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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 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 002-46577
HARTFORD LIFE INSURANCE COMPANY
(Exact name of registrant as specified in its charter)
CONNECTICUT 06-0974148
(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 October 31, 2004 there were outstanding 1,000 shares of Common Stock,
$5,690 par value per share, of the registrant.
The registrant meets the conditions set forth in General Instruction H (1) (a)
and (b) of Form 10-Q and is therefore filing this form with the reduced
disclosure format.
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INDEX
PAGE
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS 3
Report of Independent Registered Public Accounting Firm 3
Condensed Consolidated Statements of Income - Third quarter and Nine
Months Ended September 30, 2004 and 2003 4
Condensed Consolidated Balance Sheets - As of September 30, 2004
and December 31, 2003 5
Condensed Consolidated Statements of Changes in Stockholder's
Equity - Nine Months Ended September 30, 2004 and 2003 6
Condensed Consolidated Statements of Cash Flows - Nine Months Ended
September 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 39
ITEM 4. CONTROLS AND PROCEDURES 39
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 40
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 41
Signature 42
Certifications 45
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholder
Hartford Life Insurance Company
Hartford, Connecticut
We have reviewed the accompanying condensed consolidated balance sheet of
Hartford Life Insurance Company and subsidiaries (the "Company") as of September
30, 2004, and the related condensed consolidated statements of income for the
third quarter and nine months ended September 30, 2004 and 2003, and changes in
stockholder's equity, and cash flows for the nine months ended September 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. Accordingly, 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 except for
Note 14 of the consolidated financial statements as to which the date is May 27,
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
November 10, 2004
3
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
THIRD QUARTER NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
- -----------------------------------------------------------------------------------------------------------------------
(In millions) (Unaudited) 2004 2003 2004 2003
- -----------------------------------------------------------------------------------------------------------------------
REVENUES
Fee income and other $ 645 $ 556 $ 1,892 $ 1,572
Earned premiums 159 448 343 763
Net investment income 625 447 1,841 1,315
Net realized capital gains (losses) 24 (2) 111 3
- -----------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 1,453 1,449 4,187 3,653
- -----------------------------------------------------------------------------------------------------------------------
BENEFITS, CLAIMS AND EXPENSES
Benefits, claims, and claim adjustment expenses 824 895 2,296 2,110
Insurance expenses and other expenses 184 145 515 460
Amortization of deferred policy acquisition costs and
present value of future profits 194 173 588 461
Dividends to policyholders 3 16 24 56
- -----------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 1,205 1,229 3,423 3,087
- -----------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAX (BENEFIT) EXPENSE AND CUMULATIVE
EFFECT OF ACCOUNTING CHANGE 248 220 764 566
Income tax (benefit) expense (147) 53 (10) 110
- -----------------------------------------------------------------------------------------------------------------------
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE
395 167 774 456
Cumulative effect of accounting change, net of tax -- -- (18) --
- -----------------------------------------------------------------------------------------------------------------------
NET INCOME $ 395 $ 167 $ 756 $ 456
- -----------------------------------------------------------------------------------------------------------------------
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
4
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 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
$40,344 and $28,511) $ 42,393 $ 30,085
Equity securities, available for sale, at fair value (cost of $146 and $78) 147 85
Equity securities, held for trading, at fair value 1 -
Policy loans, at outstanding balance 2,620 2,470
Other investments 956 639
------------ -----------
Total investments 46,117 33,279
------------ -----------
Cash 46 96
Premiums receivable and agents' balances 23 17
Reinsurance recoverables 1,347 1,297
Deferred policy acquisition costs and present value of future profits 6,316 6,088
Deferred income taxes (686) (486)
Goodwill 186 186
Other assets 1,365 1,238
Separate account assets 131,490 130,225
- -------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 186,204 $ 171,940
- -------------------------------------------------------------------------------------------------------------
LIABILITIES
Reserve for future policy benefits $ 6,921 $ 6,518
Other policyholder funds 37,037 25,263
Other liabilities 3,649 3,330
Separate account liabilities 131,490 130,225
- -------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 179,097 165,336
- -------------------------------------------------------------------------------------------------------------
Commitments and Contingent Liabilities, Note 8 - -
STOCKHOLDER'S EQUITY
Common Stock - 1,000 shares authorized, issued and outstanding;
par value $5,690 6 6
Capital surplus 2,240 2,240
Accumulated other comprehensive income
Net unrealized capital gains on securities, net of tax 932 711
Foreign currency translation adjustments (1) (1)
------------ -----------
Total accumulated other comprehensive income 931 710
Retained earnings 3,930 3,648
- -------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDER'S EQUITY 7,107 6,604
- -------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $ 186,204 $ 171,940
- -------------------------------------------------------------------------------------------------------------
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
5
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2004
ACCUMULATED OTHER
COMPREHENSIVE INCOME
--------------------
NET
UNREALIZED NET (LOSS)
CAPITAL ON
GAINS CASH FLOW FOREIGN
(LOSSES) ON HEDGING CURRENCY TOTAL
COMMON CAPITAL SECURITIES, INSTRUMENTS, TRANSLATION RETAINED STOCKHOLDER'S
(In millions) (Unaudited) STOCK SURPLUS NET OF TAX NET OF TAX ADJUSTMENTS EARNINGS EQUITY
- ------------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2003 6 $ 2,240 $ 728 $ (17) $ (1) $ 3,648 $ 6,604
Comprehensive income
Net income 756 756
--------------
Other comprehensive income, net of
tax (1)
Cumulative effect of accounting 292 292
change
Net change in unrealized capital
losses on securities (2) (32) (32)
Net loss on cash flow hedging
instruments (39) (39)
--------------
Total other comprehensive income 221
--------------
Total comprehensive income 977
--------------
Dividends declared (474) (474)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, SEPTEMBER 30, 2004 $ 6 $ 2,240 $ 988 $ (56) $ (1) $ 3,930 $ 7,107
- ------------------------------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, 2003
ACCUMULATED OTHER
COMPREHENSIVE INCOME
----------------------
NET NET GAIN
UNREALIZED (LOSS) ON
CAPITAL CASH FLOW FOREIGN
GAINS ON HEDGING CURRENCY TOTAL
COMMON CAPITAL SECURITIES, INSTRUMENTS, TRANSLATION RETAINED STOCKHOLDER'S
(In millions) (Unaudited) STOCK SURPLUS NET OF TAX NET OF TAX ADJUSTMENTS EARNINGS EQUITY
- ----------------------------------------------------------------------------------------------------------------------------------
Balance, December 31, 2002 $ 6 $ 2,041 $ 463 $ 111 $ (1) $ 3,197 $ 5,817
Comprehensive income
Net income 456 456
-------------
Other comprehensive income, net of
tax (1)
Net change in unrealized capital
gains on securities (2) 268 268
Net loss on cash flow hedging
instruments (67) (67)
Cumulative translation adjustments
-------------
Total other comprehensive income 201
-------------
Total comprehensive income 657
-------------
Capital contribution 199 199
Dividends declared (100) (100)
- ---------------------------------------------------------------------------------------------------------------------------------
BALANCE, SEPTEMBER 30, 2003 $ 6 $ 2,240 $ 731 $ 44 $ (1) $ 3,553 $ 6,573
- ---------------------------------------------------------------------------------------------------------------------------------
(1) Unrealized capital gains(losses) on securities is reflected net of tax
(benefit) provision of $(17) and $144 for the nine months ended September
30, 2004 and 2003, respectively. Net gain (loss) on cash flow hedging
instruments is net of tax benefit of $(21) and $(36) for the nine months
ended September 30, 2004 and 2003, respectively. There is no tax effect on
cumulative translation adjustments.
(2) Net of reclassification adjustment for gains (losses) realized in net
income of $61 and $(3) for the nine months ended September 30, 2004 and
2003, respectively.
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
6
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED
SEPTEMBER 30,
(In millions) (Unaudited) 2004 2003
- -----------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 756 $ 456
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Net realized capital gains (111) (3)
Cumulative effect of adoption of SOP 03-1 18 --
Amortization of deferred policy acquisition costs and present value of future profits 588 461
Additions to deferred policy acquisition costs and present value of future profits (1,046) (954)
Depreciation and amortization 62 92
Increase in premiums receivable and agents' balances (6) (5)
(Decrease) increase in other liabilities (334) 185
Increase in receivables (226) (41)
Decrease in payables and accruals (93) (42)
Decrease in accrued taxes payable (40) (66)
Decrease in deferred income taxes 529 39
Amortization of sales inducements 19 50
Additions to deferred sales inducements (91) (101)
Increase in future policy benefits 403 703
Decrease (increase) in reinsurance recoverables 19 (41)
Decrease in other assets 146 131
- -----------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 593 864
- -----------------------------------------------------------------------------------------------------------------
INVESTING ACTIVITIES
Purchases of fixed maturity and equity security investments, available-for-sale (10,696) (9,455)
Sales of fixed maturity and equity security investments, available-for-sale 7,405 3,630
Maturities of fixed maturity and equity security investments, available-for-sale 2,658 2,461
Other 3 48
- -----------------------------------------------------------------------------------------------------------------
NET CASH USED FOR INVESTING ACTIVITIES (630) (3,316)
- -----------------------------------------------------------------------------------------------------------------
FINANCING ACTIVITIES
Capital Contributions - 199
Dividends paid (474) (100)
Net receipts for investment and universal life-type contracts charged against policyholder
accounts 461 2,360
- -----------------------------------------------------------------------------------------------------------------
NET CASH (USED FOR) PROVIDED BY FINANCING ACTIVITIES (13) 2,459
- -----------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash (50) 7
Cash - beginning of period 96 79
- -----------------------------------------------------------------------------------------------------------------
CASH - END OF PERIOD $ 46 $ 86
- -----------------------------------------------------------------------------------------------------------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
NET CASH PAID DURING THE PERIOD FOR
Income taxes $ 32 $ 36
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
7
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 Insurance Company (a Connecticut corporation), together with its
consolidated subsidiaries ("Hartford Life Insurance Company" or the "Company"),
is a leading financial services and insurance organization which provides
investment, retirement, estate planning and group benefits products. The Company
is a wholly-owned subsidiary of Hartford Life and Accident Insurance Company
("HLA"), a wholly-owned subsidiary of Hartford Life, Inc. ("Hartford Life").
Hartford Life is a direct subsidiary of Hartford Holdings, Inc., a direct
subsidiary of The Hartford Financial Services Group, Inc. ("The Hartford"), the
Company's ultimate parent company.
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 Insurance Company and its wholly-owned as well as controlled
majority owned subsidiaries. All material intercompany transactions and balances
among Hartford Life Insurance Company, its subsidiaries and affiliates have been
eliminated.
The accompanying condensed consolidated financial statements and notes as of
September 30, 2004, and for the third quarter and nine months ended September
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 Insurance Company's 2003 Form 10-K Annual Report and
Report on Form 8-K filed on May 28, 2004. Hartford Life Insurance Company filed
the Form 8-K on May 28, 2004 to report the Company's updating of certain
historical segment information included in its Annual Report on Form 10-K for
the year ended December 31, 2003, to give effect to the Company's new reportable
operating segments. (For further discussion of the new reportable operating
segments, see Note 2.) 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 Insurance Company's 2003 Form
10-K Annual Report.
8
INVESTMENTS
As discussed in Note 7 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.
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 Insurance Company's employees are included in The Hartford's stock
compensation plans, the allocated expense associated with stock-based
compensation for the third quarters ending September 30, 2004 and 2003, was
immaterial. Prior to January 1, 2004, The Hartford used the Black-Scholes model
to determine the fair value of The Hartford's stock-based compensation. For all
awards granted or modified on or after January 1, 2004, The Hartford uses 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
third quarters and nine months ended September 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 2 of Notes to Consolidated Financial
Statements included in Hartford Life Insurance Company's 2003 Form 10-K Annual
Report.)
ADOPTION OF NEW ACCOUNTING STANDARDS
During September 2004, the American Institute of Certified Public Accountants
released a set of technical questions and answers on financial accounting and
reporting issues related to Statement of Position 03-1, "Accounting and
Reporting by Insurance Enterprises for Certain Nontraditional Long Duration
Contracts and for Separate Accounts" (SOP 03-1). The questions and answers
focused on the application of certain provisions of SOP 03-1 to components of
universal life-type contracts, including the definition of an insurance benefit
feature, the definition of an assessment, the appropriate level of aggregation
in determining additional liabilities required by SOP 03-1, situations where the
amounts assessed against the contract holder for an insurance benefit feature
are expected to result in losses in early and subsequent years of a contract's
life, the impact of reinsurance and the accounting for contracts that provide
annuitization benefits. Adoption of this guidance did not have a material impact
on the Company's balance sheet or statement of operations.
FUTURE ADOPTION OF ACCOUNTING STANDARDS
EITF 03-1
In March 2004, the Emerging Issues Task Force ("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 was effective for periods
beginning after June 15, 2004 and 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.
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
9
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 99-20, "Recognition
of Interest Income and Impairments on Purchased and Retained Beneficial
Interests in Securitized Financial Assets", however, it requires investors to
determine if a security is other-than-temporarily impaired under EITF 03-1 if
the security is determined not to be other-than-temporarily impaired under EITF
99-20.
In September 2004, the FASB staff issued clarifying guidance for comment in FSP
EITF Issue 03-1-a, "Implementation Guidance for the Application of Paragraph 16
of EITF Issue No. 03-1, `The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments'", (FSP 03-1-a) and subsequently voted to
delay the implementation of the impairment measurement and recognition guidance
contained in paragraphs 10 - 20 of EITF 03-1 in order to reconsider certain
aspects of the consensus as well as the implementation guidance included in FSP
03-1-a. The disclosure guidance in paragraphs 21 and 22 of the standard remains
effective.
The ultimate impact the adoption of EITF 03-1 will have on the Company's
consolidated financial condition and results of operations is still unknown.
Depending on the nature of the ultimate guidance, adoption of the standard could
potentially result in the recognition of unrealized losses, including those
declines in value that are attributable to interest rate movements, as
other-than-temporary impairments, except those deemed to be minor in nature. As
of September 30, 2004, the Company had $184 of total gross unrealized losses.
The amount of impairments to be recognized, if any, will depend on the final
standard, market conditions and management's intent and ability to hold
securities with unrealized losses at the time of the impairment evaluation.
2. SEGMENT INFORMATION
With the recent change in Hartford Life Insurance Company's internal
organization, the Company has changed its reportable operating segments from
Investment Products, Individual Life and Corporate Owned Life Insurance ("COLI")
to Retail Products Group ("Retail"), Institutional Solutions Group
("Institutional") and Individual Life. Retail offers individual variable and
fixed annuities, 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 (formerly COLI). Individual Life sells a variety of life insurance
products, including variable universal life, universal life, interest sensitive
whole life and term life insurance. Hartford Life Insurance Company also
includes in an Other category 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 allocable to any of its reportable operating
segments, intersegment eliminations as well as certain group benefit products
including group life and group disability insurance that is directly written by
the Company and is substantially ceded to its direct parent HLA. 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 Insurance Company
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.
10
Retail Institutional
Products Solutions Individual
Group Group Life Other Total
- -------------------------------------------------------------------------------------------------------------
THIRD QUARTER ENDED SEPTEMBER 30, 2004
Total revenues $ 705 $ 442 $ 239 67 $ 1,453
Net income [1] 109 30 39 217 395
- -------------------------------------------------------------------------------------------------------------
THIRD QUARTER ENDED SEPTEMBER 30, 2003
Total revenues 459 726 227 37 1,449
Net income 84 38 36 9 167
- -------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, 2004
Total revenues 1,960 1,303 699 225 4,187
Net income [1] 280 73 106 297 756
- -------------------------------------------------------------------------------------------------------------
NINE MONTHS ENDED SEPTEMBER 30, 2003
Total revenues 1,289 1,605 666 93 3,653
Net income 246 91 99 20 456
- -------------------------------------------------------------------------------------------------------------
[1] For the third quarter and nine months ended September 30, 2004, includes a
$187 tax benefit recorded in the Other category, which relates to agreement
with the IRS on the resolution of matters pertaining to tax years prior to
2004. For further discussion of this tax benefit, see Note 8.
3. INVESTMENTS AND DERIVATIVE INSTRUMENTS
The following table identifies the Company's fixed maturity investments by
sector, as of September 30, 2004 and December 31, 2003.
COMPONENTS OF FIXED MATURITY INVESTMENTS
SEPTEMBER 30, 2004 DECEMBER 31, 2003
------------------------------------------- ------------------------------------------
GROSS GROSS GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES FAIR VALUE COST GAINS LOSSES VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
Bonds and Notes
U.S. Gov't and Gov't agencies and
authorities (guaranteed and sponsored) $ 743 $ 15 $ (3) $ 755 $ 641 $ 8 $ (2) $ 647
U.S. Gov't and Gov't agencies and
authorities (guaranteed and sponsored)
-- asset-backed 2,215 30 (7) 2,238 2,059 33 (4) 2,088
States, municipalities and political
subdivisions 634 26 (7) 653 307 6 (7) 306
International governments 656 55 (2) 709 641 55 (1) 695
Public utilities 2,009 168 (8) 2,169 1,195 103 (5) 1,293
All other corporate including 13,808 1,170 (41) 14,937
international 19,118 1,472 (64) 20,526
All other corporate - asset-backed 13,022 463 (89) 13,396 8,649 339 (81) 8,907
Short-term investments 1,946 -- -- 1,946 1,210 1 -- 1,211
Redeemable preferred stock 1 -- -- 1 1 -- -- 1
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 40,344 $ 2,229 $ (180) $ 42,393 $ 28,511 $ 1,715 $ (141) $30,085
- ------------------------------------------------------------------------------------------------------------------------------------
Included in the fair value of total fixed maturities as of September 30, 2004
are $11.1 billion of guaranteed separate account assets. Guaranteed separate
account assets were reclassified to the general account on January 1, 2004 as a
result of the adoption of SOP 03-1 (for further discussion see Note 7 of Notes
to Condensed Consolidated Financial Statements).
11
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 that 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 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 Insurance Company's 2003 Form 10-K Annual Report.
The following table summarizes the notional amount and fair value of derivatives
by hedge designation as of September 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.
SEPTEMBER 30, 2004 DECEMBER 31, 2003
--------------------------- -------------------------------
NOTIONAL AMOUNT FAIR VALUE NOTIONAL AMOUNT FAIR VALUE
- -----------------------------------------------------------------------------------------------------------------------------
Cash flow hedge $ 5,516 $ (180) $ 2,592 $ (49)
Fair value hedge 279 (6) 163 (6)
Other investment and risk management activities 56,533 (32) 33,745 (8)
- ----------------------------------------------------------------------------------------------------------------------------
Total $ 62,328 $ (218) $ 36,500 $ (63)
- ----------------------------------------------------------------------------------------------------------------------------
The increase in notional amount since December 31, 2003 is primarily due to an
increase in embedded derivatives associated with guaranteed minimum withdrawal
benefits ("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 short-term
interest rates during the third quarter of 2004 and derivatives transferred to
the general account pursuant to the adoption of SOP 03-1.
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
September 30, 2004, $28 of the derivatives were reported in other investments,
$(114) in other liabilities, and $4 of embedded derivatives in fixed maturities
in the condensed consolidated balance sheets. Management's objectives with
regard to the reclassified derivatives along with the notional amount and net
fair value are as follows:
12
SEPTEMBER 30, 2004
------------------------
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. $ 1,597 $ 31
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. 434 (109)
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. 419 --
Interest rate swaps - The Company uses interest rate swaps to manage interest rate risk. 210 4
Options - The Company writes option contracts for a premium to monetize the option embedded in
certain of its fixed maturity investments. 121 --
Foreign currency swaps - The Company enters into foreign currency swaps to hedge the foreign currency
exposures in certain of its foreign fixed maturity investments. 62 (6)
- ----------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 2,954 $ (82)
- ----------------------------------------------------------------------------------------------------------------------------------
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 September 30, 2004, the notional amount and net fair value of
these swaps totaled $350 and $2, respectively.
During the nine months ended September 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 September 30, 2004, the notional amount and net fair
value of these swaps totaled $454 and $(1), respectively.
During the nine months ended September 30, 2004, the Company entered into
interest swaps and swaptions to reduce duration risk in the investment
portfolio. These derivative instruments are structured to hedge the durations of
fixed maturity investments to match certain life product liabilities in
accordance with the Company's asset and liability management policy. As of
September 30, 2004, the notional and fair value of these swaps and swaptions
totaled $1.2 billion and $7, 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 nine months ended September
30, 2004, the Company cash settled both the original and offsetting swap
agreements, resulting in a reduction in notional amount of approximately $2.1
billion from December 31, 2003. No net realized gain or loss was recorded as a
result of the settlement.
13
Derivative instruments are recorded at fair value and presented in the condensed
consolidated balance sheets as follows:
SEPTEMBER 30, 2004 DECEMBER 31, 2003
----------------------- -------------------------
LIABILITY LIABILITY
ASSET VALUES VALUES ASSET VALUES VALUES
- ----------------------------------------------------------------------------------------
Other investments $ 64 $ -- $ 116 $ --
Reinsurance recoverables -- 73 -- 115
Other policyholder funds 73 -- 115 --
Fixed maturities 4 -- 7 --
Other liabilities -- 286 -- 186
- ---------------------------------------------------------------------------------------
Total $ 141 $ 359 $ 238 $ 301
- ---------------------------------------------------------------------------------------
For the third quarter and nine months ended September 30, 2004 and 2003, the
Company's gross gains and losses, representing the total ineffectiveness of all
fair value hedges were less than $1, with the net impact reported as net
realized capital gains and losses. For the third quarter and nine months ended
September 30, 2004, the Company recorded a net loss due to ineffectiveness on
cash flow hedges of $(3) and $(6), after-tax, respectively, primarily associated
with interest rate swap hedges, in net realized capital gains and losses. For
the third quarter and nine months ended September 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 periodic net coupon
settlements, are reported as net realized capital gains and losses in the
condensed consolidated statements of income. For the third quarter and nine
months ended September 30, 2004, the Company recognized an after-tax net (loss)
gain of $(3) and $15, respectively, for derivative-based strategies, which do
not qualify for hedge accounting treatment. For the third quarter and nine
months ended September 30, 2003, the after-tax net loss was $(9) and $(10),
respectively.
As of September 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 $8. 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 third
quarter and nine months ended September 30, 2004 and 2003, there were no
reclassifications from AOCI to earnings resulting from the discontinuance of
cash flow hedges.
4. 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. For the
third quarter and nine months ended September 30, 2004 no goodwill was acquired,
impaired or written off. As of September 30, 2004 and December 31, 2003, the
carrying amount of goodwill was $186.
The following table shows the Company's acquired intangible assets that continue
to be subject to amortization and aggregate amortization expense. Except for
goodwill, the Company has no intangible assets with indefinite useful lives.
AS OF SEPTEMBER 30, 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 $ 607 $ 144 $ 605 $ 115
- ------------------------------------------------------------------------------------------------
Total $ 607 $ 144 $ 605 $ 115
Net amortization expense for the third quarters ended September 30, 2004 and
2003 was $10 and $10, respectively. Net amortization expense for the nine months
ended September 30, 2004 and 2003 was $29 and $13, respectively.
14
Estimated future net amortization expense for the succeeding five years is as
follows:
FOR THE YEAR ENDING DECEMBER 31,
2004 $ 38
2005 $ 30
2006 $ 28
2007 $ 26
2008 $ 23
5. DEATH BENEFITS AND OTHER INSURANCE BENEFIT FEATURES
The Company issues variable annuity contracts, with separate account investment
options, 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 $217 and a related reinsurance recoverable asset of $108. As of
September 30, 2004, the liability from GMDB and other benefits sold with
variable annuity products was $182 with a related reinsurance recoverable asset
of $71. The net GMDB liability is established by estimating the expected value
of net reinsurance costs and death benefits in excess of the projected account
balance. The excess death benefits and net reinsurance costs are recognized
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 segment which comprises substantially all of the GMDB exposure:
BREAKDOWN OF VARIABLE ANNUITY ACCOUNT VALUE BY GMDB TYPE
ACCOUNT NET AMOUNT RETAINED NET AMOUNT
Maximum anniversary value (MAV) [1] VALUE AT RISK AT RISK
- ----------------------------------------------------------------------------------------------------------------------------------
MAV only $ 58,782 $ 8,817 $ 1,040
With 5% rollup [2] 3,996 733 137
With Earnings Protection Benefit Rider (EPB) [3] 4,236 146 44
With 5% rollup & EPB 1,425 124 21
- ----------------------------------------------------------------------------------------------------------------------------------
Total MAV 68,439 9,820 1,242
Asset Protection Benefit (APB) [4] 13,837 53 31
Ratchet [5] (5 years) 41 4 --
Reset [6] (5-7 years) 8,011 933 933
Return of Premium [7]/Other 1,751 14 14
- ----------------------------------------------------------------------------------------------------------------------------------
Total $ 92,079 $ 10,824 $ 2,220
- ----------------------------------------------------------------------------------------------------------------------------------
[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 and without
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 additional liabilities for universal life-type contracts and the
related secondary guarantees, in accordance with SOP 03-1, was not material.
15
6. SALES INDUCEMENTS
The Company currently offers enhanced crediting rates or bonus payments to
contractholders 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 the Company's
adoption of 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:
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2004 SEPTEMBER 30, 2004
------------------------------- -------------------------------
Balance, beginning of period $ 249 $ 198
Sales inducements deferred 28 91
Amortization charged to income (7) (19)
------------------------------ -------------------------------
Balance at September 30, 2004 $ 270 $ 270
The Company agreed to offer London Pacific Life and Annuity Company in
Liquidation ("London Pacific") deferred annuity customers the opportunity to
exchange to a Hartford Life Insurance Company ("HLIC") contract in the third
quarter of 2004. The Company assumed the contractual rights and liabilities
arising under approximately 5,500 immediate annuities in the third quarter of
2004 and expects to assume 2,000 universal life policies in the first quarter of
2005 from London Pacific pursuant to orders entered by the Wake County Superior
Court of North Carolina. During the third quarter, the Company completed the
assumption of the immediate annuity contracts. Also during the third quarter,
London Pacific deferred annuity contract holders with $566 of account value
elected to exchange their London Pacific contract for a Hartford Life contract.
Upon the exchange, which occurred in the fourth quarter of 2004, London Pacific
contract holders were given an immediate bonus. This sales inducement amounted
to $26 and will be deferred and amortized over the life of the contracts.
7. SEPARATE ACCOUNT PRESENTATION
Hartford Life Insurance Company maintains separate account assets and
liabilities, which are reported at fair value. Separate account assets are
segregated from other investments. Investment income and gains and losses from
those separate account assets accrue directly to the policyholder. See Note 5
for a discussion of death benefit guarantees offered in variable annuity
contracts sold through separate accounts. The fees earned for administrative and
contractholder 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 contractholder. Therefore, it
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.
8. COMMITMENTS AND CONTINGENCIES
LITIGATION
Hartford Life Insurance Company 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. Such putative class actions have
alleged, for example, improper sales practices in connection with the sale of
life insurance and other investment products, and improper fee arrangements in
connection with mutual funds. 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.
16
Broker Compensation Litigation - On October 14, 2004, the New York Attorney
General's Office filed a civil complaint (the "NYAG Complaint") against Marsh
Inc. and Marsh & McLennan Companies, Inc. (collectively, "Marsh") alleging,
among other things, that certain insurance companies, including The Hartford,
participated with Marsh in arrangements to submit inflated bids for business
insurance and paid contingent commissions to ensure that Marsh would direct
business to them. The Hartford is not joined as a defendant in the action. Since
the filing of the NYAG Complaint, the Company has become aware of several
private actions against The Hartford asserting claims arising from the
allegations of the NYAG Complaint.
The Company is aware of two securities class actions filed in the United States
District Court for the District of Connecticut alleging claims against The
Hartford and five of its executive officers under Section 10(b) of the
Securities Exchange Act and SEC Rule 10b-5. The complaints allege on behalf of a
putative class of shareholders that The Hartford and the five named individual
defendants, as control persons of The Hartford, "disseminated false and
misleading financial statements" by concealing that "[The Hartford] was paying
illegal and concealed 'contingent commissions' pursuant to illegal 'contingent
commission agreements.'" The class period alleged is November 5, 2003 through
October 13, 2004, the day before the NYAG Complaint was filed. The complaints
seek damages and attorneys' fees. The Hartford and the individual defendants
dispute the allegations and intend to defend these actions vigorously.
In addition, the Company is aware of three putative class actions filed in the
same court on behalf of participants in The Hartford's 401(k) plan against The
Hartford, Hartford Fire Insurance Company, The Hartford's Pension Fund Trust and
Investment Committee, The Hartford's Pension Administration Committee, The
Hartford's Chief Financial Officer, and John/Jane Does 1-15. The suits assert
claims under the Employee Retirement Income Security Act of 1974, as amended
("ERISA"), alleging that The Hartford and the other named defendants breached
their fiduciary duties to plan participants by, among other things, failing to
inform them of the risk associated with investment in The Hartford's stock as a
result of the activity alleged in the NYAG Complaint. The class period alleged
is November 5, 2003 through the present. The complaints seek restitution of
losses to the plan, declaratory and injunctive relief, and attorneys' fees. All
defendants dispute the allegations and intend to defend these actions
vigorously.
The Company also is aware of two corporate derivative actions filed in the same
court. The complaints, brought in each case by a shareholder on behalf of The
Hartford against its directors and an executive officer, allege that the
defendants knew adverse non-public information about the activities alleged in
the NYAG Complaint and concealed and misappropriated that information to make
profitable stock trades, thereby breaching their fiduciary duties, abusing their
control, committing gross mismanagement, wasting corporate assets, and unjustly
enriching themselves. The complaints seek damages, injunctive relief,
disgorgement, and attorneys' fees. All defendants dispute the allegations and
intend to defend these actions vigorously.
The Company also is aware of an amended complaint filed on or about October 19,
2004 by OptiCare Health Systems, Inc., on behalf of a putative class of
policyholders, against Marsh, other brokers and consultants, and the insurers
named in the NYAG Complaint, including certain of their respective writing
companies. The putative class action was filed in August 2004 in the United
States District Court for the Southern District of New York and originally
asserted only claims against the broker/consultant defendants. The amended
complaint alleges additional claims against both the broker/consultant
defendants and the insurer defendants. These claims include a claim under the
Racketeer Influenced and Corrupt Organizations Act ("RICO") alleging that the
insurer defendants are co-liable with the broker/consultant defendants for
alleged misrepresentations or non-disclosures of contingent commission
agreements and the solicitation or submission of inflated bids. The amended
complaint also asserts claims under the Sherman Act and state antitrust and
unfair competition laws alleging that the insurer defendants acted in concert
with the broker/consultant defendants to restrain trade. The class period
alleged is August 26, 1994 through the date of class certification, which has
not yet occurred. The amended complaint seeks treble damages, injunctive and
declaratory relief, and attorneys' fees. The Hartford disputes the allegations
in the amended complaint and intends to defend the action vigorously.
Additional complaints may be filed against the Company and The Hartford in
various courts alleging claims under federal or state law arising from the
conduct alleged in the NYAG Complaint. The Company's ultimate liability, if any,
in the pending and possible future suits is highly uncertain and subject to
contingencies that are not yet known, such as how many suits will be filed, in
which courts they will be lodged, what claims they will assert, what the outcome
of investigations by the New York Attorney General's Office and other regulatory
agencies will be, the success of defenses that the Company may assert, and the
amount of recoverable damages if liability is established. In the opinion of
management, it is possible that an adverse outcome in one or more of these suits
could have a material adverse effect on the Company's consolidated results of
operations or cash flows in particular quarterly or annual periods.
17
REGULATORY DEVELOPMENTS
In June 2004, The Hartford received a subpoena from the New York Attorney
General's Office in connection with its inquiry into compensation arrangements
between brokers and carriers. On September 17, 2004, the New York Attorney
General's Office issued two additional subpoenas to The Hartford seeking
information about possible anti-competitive activity among brokers and insurers.
Subsequently, The Hartford has received additional subpoenas from the New York
Attorney General's Office, the Connecticut Attorney General's Office, the
Insurance Division of the Illinois Department of Financial and Professional
Regulation, the Massachusetts Attorney General's Office, the Minnesota
Department of Commerce, the Ohio Attorney General's Office and the Texas
Attorney General's Office regarding broker compensation and possible
anti-competitive activity. The Company and The Hartford may receive additional
subpoenas and other information requests from these or other regulatory agencies
regarding similar issues. The Company and The Hartford intend to continue
cooperating fully with these investigations, and have initiated an internal
review, with the assistance of outside counsel, regarding the issues under
investigation.
On October 14, 2004, the New York Attorney General's Office filed a civil
complaint against Marsh & McLennan Companies, Inc., and Marsh, Inc.
(collectively, "Marsh"). The complaint alleges, among other things, that certain
insurance companies, including The Hartford, participated with Marsh in
arrangements to submit inflated bids for business insurance and paid contingent
commissions to ensure that Marsh would direct business to them. The Hartford is
not joined as a defendant in the action. Although no regulatory action has been
initiated against The Hartford in connection with the allegations described in
the civil complaint, it is possible that the New York Attorney General's Office
or one or more other regulatory agencies may pursue action against The Hartford
or one or more of its employees in the future. The potential timing of any such
action is difficult to predict. If such an action is brought, it could have a
material adverse effect on the Company.
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
Hartford has received requests for information and subpoenas from the Securities
and Exchange Commission ("SEC"), subpoenas 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 Hartford 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 and the New
York Attorney General's Office are investigating aspects of the Company's
variable annuity and mutual fund operations. The SEC's Division of Enforcement
recently commenced an investigation into the Company's use of directed
brokerage. The Hartford continues to cooperate fully with the SEC, the New York
Attorney General's Office 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, which have included a range of monetary penalties and
restitution. While no such action has been initiated against the Company, it is
possible that the SEC, the New York Attorney General's Office or other
regulatory agencies may pursue action against the Company in the future. The
potential timing of any such action is difficult to predict. If such an action
is brought, it could have a material adverse effect on the Company.
TAX MATTERS
The Company's Federal income tax returns are routinely audited by the Internal
Revenue Service ("IRS"). During the third quarter of 2004, the IRS completed its
examination of the 1998-2001 tax years, and the IRS and the Company have agreed
upon all adjustments. As a result, during the third quarter of 2004 the Company
booked a $187 tax benefit to reflect the impact of the audit settlement on tax
years prior to 2004. The benefit relates primarily to the separate account
dividends-received deduction ("DRD") and interest. (For further discussion of
the Company's separate account DRD, see Note 16 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 future tax
examinations and other tax-related matters for all open tax years.
18
9. TRANSACTIONS WITH AFFILIATES
For a description of transactions with affiliates, see Note 13 of Notes to
Consolidated Financial Statements included in Hartford Life Insurance Company's
Form 10-K Annual Report.
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 Insurance
Company and its subsidiaries ("Hartford Life Insurance Company" or the
"Company") as of September 30, 2004, compared with December 31, 2003, and its
results of operations for the third quarter and nine months ended September 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 and Report on Form 8-K filed on May 28, 2004. Hartford Life Insurance
Company filed the Form 8-K on May 28, 2004 to report the Company's updating of
certain historical segment information included in its Annual Report on Form
10-K for the year ended December 31, 2003, to give effect to the Company's new
reportable operating segments. (For further discussion see Organizational
Structure in the Consolidated Results of Operations section.)
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
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 difficulty in predicting the Company's potential exposure arising out of
regulatory proceedings or private claims relating to incentive compensation or
payments made to brokers and alleged anti-competitive conduct; the uncertain
effect on the Company of regulatory and market-driven changes in practices
relating to the payment of incentive compensation to brokers and other
distribution intermediaries, including changes that have been announced and
those which may occur in the future; 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 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 21
Consolidated Results of Operations - Operating Summary 22
Retail Products Group 24
Institutional Solutions Group 25
Individual Life 26
Investments 26
Investment Credit Risk 30
Capital Markets Risk Management 35
Capital Resources and Liquidity 37
Accounting Standards 39
20
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.
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
September 30, 2004 and December 31, 2003, the carrying value of the Company's
DAC was $6.3 billion and $6.1 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 September 30, 2004,
the present value of the EGPs utilized in the DAC amortization model falls
within a reasonable range of statistically calculated present value of EGPs. As
a result, the Company does not believe there is evidence to suggest that a
revision to the EGPs (and therefore, a revision to the DAC) as of September 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 September 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 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 September 30, 2004. If the
Company assumed a 9% average long-term rate of growth from September 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 $40-$50 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 $75-80, after-tax. Assuming that such an adjustment were
to have been required, the Company anticipates that there would have been
immaterial impacts on its DAC amortization for the 2004 and 2005 years exclusive
of the adjustment, and that there would have been positive earnings effects in
later years. Any such adjustment would not affect statutory income or surplus,
due to the prescribed accounting for such amounts that is discussed above.
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 September 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.
21
OTHER CRITICAL ACCOUNTING ESTIMATES
There have been no material changes to the identification of 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 - OPERATING SUMMARY
ORGANIZATIONAL STRUCTURE
The Company has changed its reportable operating segments from Investment
Products, Individual Life and Corporate Owned Life Insurance (COLI) to Retail
Products Group ("Retail"), Institutional Solutions Group ("Institutional") and
Individual Life. Retail offers individual variable and fixed annuities,
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. The Company also includes, in an Other category, 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, as well as
certain group benefit products including group life and group disability
insurance that is directly written by the Company and is substantially ceded to
the parent HLA. 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.
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
----------------------------------------------------------------------------
OPERATING SUMMARY 2004 2003 CHANGE 2004 2003 CHANGE
- -----------------------------------------------------------------------------------------------------------------------------------
Fee income $ 645 $ 556 16% $ 1,892 $ 1,572 20%
Earned premiums 159 411 (61%) 343 665 (48%)
Net investment income [1] 625 447 40% 1,841 1,315 40%
Other revenue -- 37 (100%) -- 98 (100%)
Net realized capital gains (losses) 24 (2) NM 111 3 NM
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 1,453 1,449 -- 4,187 3,653 15%
- ---------------------------------------------------------------------------------------------------------------------------------
Benefits, claims, and claim adjustment expenses [1] 824 895 (8%) 2,296 2,110 9%
Insurance operating costs and expenses 186 172 8% 514 524 (2%)
Amortization of deferred policy acquisition costs
and present value of future profits 194 173 12% 588 461 28%
Other expenses 1 (11) (109%) 25 (8) NM
- ---------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 1,205 1,229 (2%) 3,423 3,087 11%
- ---------------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT
OF ACCOUNTING CHANGE 248 220 13% 764 566 35%
Income tax (benefit) expense (147) 53 NM (10) 110 (109%)
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING
CHANGE 395 167 137% 774 456 70%
Cumulative effect of accounting change, net of tax [2] -- -- -- (18) -- --
- ---------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 395 $ 167 137% $ 756 $ 456 70%
- ---------------------------------------------------------------------------------------------------------------------------------
[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 $155 and $459 in net investment income and
increases of $148 and $445 in benefits, claims and claim adjustment
expenses for the third quarter and nine months ended September 30, 2004,
respectively.
[2] For the nine months ended September 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.
22
The Company's net income increased for the third quarter of 2004 compared to
2003 due primarily to lower income tax expense, increases in net income in the
Retail Products and Individual life segments and higher net realized capital
gains. (See the Investments section for further discussion of investment results
and related realized capital gains.) During the third quarter of 2004, the
Internal Revenue Service completed its examination of the 1998-2001 tax years.
(For further discussion see Note 8 of Notes to Condensed Consolidated Financial
Standards under Tax Matters). The Company recorded in the third quarter of 2004
an after-tax benefit of $187, consisting primarily of a change in estimate of
the dividends received deduction ("DRD") tax benefit reported during 2003 and
prior years and interest, and changed the estimate of the after-tax benefit for
the DRD benefit related to the 2004 tax year. As a result of this change in
estimate approximately $20 of additional DRD benefit was recorded in the third
quarter ended September 30, 2004 to reflect the change in estimate applicable to
the first three quarters of 2004.
Net income in the Retail segment increased for the third quarter ended September
30, 2004, principally driven by growth in the variable annuity business 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. Additionally, net income was
higher for Individual Life primarily driven by higher net investment income
including the effects of prepayments, growth in account values and life
insurance in force.
For the nine months ended September 30, 2004 compared to 2003, net income
increased primarily due to higher net income in the Retail segment, as discussed
in the previous paragraph, higher net realized capital gains, and a lower
effective tax rate. The effective tax rate was (1%) for the nine months ended
September 30, 2004 as compared to an effective tax rate of 19% for the
respective prior year period. The lower effective tax rate for the nine months
ended September 30, 2004 was attributed to tax related items, as discussed
above, of $187 and a year to date 2004 tax year benefit of $85, as compared to
tax related items of $23 and a year to date 2003 tax year DRD benefit of $65
reported for the nine months ended September 30, 2003, respectively. Partially
offsetting the positive earnings drivers for the nine months ended September 30,
2004 was the cumulative effect of 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 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). Additionally, the
net income for the Institutional segment for the nine months ended September 30,
2004 decreased primarily due to a $9 after-tax benefit, recorded in the third
quarter ended September 30, 2003, associated with the settlement of the Bancorp
litigation. Also contributing to this decrease was lower income from the
institutional business, which includes structured settlements and institutional.
As the Company has disclosed previously, The Hartford pays brokers and
independent agents commissions and other forms of incentive compensation in
connection with the sale of many of the Company's insurance products. Since the
New York Attorney General's Office filed a civil complaint against Marsh &
McLennan Companies, Inc. and Marsh, Inc. (collectively, "Marsh") on October 14,
2004, several of the largest national insurance brokers, including Marsh, have
announced their intention to discontinue the use of incentive compensation
arrangements. Other industry participants may make similar, or different,
determinations in the future. In addition, new regulations may require changes
to industry practices relating to incentive compensation. At this time, it is
not possible to predict the effect of these announced or potential changes on
the Company's business or distribution strategies.
23
RETAIL PRODUCTS GROUP
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------------------------------------
OPERATING SUMMARY 2004 2003 CHANGE 2004 2003 CHANGE
- ---------------------------------------------------------------------------------------------------------------------
Fee income and other $ 398 $ 340 17% $ 1,163 $ 925 26%
Earned premiums 36 (10) NM (12) (18) 33%
Net investment income 272 125 118% 811 370 119%
Net realized capital (losses) gains (1) 4 NM (2) 12 NM
- -------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 705 459 54% 1,960 1,289 52%
- -------------------------------------------------------------------------------------------------------------------
Benefits, claims, and claim adjustment expenses 335 141 138% 851 440 93%
Insurance operating costs and other expenses 115 93 24% 322 273 18%
Amortization of deferred policy acquisition costs and
present value of future profits 145 127 14% 446 320 39%
- -------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 595 361 65% 1,619 1,033 57%
- -------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT
OF ACCOUNTING CHANGE 110 98 12% 341 256 33%
Income tax expense 1 14 (93%) 42 10 NM
- -------------------------------------------------------------------------------------------------------------------
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING
CHANGE 109 84 30% 299 246 22%
Cumulative effect of accounting change, net of tax [1] -- -- -- (19) -- --
- -------------------------------------------------------------------------------------------------------------------
NET INCOME $ 109 $ 84 30% $ 280 $ 246 22%
- -------------------------------------------------------------------------------------------------------------------
Individual variable annuity account values $ 92,079 $77,572 19%
Other individual annuity account values 11,471 10,939 5%
401K and Specialty product account values 5,796 4,049 43%
- -------------------------------------------------------------------------------------------------------------------
TOTAL ACCOUNT VALUES [2] $109,346 $92,560 18%
- -------------------------------------------------------------------------------------------------------------------
S&P 500 INDEX VALUE AT END OF PERIOD 1,115 996 12%
- -------------------------------------------------------------------------------------------------------------------
[1] For the quarter and nine months ended September 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 third quarter and nine months
ended September 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 under management are driven
by the performance of the equity markets and net flows. Net flows are comprised
of new sales less surrenders, death benefits and annuitizations of variable
annuity contracts. In the mutual fund business, net flows are known as net
sales. Net sales are comprised of new sales less redemptions of mutual fund
customers.
Fee income generated by the variable annuity operation increased, as average
account values were higher in the third quarter and nine months ended September
30, 2004 compared to the respective prior year periods. The increase in average
account values can be attributed to market appreciation of $8.0 billion and net
flows of $6.5 billion over the past four quarters. The Company uses the S&P 500
Index as an indicator for evaluating market returns of the underlying account
portfolios, more specifically the average daily value of the S&P 500, which rose
by approximately 10% from September 30, 2003 to September 30, 2004.
Additionally, for the third quarter ended September 30, 2004, the segment
experienced a lower effective tax rate, primarily attributed to additional DRD
benefit of $18 recorded in the third quarter ended September 30, 2004 to reflect
the change in estimate applicable to the first three quarters of 2004. The
effective tax rate for the third quarter ended September 30, 2004 was 1% as
compared to 14% for the comparable prior year period.
Partially offsetting the positive earnings drivers discussed above was a
decrease in net income in the individual fixed annuity business and higher
amortization of deferred policy acquisition costs for the third quarter and nine
months ended September 30, 2004 as compared to the respective prior year
periods. The decrease in net income in the individual fixed annuity business was
attributed to a lower investment spread from the MVA fixed annuity product for
the third quarter and nine months ended September 30, 2004 as compared to the
comparable prior year periods. In addition, with the adoption of SOP 03-1, the
Company includes the investment return from the product in net investment income
and includes interest credited to contract holders in the benefits, claims and
claim adjustment expenses line in the operating summary rather than reporting
the net spread in fee income and other. The resulting
cumulative effect of the accounting change from the Company's adoption of SOP
03-1 recorded in the first quarter of 2004 also provided an offset to the
positive earnings growth for the nine months ended September 30, 2004.
Additionally, income tax expense was higher for the nine months ended September
30, 2004 due primarily to higher income earned by the segment and the $20 tax
benefit recorded in the second quarter of 2003 related to the change in estimate
of the DRD reported during 2002. This increase was largely offset by a higher
DRD tax benefit of $77 related to the 2004 tax year reported for the nine months
ended September 30, 2004, as discussed above, as compared to the DRD tax benefit
of $59 related to the 2003 tax year reported in the comparable prior year
period.
INSTITUTIONAL SOLUTIONS GROUP
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------------------------------------
OPERATING SUMMARY 2004 2003 CHANGE 2004 2003 CHANGE
- --------------------------------------------------------------------------------------------------------------------
Fee income and other $ 74 $ 73 1% $ 219 $ 225 (3%)
Earned premiums 100 402 (75%) 304 645 (53%)
Net investment income 266 248 7% 775 726 7%
Net realized capital gains 2 3 (33%) 5 9 (44%)
- ------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 442 726 (39%) 1,303 1,605 (19%)
- ------------------------------------------------------------------------------------------------------------------
Benefits, claims, and claim adjustment expenses 360 640 (44%) 1,074 1,343 (20%)
Insurance operating costs and other expenses 29 24 21% 94 109 (14%)
Amortization of deferred policy acquisition costs
and present value of future profits 10 6 67% 28 18 56%
- ------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 399 670 (40%) 1,196 1,470 (19%)
- ------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 43 56 (23%) 107 135 (21%)
Income tax expense 13 18 (28%) 34 44 (23%)
- ------------------------------------------------------------------------------------------------------------------
NET INCOME $ 30 $ 38 (21%) $ 73 $ 91 (20%)
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