectively.
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
6
HARTFORD LIFE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED
JUNE 30,
------------------
(In millions) (Unaudited) 2004 2003
- ------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 513 $ 369
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Net realized capital gains (102) (15)
Cumulative effect of adoption of SOP 03-1 23
Amortization of deferred policy acquisition costs and present value of future profits 466 338
Additions to deferred policy acquisition costs and present value of future profits (971) (728)
Amortization of sales inducements 12 30
Additions to deferred sales inducements (63) (66)
Depreciation and amortization 61 72
(Increase) decrease in premiums receivable and agents' balances (44) 16
Increase in receivables (209) (22)
Decrease in accrued liabilities and payables (136) (20)
(Decrease) increase in other liabilities (130) 276
Decrease in accrued taxes (2) (27)
Change in deferred income taxes 560 34
Increase in liabilities for future policy benefits 342 345
Net increase in equity securities, held for trading (2,759) -
Net receipts from investment contracts credited to policyholder accounts associated
with equity securities, held for trading 3,072 -
Decrease (increase) in reinsurance recoverables 61 (18)
Decrease (increase) in other assets 283 (254)
- ------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 977 330
- ------------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchases of fixed maturity and equity security investments, available-for-sale (7,909) (7,769)
Sales of fixed maturity and equity security investments, available-for-sale 5,585 3,192
Maturity of fixed maturity and equity security investments, available-for-sale 2,131 1,833
Purchase price adjustment of Business/Affiliate (58) -
Other (13) (3)
- ------------------------------------------------------------------------------------------------------------------
NET CASH USED FOR INVESTING ACTIVITIES (264) (2,747)
- ------------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Capital contributions 605 -
Proceeds from issuance of long-term debt 150
Repayment of short-term debt (505) -
Repayment of company obligated mandatorily redeemable preferred securities of subsidiary
trust holding solely parent junior subordinated debentures (250) -
Dividends paid (91) (34)
Net receipts (disbursements) from investment and universal life-type contracts credited to
policyholder accounts (227) 2,313
- ------------------------------------------------------------------------------------------------------------------
NET CASH (USED FOR) PROVIDED BY FINANCING ACTIVITIES (468) 2,429
- ------------------------------------------------------------------------------------------------------------------
Net increase in cash 245 12
Impact of foreign exchange (1) (1)
- ------------------------------------------------------------------------------------------------------------------
Cash - beginning of period 265 179
- ------------------------------------------------------------------------------------------------------------------
CASH - END OF PERIOD $ 509 $ 190
- ------------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
NET CASH PAID DURING THE PERIOD FOR
Income taxes $ 21 $ 20
Interest $ 55 $ 56
7
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in millions, unless otherwise stated)
(Unaudited)
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES
BASIS OF PRESENTATION
Hartford Life, Inc. (a Delaware corporation), together with its
consolidated subsidiaries ("Hartford Life" or the "Company"), is a
leading financial services and insurance organization which provides,
primarily in the United States, investment, retirement, estate
planning and group benefits insurance products to both individual and
business customers in the United States and internationally.
Hartford Life, Inc. is a direct wholly-owned subsidiary of Hartford
Holdings, Inc., a direct wholly-owned subsidiary of The Hartford
Financial Services Group, Inc. ("The Hartford").
On December 31, 2003, the Company acquired the group life and accident, and
short-term and long-term disability business of CNA Financial Corporation.
Accordingly, the Company's results of operations for the quarter and six months
ended June 30, 2004 reflect the inclusion of this business. For further
discussion of the CNA Financial Corporation acquisition, see Note 6 of these
Notes to Condensed Consolidated Financial Statements and Note 17 of Notes to
Consolidated Financial Statements included in Hartford Life's 2003 Form 10-K
Annual Report.
The condensed consolidated financial statements have been prepared on the basis
of accounting principles generally accepted in the United States of America,
which differ materially from the accounting prescribed by various insurance
regulatory authorities. The financial statements include the accounts of
Hartford Life and its wholly-owned as well as controlled majority owned
subsidiaries. Subsidiaries in which the Company has at least 20% interest, but
less than a majority ownership interest, are reported using the equity method.
All intercompany material transactions and balances between Hartford Life, its
subsidiaries and affiliates have been eliminated.
The accompanying condensed, consolidated financial statements and notes as of
June 30, 2004, and for the second quarter and six months ended June 30, 2004 and
2003 are unaudited. These condensed consolidated financial statements reflect
all adjustments (consisting only of normal accruals) which are, in the opinion
of management, necessary for the fair presentation of the financial position,
results of operations, and cash flows for the interim periods. These condensed
financial statements and notes should be read in conjunction with the
consolidated financial statements and notes thereto included in Hartford Life's
2003 Form 10-K Annual Report. The results of operations for the interim periods
should not be considered indicative of results to be expected for the full year.
RECLASSIFICATIONS
Certain reclassifications have been made to prior year financial information to
conform to the current year classifications.
USE OF ESTIMATES
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States of America, requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
The most significant estimates include those used in determining reserves for
future policy benefits and other policyholder funds; deferred policy acquisition
costs and present value of future profits; investments; and commitments and
contingencies.
SIGNIFICANT ACCOUNTING POLICIES
For a description of accounting policies, see Note 2 of Notes to Consolidated
Financial Statements included in Hartford Life's 2003 Form 10-K Annual Report.
INVESTMENTS
As discussed in Note 4 below, on January 1, 2004 the Company reclassified
certain separate account assets to the general account and classified a portion
of these assets as trading securities. Trading securities are recorded at fair
value with subsequent changes in fair value recognized in net investment income.
8
STOCK-BASED COMPENSATION
In January 2003, The Hartford began expensing all stock-based compensation
awards granted or modified after January 1, 2003 under the fair value
recognition provisions of Statement of Financial Accounting Standards ("SFAS")
No. 123, "Accounting for Stock-Based Compensation". The fair value of these
awards will be recognized over the awards' vesting period, generally 3 years.
Hartford Life's employees are included in The Hartford's stock-based
compensation plans, the allocated expense associated with stock-based
compensation for the second quarters ending June 30, 2004 and 2003, was
immaterial. Prior to January 1, 2004, The Hartford used the Black-Scholes model
to estimate the fair value of The Hartford's stock-based compensation. For all
awards granted or modified on or after January 1, 2004, The Hartford used a
binomial option-pricing model that incorporates the possibility of early
exercise of options into the valuation. The binomial model also incorporates The
Hartford's historical forfeiture and exercise experience to determine the option
value. For these reasons, The Hartford believes the binomial model provides a
fair value that is more representative of actual historical experience than the
value calculated under the Black-Scholes model.
All stock-based awards granted or modified prior to January 1, 2003, continue to
be valued using the intrinsic value-based provisions set forth in Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock-Issued to
Employees". Under the intrinsic value method, compensation expense is determined
on the measurement date, which is the first date on which both the number of
shares the employee is entitled to receive and the exercise price are known.
Compensation expense, if any, is measured based on the award's intrinsic value,
which is the excess of the market price of the stock over the exercise price on
the measurement date. The expense related to stock-based employee compensation,
including non-option plans, included in the determination of net income for the
second quarters and six months ended June 30, 2004 and 2003 is less than that
which would have been recognized if the fair value method had been applied to
all awards since the effective date of SFAS No. 123. (For further discussion of
the stock compensation plans, see Note 10 of Notes to Consolidated Financial
Statements included in Hartford Life's 2003 Form 10-K Annual Report.)
ADOPTION OF NEW ACCOUNTING STANDARDS
FSP 97-1
In June 2004, the Financial Accounting Standards Board ("FASB") issued FASB
Staff Position ("FSP") FAS 97-1, "Situations in Which Paragraphs 17(b) and 20 of
FASB Statement No. 97, Accounting and Reporting by Insurance Enterprises for
Certain Long-Duration Contracts and for Realized Gains and Losses from the Sale
of Investments ("SFAS No. 97"), Permit or Require Accrual of an Unearned Revenue
Liability." The implementation of Statement of Position 03-1, "Accounting and
Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration
Contracts and for Separate Accounts" ("SOP 03-1"), raised a question regarding
the interpretation of the requirements of SFAS No. 97 concerning when it is
appropriate to record an unearned revenue liability. This FSP clarifies that
SFAS No. 97 is clear in its intent and language; it is appropriate to recognize
an unearned revenue liability for amounts that have been assessed to compensate
the insurer for services to be performed over future periods. SOP 03-1 describes
one situation, when assessments result in profits followed by losses, where an
unearned revenue liability is required. SOP 03-1 does not amend SFAS No. 97 or
limit the recognition of an unearned revenue liability to the situation
described in SOP 03-1. The guidance in the FSP is effective for financial
statements for fiscal periods beginning after June 18, 2004. The adoption of
this FSP is not expected to have a material impact on the Company's consolidated
financial condition or results of operations. (For further discussion of SOP
03-1, see Note 3.)
SOP 03-1
In July 2003, the Accounting Standards Executive Committee of the American
Institute of Certified Public Accountants ("AICPA") issued SOP 03-1. SOP 03-1
addresses a wide variety of topics, some of which have a significant impact on
the Company. The major provisions of SOP 03-1 require:
- Recognizing expenses for a variety of contracts and contract
features, including guaranteed minimum death benefits ("GMDB"),
certain death benefits on universal-life type contracts and
annuitization options, on an accrual basis versus the previous
method of recognition upon payment;
- Reporting and measuring assets and liabilities of certain separate
account products as general account assets and liabilities when
specified criteria are not met;
- Reporting and measuring the Company's interest in its separate
accounts as general account assets based on the insurer's
proportionate beneficial interest in the separate account's
underlying assets; and
- Capitalizing sales inducements that meet specified criteria and
amortizing such amounts over the life of the contracts using the
same methodology as used for amortizing deferred acquisition costs
("DAC").
SOP 03-1 was effective for financial statements for fiscal years beginning after
December 15, 2003. At the date of initial application, January 1, 2004, the
cumulative effect of the adoption of SOP 03-1 on net income and other
comprehensive income was comprised of the following individual impacts:
9
Net Other
Income Comprehensive
Cumulative Effect of Adoption (Loss) Income (Loss)
- -------------------------------------------------------------
Establishing GMDB and other
benefit reserves for annuity
contracts $ (54) $ --
Reclassifying certain separate
accounts to general accounts 30 294
Other 1 (2)
- -------------------------------------------------------------
Total cumulative effect of adoption $ (23) $ 292
=============================================================
With the adoption of SOP 03-1, certain annuity products were accounted for in
the general account, including reporting of the spreads on the Company's MVA
fixed annuities and variable annuity products offered in Japan on a gross basis
in net investment income and benefits expense. This change in accounting
resulted in increases of $299 and $948 in net investment income and increases of
$250 and $854 in benefits, claims and claim adjustment expenses for the second
quarter and six months ended June 30, 2004, respectively.
FUTURE ADOPTION OF NEW ACCOUNTING STANDARDS
EITF 02-14
In July 2004, the Emerging Issues Task Force ("EITF") reached a final consensus
on Issue 02-14, "Whether an Investor Should Apply the Equity Method of
Accounting to Investments Other Than Common Stock If the Investor Has the
Ability to Exercise Significant Influence Over the Operating and Financial
Policies of the Investee". The EITF concluded that an investor should only apply
the equity method of accounting when it has investments in either common stock
or in-substance common stock of a corporation, provided that the investor has
the ability to exercise significant influence over the operating and financial
policies of the investee. The EITF defined in-substance common stock as an
investment that has risk and reward characteristics that are substantially
similar to common stock.
EITF 02-14 is effective for reporting periods beginning after September 15,
2004. For investments that are in-substance common stock but that were not
accounted for under the equity method prior to the consensus, the effect of
adoption should be reported as a change in accounting principle. For investments
that are not common stock or in-substance common stock but that were accounted
for under the equity method of accounting prior to the consensus, the equity
method of accounting should be discontinued prospectively from the date of
adoption and the investor should evaluate whether the investment should be
prospectively accounted for under SFAS No. 115 "Accounting for Certain
Investments in Debt and Equity Securities" or the cost method under APB Opinion
No. 18, "The Equity Method of Accounting for Investments in Common Stock". The
adoption of this standard is not expected to have a material impact on the
Company's consolidated financial condition or results of operations.
FSP 106-2
In May 2004, the FASB issued FSP FAS No. 106-2, "Accounting and Disclosure
Requirements Related to the Medicare Prescription Drug, Improvement and
Modernization Act of 2003" ("FSP 106-2"), which provides guidance on accounting
for the effects of the Medicare Prescription Drug, Improvement and Modernization
Act of 2003 ("the Act"). The Act introduces (1) a prescription drug benefit
under Medicare and (2) a federal subsidy to sponsors of retiree health care
benefit plans that provide a benefit that is at least "actuarially equivalent"
to Medicare Part D. The FASB concluded that the subsidy should be treated as an
actuarial gain pursuant to SFAS No. 106, "Employers' Accounting for
Postretirement Benefits Other Than Pensions". FSP 106-2 is effective for the
first interim period or annual period beginning after June 15, 2004. If the
effect of the Act is not considered a significant event, the effects of the Act
should be incorporated in the next measurement of plan assets and obligations.
The Hartford has determined that it will be entitled to the subsidy. The
Hartford does not consider the impact of adoption of the Act to have a
significant impact on net periodic postretirement benefit cost or accumulated
postretirement benefit obligation and will include the effects of the Act in the
Hartford's next scheduled re-measurement, January 1, 2005. Hartford Life's
employees are included in The Hartford's postretirement benefits plan, and as
such, the postretirement benefits expenses are allocated to the Company by The
Hartford.
EITF 03-1
In March 2004, the EITF reached a final consensus on Issue 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments".
EITF 03-1 adopts a three-step impairment model for securities within its scope.
The three-step model must be applied on a security-by-security basis as follows:
Step 1: Determine whether an investment is impaired. An investment is impaired
if the fair value of the investment is less than its cost basis.
10
Step 2: Evaluate whether an impairment is other-than-temporary. For debt
securities that cannot be contractually prepaid or otherwise settled in
such a way that the investor would not recover substantially all of its
cost, an impairment is deemed other-than-temporary if the investor does
not have the ability and intent to hold the investment until a
forecasted market price recovery or it is probable that the investor
will be unable to collect all amounts due according to the contractual
terms of the debt security.
Step 3: If the impairment is other-than-temporary, recognize an impairment
loss equal to the difference between the investment's cost basis and
its fair value.
Subsequent to an other-than-temporary impairment loss, a debt security should be
accounted for in accordance with SOP 03-3, "Accounting for Loans and Certain
Debt Securities Acquired in a Transfer". EITF 03-1 does not replace the
impairment guidance for investments accounted for under EITF Issue 99-20,
"Recognition of Interest Income and Impairments on Purchased and Retained
Beneficial Interests in Securitized Financial Assets", however, investors will
be required to determine if a security is other-than-temporarily impaired under
EITF 03-1 if the security is determined not to be impaired under EITF 99-20. The
disclosure provisions of EITF 03-1 adopted by the Company effective December 31,
2003 and included in Note 3 of the Notes to Consolidated Financial Statements
included in Hartford Life's 2003 Form 10-K Annual Report will prospectively
include securities subject to EITF 99-20.
In addition to the disclosure requirements adopted by the Company effective
December 31, 2003, the final consensus of EITF 03-1 included additional
disclosure requirements that are effective for fiscal years ending after June
15, 2004. The impairment evaluation and recognition guidance in EITF 03-1 will
be applied prospectively for all relevant current and future investments,
effective in reporting periods beginning after June 15, 2004. The Company
continues to assess the impact of the impairment evaluation and recognition
guidance in EITF 03-1 on the Company's consolidated financial condition and
results of operations. While certain provisions of EITF 03-1 require significant
judgment by management, the Company currently believes the most significant area
of potential impact will be related to certain asset-backed securities supported
by aircraft lease receivables that are currently accounted for under EITF 99-20.
The Company's gross unrealized loss related to these securities as of June 30,
2004 was approximately $56. The ultimate impairment recognized upon the adoption
of EITF 03-1, if any, will depend on market conditions and management's intent
and ability to hold securities with unrealized losses at the time of impairment
evaluation.
EITF 03-16
In March 2004, the EITF reached a final consensus on Issue 03-16, "Accounting
for Investments in Limited Liability Companies". EITF 03-16 will require
investors in limited liability corporations that have specific ownership
accounts to follow the equity method for investments that are more than minor
(e.g. greater than 3% ownership interest) as prescribed in SOP 78-9, "Accounting
for Investments in Real Estate Ventures", and EITF Topic No. D-46, "Accounting
for Limited Partnership Investments". Investors that do not have specific
ownership accounts or minor ownership interests should follow the significant
influence model prescribed in APB Opinion No. 18 for corporate investments. EITF
03-16 excludes securities that are required to be accounted for as debt
securities based on the guidance in paragraph 14 of SFAS No. 140, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities", and EITF 99-20. EITF 03-16 is effective for quarters beginning
after June 15, 2004 and should be applied as a change in accounting principle.
The adoption of this standard is not expected to have a material impact on the
Company's consolidated financial condition or results of operations.
2. DERIVATIVES AND HEDGING ACTIVITY
DERIVATIVE INSTRUMENTS
The Company utilizes a variety of derivative instruments, including swaps, caps,
floors, forwards, futures and options designed to achieve one of four
Company-approved objectives: to hedge risk arising from interest rate, price or
currency exchange rate volatility; to manage liquidity; to control transaction
costs; or to enter into replication transactions.
On the date the derivative contract is entered into, the Company designates the
derivative as (1) a hedge of the fair value of a recognized asset or liability
("fair value" hedge), (2) a hedge of a forecasted transaction or of the
variability of cash flows to be received or paid related to a recognized asset
or liability ("cash flow" hedge), (3) a foreign-currency fair value or cash flow
hedge ("foreign-currency" hedge), (4) a hedge of a net investment in a foreign
operation or (5) held for other investment and risk management activities, which
primarily involve managing asset or liability related risks which do not qualify
for hedge accounting under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities".
The Company's derivative transactions are permitted uses of derivatives under
the derivatives use plan filed and/or approved, as applicable, by the State of
Connecticut, the State of Illinois and the State of New York insurance
departments. The Company does not make a market or trade in these instruments
for the express purpose of earning short-term trading profits.
For a detailed discussion of the Company's use of derivative instruments, see
Notes 2 and 3 of Notes to Consolidated Financial Statements included in Hartford
Life's 2003 Form 10-K Annual Report.
11
The following table summarizes the notional amount and fair value of derivatives
by hedge designation as of June 30, 2004 and December 31, 2003. The notional
amount of derivative contracts represents the basis upon which pay or receive
amounts are calculated and are not necessarily reflective of credit risk. The
fair value amounts of derivative assets and liabilities are presented on a net
basis in the following table.
June 30, 2004 December 31, 2003
---------------------- -----------------------
Notional Notional
Amount Fair Value Amount Fair Value
- ------------------------------------------------------------------------------------------------------
Cash flow hedge $ 6,042 $ (227) $ 3,285 $ (58)
Fair value hedge 283 (10) 206 (5)
Net investment hedge 200 -- 200 (4)
Other investment and risk management activities 37,397 86 29,927 21
- ------------------------------------------------------------------------------------------------------
TOTAL $43,922 $ (151) $33,618 $ (46)
======================================================================================================
The increase in notional amount since December 31, 2003 is primarily due to an
increase in embedded derivatives associated with guaranteed minimum withdrawal
benefit ("GMWB") product sales, and, to a lesser extent, derivatives transferred
to the general account as a result of the adoption of SOP 03-1 and new hedging
strategies. The decrease in the net fair value of derivative instruments since
December 31, 2003 was primarily due to the rise in interest rates during the
second quarter of 2004, and by derivatives transferred to the general account
pursuant to the adoption of SOP 03-1, partially offset by the increase in
derivatives associated with GMWB.
Due to the adoption of SOP 03-1, derivatives previously included in separate
accounts were reclassified into various other balance sheet classifications. On
January 1, 2004, the notional amount and net fair value of derivative
instruments reclassified totaled $2.9 billion and $(71), respectively. As of
June 30, 2004, $22 of the derivatives were reported in other investments, $103
in other liabilities, and $5 of embedded derivatives in fixed maturities in the
condensed consolidated balance sheets. Management's objective with regard to the
reclassified derivatives along with the notional amount and net fair value as of
June 30, 2004 are as follows:
NOTIONAL
HEDGING STRATEGY AMOUNT FAIR VALUE
- --------------------------------------------------------------------------------------------------------------------------------
CASH FLOW HEDGES
Interest rate swaps - Interest rate swaps are primarily used to convert interest receipts on
floating-rate fixed maturity investments to fixed rates. These derivatives are predominantly used
to better match cash receipts from assets with cash disbursements required to fund liabilities. $ 1,596 $ 18
Foreign currency swaps - Foreign currency swaps are used to convert foreign denominated cash flows
associated with certain foreign denominated fixed maturity investments to U.S. dollars. The foreign
fixed maturities are primarily denominated in Euros and are swapped to minimize cash flow
fluctuations due to changes in currency rates. 413 (103)
FAIR VALUE HEDGES
Interest rate caps and floors - Interest rate caps and floors are used to offset the changes in fair
value related to corresponding interest rate caps and floors that exist in certain of the Company's
variable-rate fixed maturity investments. 111 (2)
OTHER INVESTMENT AND RISK MANAGEMENT ACTIVITIES
Credit default and total return swaps - The Company enters into swap agreements in which the Company
assumes credit exposure or reduces credit exposure from an individual entity, referenced index or
asset pool. 444 --
Interest rate swaps - The Company uses interest rate swaps to manage interest rate risk. 250 16
Options - The Company writes option contracts for a premium to monetize the option embedded in
certain of its fixed maturity investments. 162 --
Foreign currency swaps - The Company enters into foreign currency swaps to hedge the foreign
currency exposures in certain of its foreign fixed maturity investments. 45 (5)
- --------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 3,021 $ (76)
================================================================================================================================
In addition to the derivatives transferred to the general account as a result of
the adoption of SOP 03-1, during the first quarter of 2004, the Company entered
into a series of interest rate swap agreements with a combined notional value of
$350 to hedge a portion of the Company's floating rate guaranteed investment
contracts. These swaps have been designated as cash flow hedges, with the
objective of hedging changes in the benchmark interest rate (LIBOR), and were
structured to offset the payments associated with the guaranteed investment
contracts. As of June 30, 2004, the notional amount and net fair value of these
swaps totaled $350 and $13, respectively.
During the six months ended June 30, 2004, the Company entered into credit
default swap agreements in which the Company pays a derivative counterparty a
periodic fee in exchange for compensation from the counterparty should a credit
event occur on the part of the referenced security issuer. The Company entered
into these agreements as an efficient means to reduce credit exposure to the
specified issuers. As of June 30, 2004, the notional amount and net fair value
of these swaps totaled $534 and less than $1, respectively.
12
During the second quarter of 2004, the Company also entered into a series of
forward starting swap agreements to hedge interest rate exposure on anticipated
fixed-rate asset purchases and anticipated variable cash flows on floating rate
assets due to changes in the benchmark interest rate (LIBOR). These swaps have
been designated as cash flow hedges and were structured to hedge interest rate
exposure inherent in the assumptions used to price primarily certain long-term
disability products. As of June 30, 2004, the notional amount and net fair value
of these swaps totaled $720 and $(22), respectively.
Periodically the Company enters into interest rate swap agreements to terminate
existing swaps in hedging relationships, thereby offsetting the prospective
changes in value in the original swap. During the second quarter of 2004, the
Company cash settled both the original and offsetting swap agreements, resulting
in a reduction in notional amount of approximately $3.2 billion from December
31, 2003. No net realized gain or loss was recorded as a result of the
settlement.
The Company offers certain variable annuity products with a GMWB rider. As of
June 30, 2004 and December 31, 2003, $12.5 billion, or 53%, and $6.2 billion, or
36%, respectively, of account value with the GMWB feature was unreinsured. In
order to minimize the volatility associated with the unreinsured GMWB
liabilities, the Company has established an alternative risk management
strategy. In 2003, the Company began hedging its unreinsured GMWB exposure using
interest rate futures, and Standard and Poor's ("S&P") 500 and NASDAQ index
options and futures contracts. During 2004, the Company began using Europe,
Australasia and Far East ("EAFE") Index swaps to hedge GMWB exposure to
international equity markets.
The total notional amount of derivative contracts purchased to hedge the GMWB
exposure, as of June 30, 2004 and December 31, 2003, was $1.9 billion and $544,
respectively, and net fair value was $79 and $21, respectively. For the second
quarter and six months ended June 30, 2004, net realized capital gains and
losses included the change in market value of both the embedded derivative
related to the GMWB liability and the related derivative contracts that were
purchased as economic hedges, the net effect of which was a gain of $6 and $4,
respectively, before deferred policy acquisition costs and tax effects.
Derivative instruments are recorded at fair value and presented in the condensed
consolidated balance sheets as follows:
June 30, 2004 December 31, 2003
----------------------- -----------------------
Liability Liability
Asset Values Values Asset Values Values
- ------------------------------------------------------------------------------
Other investments $ 142 $ - $ 178 $ -
Reinsurance recoverables - 81 - 89
Other policyholder funds 125 - 115 -
Fixed maturities 5 - 7 -
Other liabilities - 342 - 257
- ------------------------------------------------------------------------------
TOTAL $ 272 $ 423 $ 300 $ 346
==============================================================================
For the second quarter and six months ended June 30, 2004 and 2003, the
Company's gross gains and losses representing the total ineffectiveness of all
fair value and net investment hedges were less than $1, with the net impact
reported as net realized capital gains and losses. For the second quarter and
six months ended June 30, 2004, the Company recorded a net loss due to
ineffectiveness on cash flow hedges of $3, after-tax, primarily associated with
interest rate swap hedges, in net realized capital gains and losses. For the
second quarter and six months ended June 30, 2003, the cash flow hedge
ineffectiveness was less than $1.
The total change in value for other derivative-based strategies which do not
qualify for hedge accounting treatment, including the periodic net coupon
settlements, are reported as net realized capital gains and losses in the
condensed consolidated statements of income. For the second quarter and six
months ended June 30, 2004, the Company recognized an after-tax net gain of $14
and $21, respectively, for derivative-based strategies which do not qualify for
hedge accounting treatment. For the second quarter and six months ended June 30,
2003, the after-tax net gain was $1 and $5, respectively.
As of June 30, 2004, the after-tax deferred net gains on derivative instruments
in accumulated other comprehensive income ("AOCI") that are expected to be
reclassified to earnings during the next twelve months are $11. This expectation
is based on the anticipated interest payments on hedged investments in fixed
maturity securities that will occur over the next twelve months, at which time
the Company will recognize the deferred net gains or losses as an adjustment to
interest income over the term of the investment cash flows. The maximum term
over which the Company is hedging its exposure to the variability of future cash
flows (for all forecasted transactions, excluding interest payments on
variable-rate fixed maturities) is twenty-four months. For the second quarter
and six months ended June 30, 2004 and 2003, there were no reclassifications
from AOCI to earnings resulting from the discontinuance of cash flow hedges.
The net investment hedge of the Japanese Life operation was established in the
fourth quarter of 2003. The after-tax amount of net gain (loss) included in the
foreign currency cumulative translation adjustment associated with the net
investment hedge was less than $1 and $(3) as of June 30, 2004 and December 31,
2003, respectively.
13
3. DEATH BENEFITS AND OTHER INSURANCE BENEFIT FEATURES
The Company sells variable annuity contracts, through separate accounts, that
offer various guaranteed death benefits. The Company currently reinsures a
significant portion of these death benefit guarantees associated with its
in-force block of business. Upon adoption of SOP 03-1, the Company recorded a
liability for GMDB and other benefits sold with variable annuity products of
$225 and a related reinsurance recoverable asset of $108. As of June 30, 2004,
the liability from GMDB and other benefits sold with variable annuity products
was $212 with a related reinsurance recoverable asset of $92. The net GMDB
liability is established by estimating the expected value of net reinsurance
costs and net death benefits in excess of the projected account balance and
recognizing the excess death benefits and net reinsurance costs ratably over the
accumulation period based on total expected assessments. The determination of
the GMDB liability and related reinsurance recoverable is based on models that
involve a range of scenarios and assumptions, including those regarding expected
market rates of return and volatility, contract surrender rates and mortality
experience. The assumptions used are consistent with those used in determining
estimated gross profits for purposes of amortizing deferred acquisition costs.
The following table provides details concerning GMDB exposure for the Retail
Products Group which comprises substantially all of the GMDB exposure:
BREAKDOWN OF VARIABLE ANNUITY ACCOUNT VALUE BY GMDB NET AMOUNT AT RETAINED NET
TYPE ACCOUNT VALUE RISK AMOUNT AT RISK
------------- ------------- --------------
Maximum anniversary value (MAV) [1]
- ----------------------------------------------------------------------------------------------------------------
MAV only $61,264 $ 8,299 $ 913
With 5% rollup [2] 4,132 672 121
With Earnings Protection Benefit Rider (EPB) [3] 3,974 134 40
With 5% rollup & EPB 1,469 112 19
- ----------------------------------------------------------------------------------------------------------------
Total MAV 70,839 9,217 1,093
Asset Protection Benefit (APB) [4] 11,627 17 10
Ratchet [5] (5 years) 43 3 --
Reset [6] (5-7 years) 8,478 863 862
Return of Premium [7]/Other 1,517 11 11
- ----------------------------------------------------------------------------------------------------------------
TOTAL $92,504 $10,111 $ 1,976
================================================================================================================
[1] MAV: the death benefit is the greatest of current account value, net
premiums paid and the highest account value on any anniversary before age
80 (adjusted for withdrawals).
[2] Rollup: the death benefit is the greatest of the MAV, current account
value, net premium paid and premiums (adjusted for withdrawals)
accumulated at generally 5% simple interest up to the earlier of age 80 or
100% of adjusted premiums.
[3] EPB: The death benefit is the greatest of the MAV, current account value,
or contract value plus a percentage of the contract's growth. The
contract's growth is account value less premiums net of withdrawals,
subject to a cap of 200% of premiums net of withdrawals.
[4] APB: the death benefit is the greater of current account value or MAV, not
to exceed current account value plus 25% times the greater of net premiums
and MAV (each adjusted for premiums in the past 12 months).
[5] Ratchet: the death benefit is the greatest of current account value, net
premiums paid and the highest account value on any specified anniversary
before age 85 (adjusted for withdrawals).
[6] Reset: the death benefit is the greatest of current account value, net
premiums paid and the most recent five to seven year anniversary account
value before age 80 (adjusted for withdrawals).
[7] Return of premium: the death benefit is the greater of current account
value and net premiums paid.
The Individual Life segment sells universal life-type contracts with certain
secondary guarantees, such as a guarantee that the policy will not lapse, even
if the account value is reduced to zero, as long as the policyholder makes
scheduled premium payments. The cumulative effect on net income upon recording
liabilities for secondary guarantees, in accordance with SOP 03-1, was not
material. Currently there is diversity in industry practice and inconsistent
guidance surrounding the application of SOP 03-1 to universal life-type
contracts. An AICPA task force has been convened to develop guidance surrounding
the methodology for determining reserves for universal life-type contracts and
the related secondary guarantees. This may result in an adjustment to the
cumulative effect of adopting SOP 03-1 and could impact future earnings.
4. SEPARATE ACCOUNT PRESENTATION
Hartford Life's maintains separate account assets and liabilities, which are
reported at fair value. Separate account assets are segregated from other
investments and investment income and gains and losses accrue directly to the
policyholder. See Note 3 for a discussion of death benefit guarantees offered in
variable annuity contracts sold through separate accounts. The fees earned for
administrative and contract holder maintenance services performed for these
separate accounts are included in fee income. During 2004, there were no gains
or losses on transfers of assets from the general account to the separate
account. The Company had recorded certain market value adjusted ("MVA") fixed
annuity products and modified guarantee life insurance (primarily the Company's
Compound Rate Contract ("CRC") and associated assets) as separate account assets
and liabilities through December 31, 2003. Notwithstanding the market value
adjustment feature in this product, all of the investment performance of the
separate account assets is not being passed to the contract
14
holder, and it therefore, does not meet the conditions for separate account
reporting under SOP 03-1. Separate account assets and liabilities related to CRC
of $11 billion were reclassified to, and revalued in, the general account upon
adoption of SOP 03-1.
Prior to the adoption of SOP 03-1 the Company had also recorded its variable
annuity products offered in Japan in separate account assets and liabilities
through December 31, 2003. These assets are not legally insulated from general
creditors and therefore did not meet the conditions for separate account
reporting under SOP 03-1. On January 1, 2004, separate account assets and
liabilities in Japan of $6.2 billion were reclassified to the general account
with no change in value. The investment assets were recorded at fair value in a
trading securities portfolio. As of June 30, 2004, due to strong sales of Japan
variable annuity products and positive performance of the Japanese equity
markets these assets had increased to $9.3 billion.
5. SALES INDUCEMENTS
The Company currently offers enhanced crediting rates or bonus payments to
contract holders on certain of its individual and group annuity products.
Through December 31, 2003, the expense associated with offering certain of these
bonuses was deferred and amortized over the contingent deferred sales charge
period. Others were expensed as incurred. Effective January 1, 2004, upon
adopting SOP 03-1, the expense associated with offering a bonus is deferred and
amortized over the life of the related contract in a pattern consistent with the
amortization of deferred policy acquisition costs. Also, effective January 1,
2004, amortization expense associated with expenses previously deferred is
recorded over the remaining life of the contract rather than over the contingent
deferred sales charge period. Changes in deferred sales inducement activity were
as follows:
SECOND QUARTER ENDED SIX MONTHS ENDED
JUNE 30, 2004 JUNE 30, 2004
-------------------- ----------------
Balance, beginning of period $ 225 $ 198
Sales inducements deferred 30 63
Amortization charged to income (6) (12)
----- -----
Balance at June 30, 2004 $ 249 $ 249
===== =====
6. GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets", and accordingly ceased all amortization of goodwill. As of
June 30, 2004 and December 31, 2003, the carrying amount of goodwill for the
Company's Retail Products segment was $150 and the Company's Other segment was
$646.
The following table shows the Company's acquired intangible assets that continue
to be subject to amortization and aggregate amortization expense. Except for
goodwill, the Company has no material intangible assets with indefinite useful
lives.
AS OF JUNE 30, 2004 AS OF DECEMBER 31, 2003
---------------------------- ---------------------------
GROSS ACCUMULATED GROSS ACCUMULATED
CARRYING NET CARRYING NET
AMORTIZED INTANGIBLE ASSETS AMOUNT AMORTIZATION AMOUNT AMORTIZATION
- ----------------------------------------------------------------------------------------------------------
Present value of future profits $652 $135 $658 $115
- ----------------------------------------------------------------------------------------------------------
TOTAL $652 $135 $658 $115
==========================================================================================================
Net amortization expense for the second quarter ended June 30, 2004 and 2003 was
$12 and $9, respectively. Net amortization expense for the six months ended June
30, 2004 and 2003 was $20 and $14, respectively.
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 September 30,
2003 statutory surplus. During the second quarter of 2004, the purchase price
was finalized for $543 in cash based on the actual statutory surplus at December
31, 2003. The Company continues to integrate this acquisition and obtain the
information necessary to finalize the initial estimates in purchase accounting.
The Company expects to finalize those initial fair value estimates within the
one year allocation period, ending December 31, 2004.
The Company has agreed to offer over 40,000 London Pacific Life and Annuity
Company ("London Pacific") deferred annuity customers, representing
approximately $1.5 billion in account value, the opportunity to exchange to a
Hartford Life Insurance Company contract in the third quarter of 2004. Hartford
Life Insurance Company will also assume approximately 6,000 immediate annuities
and
15
2,000 universal life policies from London Pacific pursuant to orders entered by
the Wake County Superior Court of North Carolina. The transactions are expected
to be completed in three separate blocks between July 2004 and March 2005.
Estimated future net amortization expense for the succeeding five years is as
follows:
FOR THE YEAR ENDING DECEMBER 31,
- -------------------------------------------------
2004 $ 40
2005 $ 34
2006 $ 32
2007 $ 30
2008 $ 28
- -------------------------------------------------
7. COMMITMENTS AND CONTINGENCIES
LITIGATION
Hartford Life is or may become involved in various 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 the provisions made for
potential losses and costs of defense, will not be material to the consolidated
financial position 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.
REGULATORY DEVELOPMENTS
There continues to be significant 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
has received requests for information and subpoenas from the Securities and
Exchange Commission ("SEC"), a subpoena from the New York Attorney General's
Office, and requests for information from the Connecticut Securities and
Investments Division of the Department of Banking, in each case requesting
documentation and other information regarding various mutual fund regulatory
issues. The Company continues to respond to requests for documents and
information from representatives from the SEC's Office of Compliance Inspections
and Examinations in connection with their ongoing compliance examinations
regarding market timing and late trading, revenue sharing and directed
brokerage, fees, fund service providers and transfer agents, and other mutual
fund-related issues. In addition, the SEC's Division of Enforcement has
commenced an investigation of the Company's variable annuity and mutual fund
operations. The Company continues to cooperate fully with the SEC and other
regulatory agencies.
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 have announced settlements of enforcement actions with
various regulatory agencies, primarily the SEC and the New York Attorney
General's Office. While no such action has been initiated against the Company,
it is possible that the SEC or one or more other regulatory agencies may pursue
action against the Company in the future. If such an action is brought, it could
have a material effect on the Company.
Like numerous other insurance carriers, The Hartford has received a subpoena
from the New York Attorney General's Office in connection with its inquiry into
compensation arrangements between brokers and carriers. The Hartford is
cooperating with the inquiry. Consistent with long-standing and wide-spread
industry practice, The Hartford makes incentive compensation payments to brokers
that may be based on the volume, growth and/or profitability of business placed
with The Hartford. The Hartford expects the independent brokers with whom we
work to comply with all applicable laws, including any concerning the disclosure
of compensation arrangements. At this early stage, it is too soon to tell what
impact, if any, the investigation will have on The Hartford.
On August 9, 2004, the Financial Services Agency, the Company's primary
regulator in Japan, issued draft regulations concerning new reserving
methodologies and Solvency Margin Ratio ("SMR") standards for variable annuity
contracts. The draft regulations are subject to a 30 day comment period. The
industry and Institute of Actuaries of Japan ("IAJ") have been consulting with
the regulators on the development of the new methodologies and SMR standards.
The final regulations, which may or may not reflect changes proposed by the
industry, the IAJ or others during the comment period, are expected to become
16
effective in April 2005. Although the new reserve methodologies and SMR
standards would only apply to capital requirements for Japanese regulatory
purposes, it is likely that the Company would need to provide additional capital
to support its Japanese operations, which would lower the Company's return on
invested capital for this business. Management is still evaluating the impact of
the draft regulations on the Company's Japanese operations. At this time, it is
not possible to predict the final form of any reserve methodology or SMR
standard changes.
TAX MATTERS
The Company's Federal income tax returns are routinely audited by the Internal
Revenue Service ("IRS"). The Company is currently under audit for the 1998-2001
tax years. Although there has been no agreement reached between the Company and
the IRS at this time, the amount of tax related to the separate account
dividends-received deduction ("DRD") that is under discussion for all open years
could result in a benefit to the Company's financial position and future results
of operations. There can be no assurances that such an agreement will be
reached. (For further discussion of the Company's separate account DRD, see Note
14 of Notes to Consolidated Financial Statements included in the Company's 2003
Form 10-K Annual Report.) Management believes that adequate provision has been
made in the financial statements for any potential assessments that may result
from tax examinations and other tax-related matters for all open tax years.
8. DEBT
SHORT-TERM DEBT June 30, 2004 December 31, 2003
------------------------------------
Related Party Debt $ -- $ 305
Current maturities of long-term debt -- 200
- --------------------------------------------------------------------------------
TOTAL SHORT-TERM DEBT $ -- $ 505
================================================================================
LONG-TERM DEBT June 30, 2004 December 31, 2003
- --------------------------------------------------------------------------------
7.10% Notes, due 2007 $ 200 $ 200
7.65% Notes, due 2027 250 250
7.375% Notes, due 2031 400 400
- --------------------------------------------------------------------------------
JUNIOR SUBORDINATED DEBENTURES
- --------------------------------------------------------------------------------
7.20% Notes, due 2038 -- 250
- --------------------------------------------------------------------------------
7.625% Notes, due 2050 200 200
================================================================================
TOTAL LONG-TERM DEBT $ 1,050 $ 1,300
================================================================================
On January 30, 2004, the Company received a capital contribution in the form of
cash of $305 from The Hartford which was used by the Company to fund the payment
and settlement of the related party note agreements totaling $305 with The
Hartford.
In March 2004, the Company received a capital contribution of $200 from The
Hartford which was used, with additional available cash, to redeem, at par, on
March 15, 2004, $250 million aggregate principal amount of its 7.20 percent
Junior Subordinated Deferrable Interest Debentures, due June 30, 2038,
underlying the 7.20 percent Trust Preferred Securities, Series A, originally
issued by Hartford Life Capital Trust I. The redemption price was $25 per share,
plus accumulated and unpaid distributions thereon to March 15, 2004, in the
amount of $0.30 per share. The Company recorded a $7, before-tax, expense for
the unamortized costs associated with these preferred securities in the first
quarter of 2004.
On June 15, 2004, the Company received a capital contribution of $100 from The
Hartford which was used, with additional available cash, to repay $200 of 6.9%
senior notes at maturity.
SHELF REGISTRATION
On May 15, 2001, the Company filed with the SEC a shelf registration statement
for the potential offering and sale of up to $1.0 billion in debt and preferred
securities. The registration statement was declared effective on May 29, 2001.
As of June 30, 2004, HLI had $1.0 billion remaining on its shelf.
JUNIOR SUBORDINATED DEBENTURES
The Hartford and the Company have formed statutory business trusts ("The
Hartford Trusts "), which exist for the exclusive purposes of (i) issuing Trust
Securities representing undivided beneficial interests in the assets of the
Trust; (ii) investing the gross proceeds of the Trust Securities in Junior
Subordinated Deferrable Interest Debentures ("Junior Subordinated Debentures")
of The Hartford or the Company; and (iii) engaging in only those activists
necessary or incidental thereto. The Hartford may enter into guarantees with
respect to the preferred securities of any of The Hartford Trusts.
17
COMMERCIAL PAPER
Hartford Life has a commercial paper program, which allows it to borrow up to a
maximum amount of $250 in short-term commercial paper notes. As of June 30,
2004, the Company had no outstanding borrowings under the program. In addition,
the Company's Japanese operation, Hartford Life Insurance KK, has a $18 line of
credit with a Japanese bank. As of June 30, 2004, the Company had no outstanding
borrowings under either facility.
9. TRANSACTIONS WITH AFFILIATES
For a description of transactions with affiliates, see Note 15 of Notes to
Consolidated Financial Statements included in Hartford Life's 2003 Form 10-K
Annual Report.
10. SEGMENT INFORMATION
The Company has changed its reportable operating segments from Investment
Products, Individual Life, Group Benefits and Corporate Owned Life Insurance
("COLI") to Retail Products Group ("Retail"), Institutional Solutions Group
("Institutional"), Individual Life and Group Benefits. Retail offers individual
variable and fixed annuities, mutual funds, retirement plan products and
services to corporations under Section 401(k) plans and other investment
products. Institutional primarily offers retirement plan products and services
to municipalities under Section 457 plans, other institutional investment
products and private placement life insurance. Individual Life sells a variety
of life insurance products, including variable universal life, universal life,
interest sensitive whole life and term life insurance. Group Benefits sells
group insurance products, including group life and group disability insurance as
well as other products, including medical stop loss and supplementary medical
coverages to employers and employer sponsored plans, accidental death and
dismemberment, travel accident and other special risk coverages to employers and
associations. Hartford Life also includes in an Other category its international
operations, which are primarily located in Japan and Brazil; net realized
capital gains and losses other than periodic net coupon settlements on
non-qualifying derivatives and net realized capital gains and losses related to
guaranteed minimum withdrawal benefits; corporate items not directly allocated
to any of its reportable operating segments; and intersegment eliminations.
Periodic net coupon settlements on non-qualifying derivatives and net realized
capital gains and losses related to guaranteed minimum withdrawal benefits are
reflected in each applicable segment in net realized capital gains and losses.
The accounting policies of the reportable operating segments are the same as
those described in "Basis of Presentation and Accounting Policies" in Note 2 in
the Company's 2003 Form 10-K Annual Report. Hartford Life evaluates performance
of its segments based on revenues, net income and the segment's return on
allocated capital. The Company charges direct operating expenses to the
appropriate segment and allocates the majority of indirect expenses to the
segments based on an intercompany expense arrangement. Intersegment revenues
primarily occur between corporate and the operating segments. These amounts
primarily include interest income on allocated surplus, interest charges on
excess separate account surplus, the allocation of net realized capital gains
and losses, and the allocation of credit risk charges. The Company's revenues
are primarily derived from customers within the United States. The Company's
long-lived assets primarily consist of deferred policy acquisition costs and
deferred tax assets from within the United States. The following tables present
summarized financial information concerning the Company's segments. Segment
information for the previous period has been restated to reflect the change in
composition of reportable operating segments.
18
Retail Institutional
Products Solutions Individual Group
JUNE 30, 2004 Group Group Life Benefits Other Total
- --------------------------------------------------------------------------------------------------------------------------
SECOND QUARTER ENDED
Total revenues $ 764 $ 434 $ 252 $1,000 $ 194 $2,644
Net income 128 28 37 48 14 255
- --------------------------------------------------------------------------------------------------------------------------
Retail Institutional
Products Solutions Individual Group
JUNE 30, 2003 Group Group Life Benefits Other Total
- --------------------------------------------------------------------------------------------------------------------------
SECOND QUARTER ENDED
Total revenues $ 533 $ 470 $ 240 $ 638 $ 81 $1,962
Net income 121 29 36 35 22 243
- --------------------------------------------------------------------------------------------------------------------------
Retail Institutional
Products Solutions Individual Group
JUNE 30, 2004 Group Group Life Benefits Other Total
- --------------------------------------------------------------------------------------------------------------------------
SIX MOINTHS ENDED
Total revenues $1,527 $ 876 $ 506 $2,004 $ 789 $5,702
Net income 235 56 70 95 57 513
- --------------------------------------------------------------------------------------------------------------------------
Retail Institutional
Products Solutions Individual Group
JUNE 30, 2003 Group Group Life Benefits Other Total
- --------------------------------------------------------------------------------------------------------------------------
SIX MOINTHS ENDED
Total revenues $1,011 $ 892 $ 484 $1,305 $ 56 $3,748
Net income (loss) 198 60 68 69 (26) 369
- --------------------------------------------------------------------------------------------------------------------------
19
ITEM 2. 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 June 30, 2004,
compared with December 31, 2003, and its results of operations for the second
quarter and six months ended June 30, 2004 compared with the equivalent period
in 2003. This discussion should be read in conjunction with the MD&A included in
the Company's 2003 Form 10-K Annual Report.
Certain of the statements contained herein are forward-looking statements. These
forward-looking statements are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995 and include estimates and
assumptions related to economic, competitive and legislative developments. These
forward-looking statements are subject to change and uncertainty which are, in
many instances, beyond the Company's control and have been made based upon
management's expectations and beliefs concerning future developments and their
potential effect upon the Company. There can be no assurance that future
developments will be in accordance with management's expectations or that the
effect of future developments on the 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
difficulty in predicting the Company's potential exposure for the possible
occurrence of terrorist attacks; the response of reinsurance companies under
reinsurance contracts and the availability, pricing and adequacy of reinsurance
to protect the Company against losses; changes in the stock markets, interest
rates or other financial markets, including the potential effect on the
Company's statutory capital levels; 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 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 possibility of more
unfavorable loss experience than anticipated; stronger than anticipated
competitive activity; unfavorable judicial or legislative developments,
including the possibility that the Terrorism Risk Insurance Act of 2002 is not
extended beyond 2005; the potential effect of domestic and foreign regulatory
developments, which could increase the Company's business costs and required
capital levels; the possibility of general economic and business conditions that
are less favorable than anticipated; 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 20
Consolidated Results of Operations - Operating Summary 21
Retail Products Group 23
Institutional Solutions Group 24
Individual Life 25
Group Benefits 26
Investments 26
Investment Credit Risk 30
Capital Markets Risk Management 35
Capital Resources and Liquidity 36
Accounting Standards 40
CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States of America ("GAAP"), requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ 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; investments; 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.
20
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 acquisition costs and present value of future profits ("DAC"). At June
30, 2004 and December 31, 2003, the carrying value of the Company's Life
operations' DAC was $7.1 billion and $6.6 billion, respectively. For statutory
accounting purposes, such costs are expensed as incurred.
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 gross profits or "EGPs". This range was then compared to the present value of
EGPs currently utilized in the DAC amortization model. As of June 30, 2004, 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 June 30, 2004
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 30% or
less from June 30 levels for the balance of 2004, or 20% or less over the next
twelve months, and if certain other assumptions that are implicit in the
computations of the EGPs are achieved. For further discussion of these
assumptions, see the Critical Accounting Estimates section of the Company's 2003
Form 10-K Annual Report under the heading "Deferred Policy Acquisition Costs and
Present Value of Future Profits".
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 June 30,
2004. If the Company assumed a 9% average long-term rate of growth from June 30,
2004 forward along with other appropriate assumption changes in determining the
revised EGPs, the Company estimates the cumulative increase to amortization
would be approximately $3-$7, 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 $32-$35, after-tax. Assuming that such an adjustment was
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.
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 June 30, 2004, the Company believed variable annuity
separate account assets could fall by at least 45% before portions of its DAC
asset would be unrecoverable.
OTHER CRITICAL ACCOUNTING ESTIMATES
There have been no material changes to the Company's critical accounting
estimates regarding reserves for future policy benefits and other policyholder
funds; investments; and commitments and contingencies since the filing of the
Company's 2003 Form 10-K Annual Report.
CONSOLIDATED RESULTS OF OPERATIONS
ORGANIZATIONAL STRUCTURE
The Company has changed its reportable operating segments from Investment
Products, Individual Life, Group Benefits and Corporate Owned Life Insurance
("COLI") to Retail Products Group ("Retail"), Institutional Solutions Group
("Institutional"), Individual Life and Group Benefits. Retail offers individual
variable and fixed annuities, mutual funds, retirement plan products and
services to corporations under Section 401(k) plans and other investment
products. Institutional primarily offers retirement plan products and services
to municipalities under Section 457 plans, other institutional investment
products and private placement life insurance. Individual Life sells a variety
of life insurance products, including variable universal life, universal life,
interest sensitive whole life and term life insurance. Group Benefits sells
group insurance products, including group life and group disability insurance as
well as other products, including medical stop loss and supplementary medical
coverages to employers and employer sponsored plans, accidental death and
dismemberment, travel accident and other special risk coverages to employers and
associations. The Company also includes,
21
in an Other category, its international operations, which are primarily located
in Japan and Brazil; net realized capital gains and losses other than periodic
net coupon settlements on non-qualifying derivatives and net realized capital
gains and losses related to guaranteed minimum withdrawal benefits; corporate
items not directly allocated to any of its reportable operating segments; and
intersegment eliminations. Periodic net coupon settlements on non-qualifying
derivatives and net realized capital gains and losses related to guaranteed
minimum withdrawal benefits are reflected in each applicable segment in net
realized capital gains and losses.
SECOND QUARTER ENDED SIX MONTHS
JUNE 30, JUNE 30,
--------------------------------------------------------
OPERATING SUMMARY 2004 2003 CHANGE 2004 2003 CHANGE
- -------------------------------------------------------------------------------------------------------------------------------
Earned premiums $ 970 $ 706 37% $ 1,965 $ 1,389 42%
Fee income 790 656 20% 1,576 1,273 24%
Net investment income[1] 858 504 70% 2,059 1,007 104%
Other revenue - 37 (100%) - 64 (100%)
Net realized capital gains (losses) 26 59 (56%) 102 15 NM
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 2,644 1,962 35% 5,702 3,748 52%
- -------------------------------------------------------------------------------------------------------------------------------
Benefits, claims and claim adjustment expenses [1] 1,531 1,086 41% 3,408 2,169 57%
Amortization of deferred policy acquisition costs and
present value of future profits 233 175 33% 466 338 38%
Insurance operating costs and expenses 514 398 29% 1,041 753 38%
Interest expense 22 29 (24%) 57 58 (2%)
- -------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 2,300 1,688 36% 4,972 3,318 50%
- -------------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF
ACCOUNTING CHANGE 344 274 26% 730 430 70%
Income tax expense 89 31 187% 194 61 NM
- -------------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE 255 243 5% 536 369 45%
Cumulative effect of accounting change, net of tax [2] -- -- -- (23) -- NM
- -------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 255 $ 243 5% $ 513 $ 369 39%
- -------------------------------------------------------------------------------------------------------------------------------
[1] With the adoption of SOP 03-1, certain annuity products were required to
be accounted for in the general account. This change in accounting
resulted in increases of $299 and $948 in net investment income and
increases of $250 and $854 in benefits, claims and claim adjustment
expenses for the second quarter and six months ended June 30, 2004,
respectively.
[2] For the six months ended June 30, 2004, represents the cumulative impact
of the Company's adoption of SOP 03-1.
The Company defines "NM" as not meaningful for increases or decreases greater
than 200%, or changes from a net gain to a net loss position, or vice versa.
The Company's net income increased for the second quarter of 2004 compared to
2003 due primarily to net income increases in Group Benefits, Retail and
international operations, partially offset by lower realized capital gains. (See
the Investments section for further discussion of investment results and related
realized capital gains.) Net income in the Group Benefits segment increased due
to earned premiums and net investment income growth, primarily resulting from
the Company's acquisition of the group life and accident, and short-term and
long-term disability businesses of CNA Financial Corporation ("CNA
Acquisition"). Net income in the Retail segment increased, principally driven by
growth in the variable annuity and mutual fund businesses as a result of
increasing assets under management. Partially offsetting the increase in the
Retail segment was lower spread income on market value adjusted ("MVA") fixed
annuities due to the adoption of SOP 03-1. Net income for the international
operations, which is included in the other category, increased over the
comparable prior year period primarily driven by the increase in assets under
management of the Japan annuity business. Japan's assets under management have
grown to $9.3 billion at June 30, 2004 from $3.1 billion at June 30, 2003.
For the six months ended June 30, 2004 compared to 2003, net income increased
primarily due to higher net realized capital gains, higher net income in the
Retail segment, Group Benefits segment and international operations as discussed
in the previous paragraph. Partially offsetting the positive earnings drivers
for the six months ended June 30, 2004 was the cumulative effect of the
accounting change from the Company's adoption of SOP 03-1. The adoption of SOP
03-1 also resulted in certain changes in presentation in the Company's financial
statements, including reporting of the spreads on the Company's MVA fixed
annuities and variable annuity products offered in Japan on a gross basis in net
investment income and benefits expense. Exclusive of the cumulative effect,
overall application of SOP 03-1 resulted in an immaterial reduction in net
income. (For further discussion of the impact of the Company's adoption of SOP
03-1 see Note 1 of Notes to Condensed Consolidated Financial Statements).
22
RETAIL PRODUCTS GROUP
OPERATING SUMMARY SECOND QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------------------------------
2004 2003 CHANGE 2004 2003 CHANGE
- -----------------------------------------------------------------------------------------------------------------------------
Fee income and other $ 513 $ 401 28% $ 1,019 $ 765 33%
Earned premiums (17) 1 NM (31) (8) NM
Net investment income 266 128 108% 538 245 120%
Net realized capital gains 2 3 (33%) 1 9 (89%)
- -----------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 764 533 43% 1,527 1,011 51%
- -----------------------------------------------------------------------------------------------------------------------------
Benefits, claims and claim adjustment expenses 259 153 69% 516 300 72%
Amortization of deferred policy acquisition costs
and present value of future profits 160 114 40% 327 217 51%
Insurance operating costs and other expenses 180 149 21% 355 281 26%
- -----------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 599 416 44% 1,198 798 50%
- -----------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF
ACCOUNTING CHANGE 165 117 41% 329 213 54%
Income tax expense (benefit) 37 (4) NM 75 15 NM
- -----------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE 128 121 6% 254 198 28%
Cumulative effect of accounting change, net of tax [1] -- -- -- (19) -- NM
- -----------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 128 $ 121 6% $ 235 $ 198 19%
=============================================================================================================================
JUNE 30, JUNE 30,
2004 2003 CHANGE
- -----------------------------------------------------------------------------------------------------------
Individual variable annuity account values $ 92,504 $ 73,748 25%
Other individual annuity account values 11,372 10,587 7%
401K and Specialty products account values 5,588 3,720 50%
- -----------------------------------------------------------------------------------------------------------
TOTAL ACCOUNT VALUES [2] 109,464 88,055 24%
Mutual fund assets under management 23,897 17,012 40%
- -----------------------------------------------------------------------------------------------------------
TOTAL ASSETS UNDER MANAGEMENT $133,361 $105,067 27%
- -----------------------------------------------------------------------------------------------------------
S&P 500 INDEX VALUE AT END OF PERIOD 1,141 975 17%
===========================================================================================================
[1] For the six months ended June 30, 2004, represents the cumulative impact
of the Company's adoption of SOP 03-1.
[2] Includes policyholder balances for investment contracts and reserves for
future policy benefits for insurance contracts.
Net income in the Retail segment increased for the second quarter and six months
ended June 30, 2004, principally driven by significant growth in the assets
under management within the variable annuity and mutual fund businesses. The
Company uses assets under management as an internal performance measure.
Relative profitability of the Retail segment is highly correlated to the growth
in assets under management since the segment generally earns fee income on a
daily basis on its assets under management. Assets und