Attached files
file | filename |
---|---|
EX-32.01 - EX-32.01 - TALCOTT RESOLUTION LIFE INSURANCE CO | y80151exv32w01.htm |
EX-31.01 - EX-31.01 - TALCOTT RESOLUTION LIFE INSURANCE CO | y80151exv31w01.htm |
EX-12.01 - EX-12.01 - TALCOTT RESOLUTION LIFE INSURANCE CO | y80151exv12w01.htm |
EX-31.02 - EX-31.02 - TALCOTT RESOLUTION LIFE INSURANCE CO | y80151exv31w02.htm |
EX-32.02 - EX-32.02 - TALCOTT RESOLUTION LIFE INSURANCE CO | y80151exv32w02.htm |
EX-15.01 - EX-15.01 - TALCOTT RESOLUTION LIFE INSURANCE CO | y80151exv15w01.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For
the quarterly period ended September 30, 2009
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For
the transition period from
to
Commission file number 001-32293
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)
(Address of principal executive offices)
(860) 547-5000
(Registrants telephone number, including area code)
(Registrants 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 þ No o
Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files).
Yes o No o
Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer o | Accelerated filer o | Non-accelerated filer þ | Smaller reporting company o | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act)
Yes o No þ
Yes o No þ
As of October 27, 2009 there were outstanding 1,000 shares of Common Stock, $5,690 par value per
share, of the registrant, all of which were directly owned by Hartford Life and Accident Insurance
Company. The Hartford Financial Services Group, Inc. is the ultimate parent 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
INDEX
Page | ||||||||
PART I. FINANCIAL INFORMATION |
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3 | ||||||||
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94 | ||||||||
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96 | ||||||||
96 | ||||||||
97 | ||||||||
98 | ||||||||
EX-12.01 | ||||||||
EX-15.01 | ||||||||
EX-31.01 | ||||||||
EX-31.02 | ||||||||
EX-32.01 | ||||||||
EX-32.02 |
2
Table of Contents
Item I. FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholder of
Hartford Life Insurance Company
Hartford, Connecticut
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, 2009, and the related condensed
consolidated statements of operations for the three-month and nine-month periods ended September
30, 2009 and 2008, and changes in stockholders equity and cash flows for the nine-month periods
ended September 30, 2009 and 2008. These interim financial statements are the responsibility of the
Companys management.
We conducted our reviews in accordance with the 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
the 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 the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheet of the Company as of December 31,
2008, and the related consolidated statements of operations, changes in stockholders equity, and
cash flows for the year then ended (not presented herein); and in our report dated February 11,
2009 (April 29, 2009 as to the effects of the change in reporting entity structure and the
retrospective adoption of Financial Accounting Standards Board Accounting Standards Codification
810, Consolidation described in Notes 1 and 17), (which report includes an explanatory paragraph
relating to the Companys change in its method of accounting and reporting for the fair value
measurement of financial instruments in 2008), 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, 2008 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 3, 2009
November 3, 2009
3
Table of Contents
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
Three Months ended | Nine Months ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
(In millions) | 2009 | 2008 | 2009 | 2008 | ||||||||||||
(Unaudited) | (Unaudited) | |||||||||||||||
Revenues |
||||||||||||||||
Fee income and other |
$ | 910 | $ | 1,082 | $ | 2,697 | $ | 3,295 | ||||||||
Earned premiums |
51 | 277 | 387 | 733 | ||||||||||||
Net investment income (loss) |
||||||||||||||||
Securities available-for-sale and other |
644 | 643 | 1,881 | 2,078 | ||||||||||||
Equity securities, trading |
299 | (118 | ) | 308 | (240 | ) | ||||||||||
Total net investment income |
943 | 525 | 2,189 | 1,838 | ||||||||||||
Net realized capital gains (losses): |
||||||||||||||||
Total other-than-temporary impairment (OTTI) losses |
(588 | ) | (1,310 | ) | (1,178 | ) | (1,624 | ) | ||||||||
OTTI losses recognized to other comprehensive income |
173 | | 330 | | ||||||||||||
Net OTTI losses recognized in earnings |
(415 | ) | (1,310 | ) | (848 | ) | (1,624 | ) | ||||||||
Net realized capital gains (losses), excluding net OTTI losses
recognized in earnings |
(1,097 | ) | (650 | ) | 830 | (2,046 | ) | |||||||||
Total net realized capital gains (losses) |
(1,512 | ) | (1,960 | ) | (18 | ) | (3,670 | ) | ||||||||
Total revenues |
392 | (76 | ) | 5,255 | 2,196 | |||||||||||
Benefits, losses and expenses |
||||||||||||||||
Benefits, losses and loss adjustment expenses |
674 | 1,136 | 2,999 | 3,009 | ||||||||||||
Benefits, loss and loss adjustment expenses returns credited on
International unit-linked bonds and pension products |
299 | (118 | ) | 308 | (240 | ) | ||||||||||
Insurance operating costs and other expenses |
482 | 498 | 1,370 | 1,463 | ||||||||||||
Amortization of deferred policy acquisition costs and present value
of future profits |
93 | 1,289 | 1,792 | 1,380 | ||||||||||||
Dividends to policyholders |
1 | | 12 | 10 | ||||||||||||
Total benefits, losses and expenses |
1,549 | 2,805 | 6,481 | 5,622 | ||||||||||||
Income (loss) before income tax expense (benefit) |
(1,157 | ) | (2,881 | ) | (1,226 | ) | (3,426 | ) | ||||||||
Income tax expense (benefit) |
(447 | ) | (1,049 | ) | (525 | ) | (1,346 | ) | ||||||||
Net income (loss) |
(710 | ) | (1,832 | ) | (701 | ) | (2,080 | ) | ||||||||
Less: Net (income) loss attributable to the noncontrolling interest |
(3 | ) | 10 | (9 | ) | 52 | ||||||||||
Net income (loss) attributable to shareholder |
$ | (713 | ) | $ | (1,822 | ) | $ | (710 | ) | $ | (2,028 | ) | ||||
4
Table of Contents
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
September | December | |||||||
(In millions, except for share data) | 30, 2009 | 31, 2008 | ||||||
(Unaudited) | ||||||||
Assets |
||||||||
Investments |
||||||||
Fixed maturities, available for sale, at fair value (amortized cost of $44,197 and $48,444) |
$ | 39,436 | $ | 39,560 | ||||
Equity securities, trading, at fair value (cost of $2,359 and $1,830) |
2,465 | 1,634 | ||||||
Equity securities, available-for-sale, at fair value (cost of $464 and $614) |
409 | 434 | ||||||
Mortgage loans |
4,630 | 4,896 | ||||||
Policy loans, at outstanding balance |
2,156 | 2,154 | ||||||
Limited partnership and other alternative investments |
776 | 1,033 | ||||||
Other investments |
1,370 | 1,237 | ||||||
Short-term investments |
5,901 | 5,742 | ||||||
Total investments |
57,143 | 56,690 | ||||||
Cash |
956 | 661 | ||||||
Premiums receivable and agents balances |
25 | 25 | ||||||
Reinsurance recoverables |
2,557 | 3,195 | ||||||
Deferred policy acquisition costs and present value of future profits |
7,932 | 9,944 | ||||||
Deferred income taxes |
2,671 | 3,444 | ||||||
Goodwill |
470 | 462 | ||||||
Other assets |
1,098 | 3,267 | ||||||
Separate account assets |
155,944 | 130,171 | ||||||
Total assets |
$ | 228,796 | $ | 207,859 | ||||
Liabilities |
||||||||
Reserve for future policy benefits and unpaid losses and loss adjustment expenses |
$ | 11,285 | $ | 10,602 | ||||
Other policyholder funds and benefits payable |
45,605 | 52,647 | ||||||
Other policyholder funds and benefits payable International unit-linked bonds and
pension products |
2,441 | 1,613 | ||||||
Consumer notes |
1,193 | 1,210 | ||||||
Other liabilities |
6,225 | 8,373 | ||||||
Separate account liabilities |
155,944 | 130,171 | ||||||
Total liabilities |
$ | 222,693 | $ | 204,616 | ||||
Commitments and Contingencies (Note 9) |
||||||||
Equity |
||||||||
Common stock - 1,000 shares authorized, issued and outstanding, par value $5,690 |
6 | 6 | ||||||
Additional paid in capital |
7,065 | 6,157 | ||||||
Accumulated other comprehensive loss, net of tax |
(2,184 | ) | (4,531 | ) | ||||
Retained earnings |
1,159 | 1,446 | ||||||
Total stockholders equity |
6,046 | 3,078 | ||||||
Noncontrolling interest |
57 | 165 | ||||||
Total equity |
6,103 | 3,243 | ||||||
Total liabilities and equity |
$ | 228,796 | $ | 207,859 | ||||
See Notes to Condensed Consolidated Financial Statements
5
Table of Contents
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
Condensed Consolidated Statements Of Changes In Equity
Accumulated Other | ||||||||||||||||||||||||||||||||||||
(Unaudited) | Comprehensive Income (Loss) | |||||||||||||||||||||||||||||||||||
Net | ||||||||||||||||||||||||||||||||||||
Unrealized | ||||||||||||||||||||||||||||||||||||
Capital | Net (Loss) | |||||||||||||||||||||||||||||||||||
Gains | Gain On | |||||||||||||||||||||||||||||||||||
(Losses) | Cash Flow | Foreign | ||||||||||||||||||||||||||||||||||
Additional | On | Hedging | Currency | Non- | ||||||||||||||||||||||||||||||||
Common | Paid In | Securities, | Instruments, | Translation | Retained | Total | Controlling | Total | ||||||||||||||||||||||||||||
(In millions) | Stock | Capital | Net of Tax | Net of Tax | Adjustments | Earnings | S.E. | Interest | Equity | |||||||||||||||||||||||||||
Nine months ended September 30, 2009 |
||||||||||||||||||||||||||||||||||||
Balance, December 31, 2008 |
6 | 6,157 | (4,806 | ) | 440 | (165 | ) | 1,446 | 3,078 | 165 | 3,243 | |||||||||||||||||||||||||
Comprehensive income |
||||||||||||||||||||||||||||||||||||
Net income (loss) |
(710 | ) | (710 | ) | (710 | ) | ||||||||||||||||||||||||||||||
Other comprehensive income, net of tax (1) |
||||||||||||||||||||||||||||||||||||
Net change in unrealized capital losses on
securities (2) |
2,897 | 2,897 | 2,897 | |||||||||||||||||||||||||||||||||
Net gains (losses) on cash flow hedging
instruments |
(199 | ) | (199 | ) | (199 | ) | ||||||||||||||||||||||||||||||
Cumulative translation adjustments |
111 | 111 | 111 | |||||||||||||||||||||||||||||||||
Total other comprehensive income (loss) |
2,809 | 2,809 | ||||||||||||||||||||||||||||||||||
Total comprehensive income (loss) |
2,099 | 2,099 | ||||||||||||||||||||||||||||||||||
Capital contribution from parent |
908 | 908 | 908 | |||||||||||||||||||||||||||||||||
Dividends declared |
(39 | ) | (39 | ) | (39 | ) | ||||||||||||||||||||||||||||||
Cumulative effect of accounting changes,
net of DAC and tax |
(462 | ) | 462 | |||||||||||||||||||||||||||||||||
Change in noncontrolling interest ownership |
(117 | ) | (117 | ) | ||||||||||||||||||||||||||||||||
Noncontrolling income (loss) |
9 | 9 | ||||||||||||||||||||||||||||||||||
Balance, September 30, 2009 |
6 | 7,065 | (2,371 | ) | 241 | (54 | ) | 1,159 | 6,046 | 57 | 6,103 | |||||||||||||||||||||||||
Nine months ended September 30, 2008 |
||||||||||||||||||||||||||||||||||||
Balance, December 31, 2007 |
6 | 3,746 | (318 | ) | (137 | ) | 8 | 5,315 | 8,620 | 255 | 8,875 | |||||||||||||||||||||||||
Comprehensive income |
||||||||||||||||||||||||||||||||||||
Net income (loss) |
(2,028 | ) | (2,028 | ) | (2,028 | ) | ||||||||||||||||||||||||||||||
Other comprehensive income, net of tax (1) |
||||||||||||||||||||||||||||||||||||
Net change in unrealized capital gains on
securities (2) |
(2,161 | ) | (2,161 | ) | (2,161 | ) | ||||||||||||||||||||||||||||||
Net losses on cash flow hedging instruments |
134 | 134 | 134 | |||||||||||||||||||||||||||||||||
Cumulative translation adjustments |
(40 | ) | (40 | ) | (40 | ) | ||||||||||||||||||||||||||||||
Total other comprehensive income (loss) |
(2,067 | ) | (2,067 | ) | ||||||||||||||||||||||||||||||||
Total comprehensive income (loss) |
(4,095 | ) | (4,095 | ) | ||||||||||||||||||||||||||||||||
Capital contribution from parent |
480 | 480 | 480 | |||||||||||||||||||||||||||||||||
Dividends declared |
(268 | ) | (268 | ) | (268 | ) | ||||||||||||||||||||||||||||||
Cumulative effect of accounting changes,
net of tax |
(3 | ) | (3 | ) | (3 | ) | ||||||||||||||||||||||||||||||
Change in noncontrolling interest ownership |
50 | 50 | ||||||||||||||||||||||||||||||||||
Noncontrolling income (loss) |
(52 | ) | (52 | ) | ||||||||||||||||||||||||||||||||
Balance, September 30, 2008 |
6 | 4,226 | (2,479 | ) | (3 | ) | (32 | ) | 3,016 | 4,734 | 253 | 4,987 | ||||||||||||||||||||||||
(1) | Net change in unrealized capital gains on securities is reflected net of tax benefit and other items of $(1,560) and $1,165 for the nine months ended September 30, 2009 and 2008, respectively. Net gain (loss) on cash flow hedging instruments is net of tax provision (benefit) of $107 and $(72) for the nine months ended September 30, 2009 and 2008, respectively. There is no tax effect on cumulative translation adjustments. | |
(2) | There were reclassification adjustments for after-tax gains (losses) realized in net income of $(12) and $(2,386) for the nine months ended September 30, 2009 and 2008, respectively. |
See Notes to Condensed Consolidated Financial Statements
6
Table of Contents
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
Nine months ended September 30, | ||||||||
(In millions) | 2009 | 2008 | ||||||
(Unaudited) | ||||||||
Operating Activities |
||||||||
Net income (loss) |
$ | (701 | ) | $ | (2,080 | ) | ||
Adjustments to reconcile net income to net cash provided by operating activities |
||||||||
Amortization of deferred policy acquisition costs and present value of future profits |
1,792 | 1,380 | ||||||
Additions to deferred policy acquisition costs and present value of future profits |
(537 | ) | (990 | ) | ||||
Change in: |
||||||||
Reserve for future policy benefits and unpaid losses and loss adjustment expenses |
464 | 1,006 | ||||||
Reinsurance recoverables |
31 | (53 | ) | |||||
Receivables |
(127 | ) | 512 | |||||
Payables and accruals |
(15 | ) | (477 | ) | ||||
Accrued and deferred income taxes |
344 | (1,202 | ) | |||||
Net realized capital (gains) losses |
18 | 3,670 | ||||||
Net receipts from investment contracts related to policyholder funds International
unit-linked bonds and pension products |
828 | 481 | ||||||
Net increase in equity securities trading |
(832 | ) | (469 | ) | ||||
Depreciation and amortization |
126 | 115 | ||||||
Other, net |
(285 | ) | (724 | ) | ||||
Net cash provided by operating activities |
1,107 | 1,169 | ||||||
Investing Activities |
||||||||
Proceeds from the sale/maturity/prepayment of: |
||||||||
Fixed maturities and short-term investments, available-for-sale |
31,939 | 8,368 | ||||||
Equity securities, available-for-sale |
134 | 406 | ||||||
Mortgage loans |
314 | 310 | ||||||
Partnerships |
202 | 85 | ||||||
Payments for the purchase of: |
||||||||
Fixed maturities and short-term investments, available-for-sale |
(29,580 | ) | (9,721 | ) | ||||
Equity securities, available-for-sale |
(50 | ) | (116 | ) | ||||
Mortgage loans |
(189 | ) | (848 | ) | ||||
Partnerships |
(97 | ) | (266 | ) | ||||
Purchase price of business acquired |
(8 | ) | | |||||
Change in policy loans, net |
(2 | ) | (91 | ) | ||||
Change in payables for collateral under securities lending, net |
(1,648 | ) | (104 | ) | ||||
Derivative receipts (payments) |
(542 | ) | (121 | ) | ||||
Change in all other, net |
26 | (380 | ) | |||||
Net cash provided by investing activities |
499 | (2,478 | ) | |||||
Financing Activities |
||||||||
Deposits and other additions to investment and universal life-type contracts |
10,172 | 16,603 | ||||||
Withdrawals and other deductions from investment and universal life-type contracts |
(17,466 | ) | (20,924 | ) | ||||
Net transfers from (to) separate accounts related to investment and universal
life-type contracts |
5,021 | 5,407 | ||||||
Capital Contributions |
902 | 483 | ||||||
Dividends paid |
(34 | ) | (255 | ) | ||||
Proceeds from issuance of consumer notes |
| 445 | ||||||
Repayment at maturity of consumer notes |
(17 | ) | (29 | ) | ||||
Net cash used for financing activities |
(1,422 | ) | 1,730 | |||||
Foreign exchange rate effect on cash |
111 | (29 | ) | |||||
Net increase in cash |
295 | 392 | ||||||
Cash beginning of period |
661 | 423 | ||||||
Cash end of period |
$ | 956 | $ | 815 | ||||
Supplemental Disclosure of Cash Flow Information: |
||||||||
Net Cash Paid During the Period For: |
||||||||
Income taxes paid (received) |
$ | (552 | ) | $ | (35 | ) |
For the nine months ended September 30, 2009, the Company made noncash net dividends of $6 to its
parent company related to the guaranteed minimum income and accumulation benefit reinsurance
agreements with Hartford Life Insurance K.K. (HLIKK). For the nine months ended September 30,
2008, the Company made noncash dividends of $11 from its parent company related to the guaranteed
minimum income and accumulation benefit reinsurance agreements with HLIKK.
See Notes to Condensed Consolidated Financial Statements
7
Table of Contents
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in millions, unless otherwise stated)
(unaudited)
1. Basis of Presentation and Accounting Policies
Basis of Presentation
These condensed consolidated financial statements include Hartford Life Insurance Company and its
wholly-owned subsidiaries (collectively, Hartford Life Insurance Company or the Company),
Hartford Life and Annuity Insurance Company (HLAI), Hartford International Life Reassurance
Corporation (HLRe) Hartford Financial Services LLC (HFSC), Hartford Life International LTD
(HLINT) and Woodbury Financial Services Corporation (WFS). The Company is a wholly-owned
subsidiary of Hartford Life and Accident Insurance Company (HLA), which is a wholly-owned
subsidiary of Hartford Life, Inc. (Hartford Life). Hartford Life is a direct wholly-owned
subsidiary of Hartford Holdings, Inc., a direct wholly-owned subsidiary of The Hartford Financial
Services Group, Inc., the Companys ultimate parent company. As used herein, The Hartford refers
broadly to The Hartford Financial Services Group, Inc. and its subsidiaries, which may or may not
include the Company and its subsidiaries with respect to a particular issue.
The accompanying condensed consolidated financial statements and notes as of September 30, 2009,
and for the three and nine months ended September 30, 2009 and 2008 are unaudited. These financial
statements reflect all adjustments (consisting only of normal accruals) which are, in the opinion
of management, necessary for the fair presentation of the financial position, results of
operations, and cash flows for the interim periods. These condensed consolidated financial
statements and notes should be read in conjunction with the consolidated financial statements and
notes thereto included in The Companys 2008 Form 10-K Annual Report and the Current Report on Form
8-K filed on April 29, 2009. The results of operations for the interim periods should not be
considered indicative of the results to be expected for the full year.
Effective March 31,2009, Hartford Life changed its reporting entity structure to contribute certain
wholly owned subsidiaries, including Hartford Lifes European insurance operations, several broker
dealer entities and investment advisory and service entities from Hartford Life and Accident to the
Company. The contribution of subsidiaries was effected to more closely align servicing entities
with the writing company issuing the business they service as well as to more efficiently deploy
capital across the organization. The change in reporting entity was retrospectively applied to the
financial statements of the Company for all periods presented.
Along with its parent, HLA, the Company is a financial services and insurance group which provides
(a) investment products, such as individual variable annuities and fixed market value adjusted
annuities, mutual funds and retirement plan services; (b) individual life insurance; (c) group
benefits products such as group life and group disability insurance that is directly written by the
Company and is substantially ceded to its parent, HLA, (d) private placement life insurance and
(e) assumes fixed market value adjusted annuities, guaranteed minimum withdrawal benefits (GMWB),
guaranteed minimum income benefits (GMIB), guaranteed minimum accumulation benefits (GMAB) and
guaranteed minimum death benefits (GMDB) from Hartford Lifes international operations.
The condensed consolidated financial statements have been prepared on the basis of accounting
principles generally accepted in the United States of America (U.S. GAAP), which differ
materially from the accounting practices prescribed by various insurance regulatory authorities.
Consolidation
The condensed consolidated financial statements include the accounts of Hartford Life Insurance
Company, companies in which the Company directly or indirectly has a controlling financial interest
and those variable interest entities in which the Company is the primary beneficiary. The Company
determines if it is the primary beneficiary using both qualitative and quantitative analyses.
Entities in which Hartford Life Insurance Company does not have a controlling financial interest
but in which the Company has significant influence over the operating and financing decisions are
reported using the equity method. Material intercompany transactions and balances between Hartford
Life Insurance Company and its subsidiaries and affiliates have been eliminated.
Use of Estimates
The preparation of financial statements, in conformity with U.S. GAAP, requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities and the
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 estimated gross profits used in
the valuation and amortization of assets and liabilities associated with variable annuity and other
universal life-type contracts; living benefits required to be fair valued; valuation of investments
and derivative instruments, evaluation of other-than-temporary impairments on available-for-sale
securities; and contingencies relating to corporate litigation and regulatory matters; and goodwill
impairment. Certain of these estimates are particularly sensitive to market conditions, and
deterioration and/or volatility in the worldwide debt or equity markets could have a material
impact on the condensed consolidated financial statements.
8
Table of Contents
1. Basis
of Presentation and Accounting Policies (continued)
Subsequent Events
The Company has evaluated events subsequent to September 30, 2009 and through the condensed
consolidated financial statement issuance date of November 3, 2009. The Company has not evaluated
subsequent events after that date for presentation in these condensed consolidated financial
statements.
Significant Accounting Policies
For a description of significant accounting policies, see Note 1 of Notes to Consolidated Financial
Statements included in the Companys 2008 Form 10-K Annual Report and the Current Report on Form
8-K filed on April 29, 2009, which, accordingly, should be read in conjunction with these
accompanying condensed consolidated financial statements.
Adoption of New Accounting Standards
Fair Value
In August 2009, the Financial Accounting Standards Board (FASB) updated the accounting standard
related to the fair value measurement of liabilities. This update provides guidance on the fair
value measurement of liabilities and reaffirms that the fair value measurement of a liability
assumes the transfer of a liability to a market participant, that is the liability is presumed to
continue and is not settled with the counterparty. This guidance also provides clarification that
in circumstances in which a quoted price in an active market for the identical liability is not
available, a reporting entity is required to measure fair value using one or more of the following
valuation techniques: a) quoted price of an identical liability when traded as an asset, b) quoted
price of a similar liability or of a similar liability when traded as an asset, or c) another
valuation technique consistent with the fair value principles within U.S. GAAP such as a market
approach or an income approach. The amendments in this guidance also clarify that when estimating
the fair value of a liability, a reporting entity is not required to include a separate adjustment
relating to transfer restriction of the liability. This guidance is effective for the first
reporting period, including interim periods, beginning after issuance. The Company adopted this
guidance as of September 30, 2009, and the adoption did not have an impact on the Companys
condensed consolidated financial statements
Recognition and Presentation of Other-Than-Temporary Impairments
In April 2009, the FASB updated the guidance related to the recognition and presentation of
other-than-temporary impairments which modifies the recognition of other-than-temporary impairment
(impairment) losses for debt securities. This new guidance is also applied to certain equity
securities with debt-like characteristics (collectively debt securities). Under the new
guidance, a debt security is deemed to be other-than-temporarily impaired if it meets the following
conditions: 1) the Company intends to sell or it is more likely than not the Company will be
required to sell the security before a recovery in value, or 2) the Company does not expect to
recover the entire amortized cost basis of the security. If the Company intends to sell or it is
more likely than not that the Company will be required to sell the security before a recovery in
value, a charge is recorded in net realized capital losses equal to the difference between the fair
value and amortized cost basis of the security. For those other-than-temporarily impaired debt
securities which do not meet the first condition and for which the Company does not expect to
recover the entire amortized cost basis, the difference between the securitys amortized cost basis
and the fair value is separated into the portion representing a credit impairment, which is
recorded in net realized capital losses, and the remaining impairment, which is recorded in other
comprehensive income (OCI). Generally, the Company determines a securitys credit impairment as
the difference between its amortized cost basis and its best estimate of expected future cash flows
discounted at the securitys effective yield prior to impairment. The previous amortized cost
basis less the impairment recognized in net realized capital losses becomes the securitys new cost
basis. The Company accretes the new cost basis to the estimated future cash flows over the
expected remaining life of the security by prospectively adjusting the securitys yield, if
necessary.
The Company evaluates whether a credit impairment exists, by considering primarily the following
factors: (a) the length of time and extent to which the fair value has been less than the amortized
cost of the security, (b) changes in the financial condition, credit rating and near-term prospects
of the issuer, (c) whether the issuer is current on contractually obligated interest and principal
payments, (d) changes in the financial condition of the securitys underlying collateral and (e)
the payment structure of the security. The Companys best estimate of expected future cash flows
used to determine the credit loss amount is a quantitative and qualitative process that
incorporates information received from third party sources along with certain internal assumptions
and judgments regarding the future performance of the security. The Companys best estimate of
future cash flows involves assumptions including, but not limited to, various performance
indicators, such as historical and projected default and recovery rates, credit ratings, current
delinquency rates, loan-to-value ratios and the possibility of obligor re-financing. In addition,
for securitized debt securities, the Company considers factors including, but not limited to,
commercial and residential property value declines that vary by property type and location and
average cumulative collateral loss rates that vary by vintage year. These assumptions require the
use of significant management judgment and include the probability of issuer default and estimates
regarding timing and amount of expected recoveries which may include estimating the underlying
collateral value. In addition, projections of expected future debt security cash flows may change
based upon new information regarding the performance of the issuer and/or underlying collateral
such as changes in the projections of the underlying property value estimates.
This guidance does not impact the evaluation for impairment for equity securities. For those
equity securities where the decline in the fair value is deemed to be other-than-temporary, a
charge is recorded in net realized capital losses equal to the difference between the fair value
and cost basis of the security. The previous cost basis less the impairment becomes the securitys
new cost basis. The Company asserts its intent and ability to retain those equity
securities deemed to be temporarily impaired until the price recovers. Once identified, these
securities are systematically restricted from trading unless approved by the committee of
investment and accounting
9
Table of Contents
1. Basis
of Presentation and Accounting Policies (continued)
professionals (the Committee). The Committee will only authorize the sale of these securities
based on predefined criteria that relate to events that could not have been reasonably foreseen.
Examples of the criteria include, but are not limited to, the deterioration in the issuers
financial condition, security price declines, a change in regulatory requirements or a major
business combination or major disposition.
The primary factors considered in evaluating whether an impairment exists for an equity
security include, but are not limited to: (a) the length of time and extent to which the fair value
has been less than the cost of the security, (b) changes in the financial condition, credit rating
and near-term prospects of the issuer, (c) whether the issuer is current on contractually obligated
payments and (d) the intent and ability of the Company to retain the investment for a period of
time sufficient to allow for recovery.
This guidance also expands and increases the frequency of existing disclosures about
other-than-temporary impairments for debt and equity securities. The Company adopted this new
guidance for its interim reporting period ending on June 30, 2009 and upon adoption of this
guidance, the Company recognized a $462, net of tax and deferred acquisition costs, increase to
Retained Earnings with an offsetting decrease in Accumulated Other Comprehensive Income (AOCI).
See Note 4 for expanded interim disclosures. Disclosures regarding the effect of the adoption of
this guidance on income for interim periods subsequent to adoption have not been made, as it is not
practicable to estimate the effect of such amounts.
Noncontrolling Interests in Consolidated Financial Statements
In December 2007, the FASB updated guidance for noncontrolling interests. A noncontrolling
interest refers to the minority interest portion of the equity of a subsidiary that is not
attributable directly or indirectly to a parent. This updated guidance establishes accounting and
reporting standards that require for-profit entities that prepare consolidated financial statements
to: (a) present noncontrolling interests as a component of equity, separate from the parents
equity, (b) separately present the amount of consolidated net income attributable to
noncontrolling interests in the income statement, (c) consistently account for changes in a
parents ownership interests in a subsidiary in which the parent entity has a controlling financial
interest as equity transactions, (d) require an entity to measure at fair value its remaining
interest in a subsidiary that is deconsolidated, and (e) require an entity to provide sufficient
disclosures that identify and clearly distinguish between interests of the parent and interests of
noncontrolling owners. This guidance applies to all for-profit entities that prepare consolidated
financial statements, and affects those for-profit entities that have outstanding noncontrolling
interests in one or more subsidiaries or that deconsolidate a subsidiary. This guidance is
effective for fiscal years, and interim periods within those fiscal years, beginning on or after
December 15, 2008 with earlier adoption prohibited. Upon adoption of this guidance on January 1,
2009, the Company reclassified $255 of noncontrolling interest, recorded in other liabilities, to
equity as of January 1, 2008. See the Companys Condensed Consolidated Statement of Changes in
Equity. The adoption of this guidance resulted in certain reclassifications of noncontrolling
interests within the Companys Condensed Consolidated Statements of Operations. The adoption did
not impact the Companys accounting for separate account assets and liabilities. The FASB has added
a topic to the Emerging Issues Task Force (EITF) agenda, Consideration of an Insurers
Accounting for Majority Owned Investments When the Ownership Is Through a Separate Account. In
September 2009 the FASB issued for comment, a proposal on this topic in which they clarify that
specialized accounting for investments held by a separate account should continue in consolidation.
In addition, the proposed amendments would not require an insurer to consolidate a majority owned
voting-interest investment held by a separate account if the investment is not or would not be
consolidated in the stand-alone financial statement of the separate account. The Company currently
follows this proposed guidance and excludes the noncontrolling interest from its majority owned
separate accounts. The resolution of this FASB agenda item will continue to be followed by the
Company; however it is not expected to have an impact on the Companys accounting for separate
account assets and liabilities.
10
Table of Contents
1. Basis
of Presentation and Accounting Policies (continued)
Future Adoption of New Accounting Standards
Accounting for Transfers of Financial Assets
In June 2009, the FASB issued updated guidance related to the accounting for transfers of financial
assets. These amendments revise derecognition guidance and eliminates the concept of a qualifying
special-purpose entities (QSPEs). This guidance is effective for fiscal years and interim
periods beginning after November 15, 2009. Early adoption is prohibited. The Company will adopt
this guidance on January 1, 2010 and has not yet determined the effect of the adoption on its
consolidated financial statements.
Amendments to Consolidation Guidance for Variable Interest Entities
In June 2009, the FASB issued updated guidance which amends the consolidation requirements
applicable to variable interest entities (VIE). An entity would consolidate a VIE, as the
primary beneficiary, when the entity has both of the following characteristics: (a) The power to
direct the activities of a VIE that most significantly impact the entitys economic performance and
(b) The obligation to absorb losses of the entity that could potentially be significant to the VIE
or the right to receive benefits from the entity that could potentially be significant to the VIE.
Ongoing reassessment of whether an enterprise is the primary beneficiary of a VIE is required.
This updated guidance replaces the quantitative approach previously required for determining the
primary beneficiary of a VIE with a qualitative approach, modifies the criteria for determining
whether a service provider or decision maker contract is a variable interest. and changes the
consideration of removal rights in determining if an entity is a VIE. These changes may cause
certain additional entities to now be considered a VIE. This Statement is effective for fiscal
years and interim periods beginning after November 15, 2009. Although the Company has not yet
determined the effect of the adoption on its consolidated financial statements, a review of the
impact to the Company is currently being evaluated. The following areas of potential impact are
being assessed: The Hartford managed mutual funds, (both retail and those within the Companys
separate accounts), limited partnership investments, and Company sponsored collateralized debt
obligations (CDOs) and collateralized loan obligations (CLOs). The Company will adopt this
guidance on January 1, 2010.
Income Taxes
The effective tax rate for the three months ended September 30, 2009 and 2008 was 39% and 37%,
respectively. The effective tax rate for the nine months ended September 30, 2009 and 2008 was 43%
and 40%, respectively. The principal cause of the difference between the effective rate and the
U.S. statutory rate of 35% was the separate account dividends received deduction (DRD). The DRD
caused an increase from the statutory rate as a result of a tax benefit on pretax losses.
The separate account DRD is estimated for the current year using information from the prior
year-end, adjusted for current year equity market performance and other appropriate factors,
including estimated levels of corporate dividend payments. The actual current year DRD can vary
from estimates based on, but not limited to, changes in eligible dividends received by the mutual
funds, amounts of distributions from these mutual funds, amounts of short-term capital gains at the
mutual fund level and the Companys taxable income before the DRD. Given recent financial markets
volatility, the Company is reviewing its DRD computations on a quarterly basis. The Company
recorded benefits related to the separate account DRD of $33 and $50 in the three months ended
September 30, 2009 and 2008, and $108 and $158 in the nine months ended September 30, 2009 and
2008, respectively. The benefit recorded in the three months ended September 30, 2009 included
prior period adjustments of $(6) related to the 2008 tax return and $1 related to the three months
ended June 30, 2009.
The Companys federal income tax returns are routinely audited by the IRS as part of the Hartfords
consolidated tax return. During the first quarter of 2009, the Company received notification of
the approval by the Joint Committee on Taxation of the results of the 2002 through 2003
examination. As a result, the Company recorded a tax benefit of $4. The 2004 through 2006
examination began during the second quarter of 2008, and is expected to close in early 2010. In
addition, the Company is working with the IRS on a possible settlement of a DRD issue related to
prior periods which, if settled, may result in the booking of tax benefits. Such benefits are not
expected to be material to the statement of operations.
The Company has determined a deferred tax asset valuation allowance that is adequate to reduce the
total deferred tax asset to an amount that will more likely than not be realized. In assessing the
need for a valuation allowance, management considered future reversals of existing taxable
temporary differences, future taxable income exclusive of reversing temporary differences and
carryforwards, and taxable income in prior carry back years, as well as tax planning strategies
that include holding debt securities with market value losses until maturity, selling appreciated
securities to offset capital losses, and sales of certain corporate assets. Such tax planning
strategies are viewed by management as prudent and feasible and will be implemented if necessary to
realize the deferred tax asset. However, future realized losses on investment securities could
result in the recognition of additional valuation allowance if additional tax planning strategies
are not available. At September 30, 2009 if the Company were to follow a separate entity
approach, it would have recorded a valuation allowance of $280 related to realized capital losses.
In addition, the current tax benefit related to any of the Companys tax attributes realized by
virtue of its inclusion in The Hartfords consolidated tax return would have recorded directly to
surplus rather than income. These benefits were $153 and $231 for the nine months ended September
30, 2009 and 2008, respectively.
11
Table of Contents
1.
Basis of Presentation and Accounting Policies (Continued)
Reinsurance
As of September 30, 2009 the Companys reinsurance-related concentrations of credit risk greater
than 10% of the companys stockholders equity was reinsurance recoverables of $614 with
Connecticut General Life Insurance Company.
2. Segment Information
The Company has three groups comprised of four reporting segments: The Retail Products Group
(Retail) and Individual Life segments make up the Individual Markets Group. The Retirement Plans
segment represents the Employer Market Group and the Institutional Solutions Group
(Institutional) make up its own group.
Financial Measures and Other Segment Information
The accounting policies of the reporting segments are the same as those described in the summary of
significant accounting policies in Note 1. Life primarily evaluates performance of its segments
based on revenues, net income and the segments return on allocated capital. Each reporting segment
is allocated corporate surplus as needed to support its business.
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. Inter-segment
revenues primarily occur between the Companys Other category and the reporting segments. These
amounts primarily include interest income on allocated surplus and interest charges on excess
separate account surplus. Consolidated net investment income is unaffected by such transactions.
For further discussion of the types of products offered by each segment, see Note 2 of Notes to the
Condensed Consolidated Financial Statements included in the Companys 2008 Form 10-K Annual Report
and the current report on Form 8-K filed on April 30, 2009.
The following tables represent summarized financial information concerning the Companys segments.
Three Months ended September 30, | Nine Months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Revenues |
||||||||||||||||
Retail [1] |
$ | 90 | $ | 420 | 1,881 | $ | 1,432 | |||||||||
Individual Life |
258 | 103 | 798 | 614 | ||||||||||||
Retirement Plans |
75 | 1 | 246 | 293 | ||||||||||||
Institutional |
126 | (81 | ) | 561 | 688 | |||||||||||
Other [1][2] |
(157 | ) | (519 | ) | 1,769 | (831 | ) | |||||||||
Total revenues [1][2] |
$ | 392 | $ | (76 | ) | $ | 5,255 | $ | 2,196 | |||||||
[1] | The transition impact related to the adoption of fair value was a reduction in revenues of $616 and $172 in Retail and Other, respectively, for the nine months ended September 30, 2008. | |
[2] | Other segment contains the free standing derivative associated with the GMIB and GMAB reinsurance from the Companys, affiliate, HLIKK. The reinsurance agreement is the primary driver of the revenue and net income (loss) for the Other segment. |
Three Months ended September 30, | Nine Months ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Net Income (Loss) |
||||||||||||||||
Retail [1] |
$ | (172 | ) | $ | (825 | ) | $ | (725 | ) | $ | (732 | ) | ||||
Individual Life |
(1 | ) | (105 | ) | (8 | ) | (58 | ) | ||||||||
Retirement Plans |
(34 | ) | (160 | ) | (162 | ) | (134 | ) | ||||||||
Institutional |
(104 | ) | (391 | ) | (350 | ) | (543 | ) | ||||||||
Other [1][2] |
(399 | ) | (351 | ) | 544 | (613 | ) | |||||||||
Total net income (loss) [1] |
$ | (710 | ) | $ | (1,832 | ) | $ | (701 | ) | $ | (2,080 | ) | ||||
[1] | The transition impact related to the adoption of fair value was a reduction in net income of $209 and $102 in Retail and Other, respectively, for the nine months ended September 30, 2008. | |
[2] | Other segment contains the free standing derivative associated with the GMIB and GMAB reinsurance from the Companys, affiliate, HLIKK. The reinsurance agreement is the primary driver of the revenue and net income (loss) for the Other segment. |
12
Table of Contents
3. Fair Value Measurements
The following financial instruments are carried at fair value in the Companys Condensed
Consolidated Financial Statements: fixed maturities and equity securities, available-for-sale
(AFS), equity securities, trading, short-term investments, freestanding and embedded derivatives,
and separate account assets.
The following section applies the fair value hierarchy and disclosure requirements for the
Companys financial instruments that are carried at fair value. The fair value hierarchy
prioritizes the inputs in the valuation techniques used to measure fair value into three broad
Levels (Level 1, 2 or 3)
Level 1
|
Observable inputs that reflect quoted prices for identical assets or liabilities in active markets that the Company has the ability to access at the measurement date. Level 1 securities include highly liquid U.S. Treasuries, money market funds and exchange traded equity, open-ended mutual funds reported in separate account assets and derivative securities, including futures and certain option contracts. | |
Level 2
|
Observable inputs, other than quoted prices included in Level 1, for the asset or liability or prices for similar assets and liabilities. Most debt securities and preferred stocks, including those reported in separate account assets, are model priced by vendors using observable inputs and are classified within Level 2. Also included in the Level 2 category are derivative instruments that are priced using models with significant observable market inputs, including interest rate, foreign currency and certain credit swap contracts and have no significant unobservable market inputs. | |
Level 3
|
Valuations that are derived from techniques in which one or more of the significant inputs are unobservable (including assumptions about risk). Level 3 securities include less liquid securities such as highly structured and/or lower quality asset-backed securities (ABS), commercial mortgage-backed securities (CMBS), commercial real estate (CRE) CDOs, residential mortgage-backed securities (RMBS) primarily backed by below- prime loans, and private placement debt and equity securities reported in both the general and separate accounts. Embedded derivatives, including GMWB liabilities, and complex derivatives securities, including equity derivatives, longer dated interest rate swaps or swaps with optionality and certain complex credit derivatives are also included in Level 3. Because Level 3 fair values, by their nature, contain unobservable market inputs as there is little or no observable market for these assets and liabilities, considerable judgment is used to determine the Level 3 fair values. Level 3 fair values represent the Companys best estimate of an amount that could be realized in a current market exchange absent actual market exchanges. |
In many situations, inputs used to measure the fair value of an asset or liability position may
fall into different levels of the fair value hierarchy. In these situations, the Company will
determine the level in which the fair value falls based upon the lowest level input that is
significant to the determination of the fair value. In most cases, both observable (e.g., changes
in interest rates) and unobservable (e.g., changes in risk assumptions) inputs are used in the
determination of fair values that the Company has classified within Level 3. Consequently, these
values and the related gains and losses are based upon both observable and unobservable inputs. The
Companys fixed maturities included in Level 3 are classified as such as they are primarily priced
by independent brokers and/or within illiquid markets (i.e., below-prime RMBS).
13
Table of Contents
3. Fair Value Measurements (continued)
These disclosures provide information as to the extent to which the Company uses fair value to
measure financial instruments and information about the inputs used to value those financial
instruments to allow users to assess the relative reliability of the measurements. The following
tables present assets and (liabilities) carried at fair value by hierarchy level.
September 30, 2009 | ||||||||||||||||
Quoted Prices | ||||||||||||||||
in Active | Significant | Significant | ||||||||||||||
Markets for | Observable | Unobservable | ||||||||||||||
Identical Assets | Inputs | Inputs | ||||||||||||||
Total | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Assets accounted for at fair value on a recurring basis |
||||||||||||||||
Fixed maturities, AFS |
||||||||||||||||
ABS |
$ | 1,988 | $ | | $ | 1,502 | $ | 486 | ||||||||
CDOs |
2,114 | | 34 | 2,080 | ||||||||||||
CMBS |
5,673 | | 5,333 | 340 | ||||||||||||
Corporate |
23,192 | | 18,474 | 4,718 | ||||||||||||
Foreign government/government agencies |
525 | | 471 | 54 | ||||||||||||
RMBS |
3,309 | | 2,315 | 994 | ||||||||||||
States, municipalities and political subdivisions |
800 | | 580 | 220 | ||||||||||||
U.S. Treasuries |
1,835 | 181 | 1,654 | | ||||||||||||
Total fixed maturities, AFS |
39,436 | 181 | 30,363 | 8,892 | ||||||||||||
Equity securities, trading |
2,465 | 2,465 | | | ||||||||||||
Equity securities, AFS |
409 | 98 | 287 | 24 | ||||||||||||
Other investments |
||||||||||||||||
Variable annuity hedging derivatives |
733 | | (21 | ) | 754 | |||||||||||
Other derivatives[1] |
509 | | 518 | (9 | ) | |||||||||||
Total other investments |
1,242 | | 497 | 745 | ||||||||||||
Short-term investments |
5,901 | 4,051 | 1,850 | | ||||||||||||
Reinsurance recoverable for U.S. GMWB |
538 | | | 538 | ||||||||||||
Separate account assets [2] |
144,009 | 110,050 | 33,241 | 718 | ||||||||||||
Total assets accounted for at fair value on a recurring basis |
$ | 194,000 | $ | 116,845 | $ | 66,238 | $ | 10,917 | ||||||||
Liabilities accounted for at fair value on a recurring basis |
||||||||||||||||
Other policyholder funds and benefits payable |
||||||||||||||||
Guaranteed living benefits |
$ | (4,559 | ) | $ | | $ | | $ | (4,559 | ) | ||||||
Institutional notes |
(7 | ) | | | (7 | ) | ||||||||||
Equity linked notes |
(8 | ) | | | (8 | ) | ||||||||||
Total other policyholder funds and benefits payable |
(4,574 | ) | | | (4,574 | ) | ||||||||||
Other liabilities [3] |
||||||||||||||||
Variable annuity hedging derivatives |
(27 | ) | | (44 | ) | 17 | ||||||||||
Other derivative liabilities |
(355 | ) | | (180 | ) | (175 | ) | |||||||||
Total other liabilities |
(382 | ) | | (224 | ) | (158 | ) | |||||||||
Consumer notes [4] |
(5 | ) | | | (5 | ) | ||||||||||
Total liabilities accounted for at fair value on a recurring
basis |
$ | (4,961 | ) | $ | | $ | (224 | ) | $ | (4,737 | ) | |||||
(1) | Includes over-the-counter derivative instruments in a net asset value position which may require the counterparty to pledge collateral to the Company. As of September 30, 2009, $1 billion of cash collateral liability was netted against the derivative asset value in the Condensed Consolidated Balance Sheets and is excluded from the table above. See footnote 3 below for derivative liabilities. | |
(2) | As of September 30, 2009, excludes approximately $12 billion of investment sales receivable net of investment purchases payable that are not subject to fair value accounting. | |
(3) | Includes over-the-counter derivative instruments in a net negative market value (derivative liability). In the Level 3 roll forward table included below in this Note 3, the derivative asset and liability are referred to as freestanding derivatives and are presented on a net basis. | |
(4) | Represents embedded derivatives associated with non-funding agreement-backed consumer equity-linked notes. |
14
Table of Contents
3. Fair Value Measurements (continued)
December 31, 2008 | ||||||||||||||||
Quoted Prices in | ||||||||||||||||
Active Markets | Significant | Significant | ||||||||||||||
for Identical | Observable | Unobservable | ||||||||||||||
Assets | Inputs | Inputs | ||||||||||||||
Total | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Assets accounted for at fair value on a recurring basis |
||||||||||||||||
Fixed maturities, AFS |
$ | 39,560 | $ | 3,502 | $ | 27,316 | $ | 8,742 | ||||||||
Equity securities, trading |
1,634 | 1,634 | | | ||||||||||||
Equity securities, AFS |
434 | 148 | 227 | 59 | ||||||||||||
Other investments |
||||||||||||||||
Variable annuity hedging derivatives |
600 | | 13 | 587 | ||||||||||||
Other derivatives [1] |
522 | | 588 | (66 | ) | |||||||||||
Total other investments |
1,122 | | 601 | 521 | ||||||||||||
Short-term investments |
5,742 | 4,030 | 1,712 | | ||||||||||||
Reinsurance recoverable for U.S. GMWB |
1,302 | | | 1,302 | ||||||||||||
Separate account assets [2] |
126,367 | 94,394 | 31,187 | 786 | ||||||||||||
Total assets accounted for at fair value on a recurring basis |
$ | 176,161 | $ | 103,708 | $ | 61,043 | $ | 11,410 | ||||||||
Liabilities accounted for at fair value on a recurring basis |
||||||||||||||||
Other policyholder funds and benefits payable |
||||||||||||||||
Guaranteed living benefits |
$ | (9,206 | ) | $ | | $ | | $ | (9,206 | ) | ||||||
Institutional notes |
(41 | ) | | | (41 | ) | ||||||||||
Equity linked notes |
(8 | ) | | | (8 | ) | ||||||||||
Total other policyholder funds and benefits payable |
(9,255 | ) | | | (9,255 | ) | ||||||||||
Other liabilities [3] |
||||||||||||||||
Variable annuity hedging derivatives |
2,201 | | 14 | 2,187 | ||||||||||||
Other derivative liabilities |
5 | | 173 | (168 | ) | |||||||||||
Total other liabilities |
2,206 | | 187 | 2,019 | ||||||||||||
Consumer notes [4] |
(5 | ) | | | (5 | ) | ||||||||||
Total liabilities accounted for at fair value on a recurring
basis |
$ | (7,054 | ) | $ | | $ | 187 | $ | (7,241 | ) | ||||||
(1) | Includes over-the-counter derivative instruments in a net asset value position which may require the counterparty to pledge collateral to the Company. As of December 31, 2008, $507 of cash collateral liability was netted against the derivative asset value in the Condensed Consolidated Balance Sheets and is excluded from the table above. See footnote 3 below for derivative liabilities. | |
(2) | As of December 31, 2008, excludes approximately $3 billion of investment sales receivable net of investment purchases payable that are not subject to fair value accounting. | |
(3) | Includes over-the-counter derivative instruments in a net negative market value (derivative liability). In the Level 3 roll-forward table included below in this Note 3, the derivative asset and liability are referred to as freestanding derivatives and are presented on a net basis. | |
(4) | Represents embedded derivatives associated with non-funding agreement-backed consumer equity linked notes. |
15
Table of Contents
3. Fair Value Measurements (continued)
Determination of fair values
The valuation methodologies used to determine the fair values of assets and liabilities under the
exit price notion, reflect market-participant objectives and are based on the application of the
fair value hierarchy that prioritizes relevant observable market inputs over unobservable inputs.
The Company determines the fair values of certain financial assets and financial liabilities based
on quoted market prices, where available and where prices represent a reasonable estimate of fair
value. The Company also determines fair value based on future cash flows discounted at the
appropriate current market rate. Fair values reflect adjustments for counterparty credit quality,
the Companys default spreads, liquidity and, where appropriate, risk margins on unobservable
parameters. The following is a discussion of the methodologies used to determine fair values for
the financial instruments listed in the above tables.
Available-for-Sale Securities and Short-term Investments
The fair value of AFS securities and short-term investments, in an active and orderly market (e.g.
not distressed or forced liquidation) is determined by management after considering one of three
primary sources of information: third party pricing services, independent broker quotations or
pricing matrices. Security pricing is applied using a waterfall approach whereby publicly
available prices are first sought from third party pricing services, the remaining unpriced
securities are submitted to independent brokers for prices, or lastly, securities are priced using
a pricing matrix. Typical inputs used by these three pricing methods include, but are not limited
to, reported trades, benchmark yields, issuer spreads, bids, offers, and/or estimated cash flows
and prepayments speeds. Based on the typical trading volumes and the lack of quoted market prices
for fixed maturities, third party pricing services will normally derive the security prices from
recent reported trades for identical or similar securities making adjustments through the reporting
date based upon available market observable information as outlined above. If there are no recent
reported trades, the third party pricing services and brokers may use matrix or model processes to
develop a security price where future cash flow expectations are developed based upon collateral
performance and discounted at an estimated market rate. Included in the pricing of ABS and RMBS
are estimates of the rate of future prepayments of principal over the remaining life of the
securities. Such estimates are derived based on the characteristics of the underlying structure
and prepayment speeds previously experienced at the interest rate levels projected for the
underlying collateral. Actual prepayment experience may vary from these estimates.
Prices from third party pricing services are often unavailable for securities that are rarely
traded or are traded only in privately negotiated transactions. As a result, certain securities
are priced via independent broker quotations which utilize inputs that may be difficult to
corroborate with observable market based data. Additionally, the majority of these independent
broker quotations are non-binding. A pricing matrix is used to price securities for which the
Company is unable to obtain either a price from a third party pricing service or an independent
broker quotation. The pricing matrix used by the Company begins with current spread levels to
determine the market price for the security. The credit spreads, as assigned by a knowledgeable
private placement broker, incorporate the issuers credit rating and a risk premium, if warranted,
due to the issuers industry and the securitys time to maturity. The issuer-specific yield
adjustments, which can be positive or negative, are updated twice per year, as of June 30 and
December 31, by the private placement broker and are intended to adjust security prices for
issuer-specific factors. The Company assigns a credit rating to these securities based upon an
internal analysis of the issuers financial strength.
The Company performs a monthly analysis of the prices and credit spreads received from third
parties to ensure that the prices represent a reasonable estimate of the fair value. As a part of
this analysis, the Company considers trading volume and other factors to determine whether the
decline in market activity is significant when compared to normal activity in an active market, and
if so, whether transactions may not be orderly considering the weight of available evidence. If
the available evidence indicates that pricing is based upon transactions that are stale or not
orderly, the Company places little, if any, weight on the transaction price and will estimate fair
value utilizing an internal pricing model. This process involves quantitative and qualitative
analysis and is overseen by investment and accounting professionals. Examples of procedures
performed include, but are not limited to, initial and on-going review of third party pricing
services methodologies, review of pricing statistics and trends, back testing recent trades, and
monitoring of trading volumes, new issuance activity and other market activities. In addition, the
Company ensures that prices received from independent brokers represent a reasonable estimate of
fair value through the use of internal and external cash flow models developed based on spreads,
and when available, market indices. As a result of this analysis, if the Company determines that
there is a more appropriate fair value based upon the available market data, the price received
from the third party is adjusted accordingly. The Companys internal pricing model utilizes the
Companys best estimate of expected future cash flows discounted at a rate of return that a market
participant would require. The significant inputs to the model include, but are not limited to,
current market inputs, such as credit loss assumptions, estimated prepayment speeds and market risk
premiums.
16
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3. Fair Value Measurements (continued)
The Company has analyzed the third party pricing services valuation methodologies and related
inputs, and has also evaluated the various types of securities in its investment portfolio to
determine an appropriate fair value hierarchy level based upon trading activity and the
observability of market inputs. Most prices provided by third party pricing services are
classified into Level 2 because the inputs used in pricing the securities are market observable.
Due to a general lack of transparency in the process that brokers use to develop prices, most
valuations that are based on brokers prices are classified as Level 3. Some valuations may be
classified as Level 2 if the price can be corroborated. Internal matrix priced securities,
primarily consisting of certain private placement debt, are also classified as Level 3 due to
significant non-observable inputs.
Derivative Instruments, including embedded derivatives within investments
Freestanding derivative instruments are reported in the condensed consolidated balance sheets at
fair value and are reported in Other Investments and Other Liabilities. Embedded derivatives are
reported with the host instruments on the consolidated balance sheet. Derivative instruments are
fair valued using pricing valuation models, which utilize market data inputs or independent broker
quotations. Excluding embedded and reinsurance related derivatives, as of September 30, 2009, 96%
of derivatives, based upon notional values, were priced by valuation models, which utilize
independent market data. The remaining derivatives were priced by broker quotations. The
derivatives are valued using mid-market inputs that are predominantly observable in the market.
Inputs used to value derivatives include, but are not limited to, interest swap rates, foreign
currency forward and spot rates, credit spreads and correlations, interest and equity volatility
and equity index levels. The Company performs a monthly analysis on derivative valuations which
includes both quantitative and qualitative analysis. Examples of procedures performed include, but
are not limited to, review of pricing statistics and trends, back testing recent trades, analyzing
the impacts of changes in the market environment, and review of changes in market value for each
derivative including those derivatives priced by brokers.
The Company utilizes derivative instruments to manage the risk associated with certain assets and
liabilities. However, the derivative instrument may not be classified with the same fair value
hierarchy level as the associated assets and liabilities. Therefore the realized and unrealized
gains and losses on derivatives reported in Level 3 may not reflect the offsetting impact of the
realized and unrealized gains and losses of the associated assets and liabilities.
U.S. GMWB Reinsurance Derivatives
The fair values of the U.S. GMWB reinsurance derivatives are calculated as an aggregation of the
components described in the Living Benefits Required to be Fair Valued discussion below and is
modeled using significant unobservable policyholder behavior inputs, identical to those used in
calculating the underlying liability, such as lapses, fund selection, resets and withdrawal
utilization and risk margins.
Separate Account Assets
Separate account assets are primarily invested in mutual funds but also have investments in fixed
maturity and equity securities. The separate account investments are valued in the same manner,
and using the same pricing sources and inputs, as the fixed maturity, equity security, and
short-term investments of the Company.
Living Benefits Required to be Fair Valued (in Other Policyholder Funds and Benefits Payable)
Fair values for directly written GMWB contracts and the related reinsurance and customized
derivatives that hedge certain equity markets exposure for those contracts and GMIB, GMWB and GMAB
contracts assumed under reinsurance are calculated based upon internally developed models because
active, observable markets do not exist for those items. The fair value of the Companys
guaranteed benefit liabilities, classified as embedded derivatives, and the related reinsurance and
customized freestanding derivatives is calculated as an aggregation of the following components:
Best Estimate; Actively-Managed Volatility Adjustment; Credit Standing Adjustment; Market
Illiquidity Premium; and Behavior Risk Margin. The resulting aggregation is reconciled or
calibrated, if necessary, to market information that is, or may be, available to the Company, but
may not be observable by other market participants, including reinsurance discussions and
transactions. The Company believes the aggregation of each of these components, as necessary and
as reconciled or calibrated to the market information available to the Company, results in an
amount that the Company would be required to transfer, for a liability, or receive, for an asset,
to or from market participants in an active liquid market, if one existed, for those market
participants to assume the risks associated with the guaranteed minimum benefits and the related
reinsurance and customized derivatives. The fair value is likely to materially diverge from the
ultimate settlement of the liability as the Company believes settlement will be based on our best
estimate assumptions rather than those best estimate assumptions plus risk margins. In the absence
of any transfer of the guaranteed benefit liability to a third party, the release of risk margins
is likely to be reflected as realized gains in future periods net income. Each of the components
described below are unobservable in the marketplace and require subjectivity by the Company in
determining their value.
| Best Estimate. This component represents the estimated amount for which a financial instrument could be exchanged in a current transaction between knowledgeable, unrelated willing parties using identifiable, measurable and significant inputs. |
The Best Estimate is calculated based on actuarial and capital market assumptions related to projected cash flows, including benefits and related contract charges, over the lives of the contracts, incorporating expectations concerning policyholder behavior such as lapses, fund selection, resets and withdrawal utilization (for the customized derivatives, policyholder behavior is prescribed in the derivative contract). Because of the dynamic and complex nature of these cash flows, best estimate assumptions and a Monte |
17
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3. Fair Value Measurements (continued)
Carlo stochastic process involving the generation of thousands of scenarios that assume risk neutral returns consistent with swap rates and a blend of observable implied index volatility levels were used. Estimating these cash flows involves numerous estimates and subjective judgments including those regarding expected markets rates of return, market volatility, correlations of market index returns to funds, fund performance, discount rates and policyholder behavior. At each valuation date, the Company assumes expected returns based on: |
| risk-free rates as represented by the current LIBOR forward curve rates; |
| forward market volatility assumptions for each underlying index based primarily on a blend of observed market implied volatility data; |
| correlations of market returns across underlying indices based on actual observed market returns and relationships over the ten years preceding the valuation date; |
| three years of history for fund regression; and |
| current risk-free spot rates as represented by the current LIBOR spot curve to determine the present value of expected future cash flows produced in the stochastic projection process. |
As many guaranteed benefit obligations are relatively new in the marketplace, actual policyholder
behavior experience is limited. As a result, estimates of future policyholder behavior are
subjective and based on analogous internal and external data. As markets change, mature and evolve
and actual policyholder behavior emerges, management continually evaluates the appropriateness of
its assumptions for this component of the fair value model.
On a daily basis, the Company updates capital market assumptions used in the GMWB liability model
such as interest rates, equity indices and a blend of implied equity index volatilities. The
Company continually monitors actual policyholder behavior and revises assumptions regarding
policyholder behavior as credible trends of policyholder behavior emerge. With the unprecedented
market conditions beginning in the third quarter of 2008, the Company, for the first time, was able
to observe policyholder behavior on its living benefit products in adverse market conditions. As
actual policyholder behavior emerged in this environment, new data suggested that policyholder
behavior in declining market scenarios was not as adverse as our prior assumptions. As a result,
in the second quarter the Company adjusted the behavior assumptions in the GMWB model. The Company
is continually evaluating various aspects of policyholder behavior and may modify certain of its
assumptions, including living benefit lapses and withdrawal rates, if credible emerging data
indicates that changes are warranted. At a minimum, all policyholder behavior assumptions are
reviewed and updated, as appropriate, in conjunction with the completion of the Companys
comprehensive study to refine its estimate of future gross profits during the third quarter of each
year.
| Actively-Managed Volatility Adjustment. This component incorporates the basis differential between the observable index implied volatilities used to calculate the Best Estimate component and the actively-managed funds underlying the variable annuity product. The Actively-Managed Volatility Adjustment is calculated using historical fund and weighted index volatilities. |
| Credit Standing Adjustment. This assumption makes an adjustment that market participants would make to reflect the risk that guaranteed benefit obligations or the GMWB reinsurance recoverables will not be fulfilled (nonperformance risk). As a result of sustained volatility in the Companys credit default spreads, during the first quarter of 2009 the Company changed its estimate of the Credit Standing Adjustment to incorporate observable Company and reinsurer credit default spreads from capital markets, adjusted for market recoverability. Prior to the first quarter of 2009, the Company calculated the Credit Standing Adjustment by using default rates published by rating agencies, adjusted for market recoverability. The changes made in the first quarter of 2009 resulted in a realized gain of $383, before-tax, for U.S. GMWB liabilities, a realized gain of $1.1 billion, before-tax for reinsured Japan GMIB, and a realized loss of $185, before-tax, for uncollateralized reinsurance recoverable assets. For the three and nine months ended September 30, 2009, the credit standing adjustment for U.S. GMWB liabilities resulted in a pre-tax loss of $70 and a pre-tax gain of $163, respectively. For the three and nine months ended September 30, 2009, the credit standing adjustment for reinsured Japan GMIB liabilities resulted in a pre-tax loss of $456 and a pre-tax gain of $286, respectively. |
| Market Illiquidity Premium. This component makes an adjustment that market participants would require to reflect that guaranteed benefit obligations are illiquid and have no market observable exit prices in the capital markets. |
| Behavior Risk Margin and Other Policyholder Behavior Assumptions. The behavior risk margin adds a margin that market participants would require for the risk that the Companys assumptions about policyholder behavior could differ from actual experience. The behavior risk margin is calculated by taking the difference between adverse policyholder behavior assumptions and best estimate assumptions. During the first half of 2009, the Company revised certain adverse assumptions in the behavior risk margin for withdrawals, lapses and annuitization behavior as emerging policyholder behavior experience suggested the prior adverse policyholder behavior assumptions were no longer representative of an appropriate margin for risk. These changes resulted in a realized gain of $352, before-tax, in the first quarter of 2009 and a realized gain of $118, before-tax, in the second quarter of 2009. |
18
Table of Contents
3. Fair Value Measurements (continued)
In
addition to the credit standing update described above, during the third quarter of 2009, the
Company recognized non-market-based updates to the U.S. GMWB fair value driven by:
| The impact of having lower future expected separate account growth assumption caused by the Companys decision to increase the mortality and expense fees charged to policyholders and mortality assumption updates, resulting in a pre-tax loss of approximately $126; and |
| The relative outperformance of the underlying actively managed funds as compared to their respective indices and regression updates, resulting in a pre-tax gain of approximately $165. |
For the nine months ended September 30, 2009, the Company recognized non-market-based assumption
updates to the U.S. GMWB fair value driven by:
| The relative outperformance of the underlying actively managed funds as compared to their respective indices and regression updates, resulting in a pre-tax gain of approximately $528; |
| Updates to the behavior risk margin (described above), the third quarter increase in mortality and expense fees (described above) and other policyholder behavior assumption changes made during the nine months ended September 30, 2009, resulting in a pre-tax gain of approximately $306; and |
| The credit standing adjustment (described above), resulting in a pre-tax gain of approximately $163. |
In addition to the non-market-based updates described above, during the third quarter of 2009, the
Company recognized non-market-based updates to the reinsured Japan GMIB fair value primarily driven
by updates to dynamic lapse assumptions and mortality assumptions,
resulting in a pre-tax loss of
approximately $233. For the nine months ended September 30, 2009, the Company recognized
non-market-based assumption updates to the reinsured Japan GMIB fair value primarily driven by:
| The credit standing adjustment (described above), resulting in a pre-tax gain of approximately $286; and |
| The aforementioned updates to dynamic lapse assumptions and mortality assumptions. |
Assets and Liabilities Measured at Fair Value on a Recurring Basis Using Significant Unobservable
Inputs (Level 3)
The tables below provide a fair value roll forward for the three and nine months ending September
30, 2009 and 2008, for the financial instruments classified as Level 3.
19
Table of Contents
3. Fair Value Measurements (continued)
Roll-forward of Financial Instruments Measured at Fair Value on a Recurring Basis Using
Significant Unobservable Inputs (Level 3) for the three months ended September 30, 2009:
Changes in unrealized | ||||||||||||||||||||||||||||
gains (losses) | ||||||||||||||||||||||||||||
Total realized/unrealized | Purchases, | included in net income | ||||||||||||||||||||||||||
Fair value | gains (losses) included in: | issuances, | Transfers in | Fair value | related to financial | |||||||||||||||||||||||
as of | Net income | and | and/or (out) | as of | instruments still held at | |||||||||||||||||||||||
Asset (Liability) | July 1, 2009 | [1], [2] | OCI [3] | settlements | of Level 3 [4] | September 30, 2009 | September 30, 2009 [2] | |||||||||||||||||||||
Assets |
||||||||||||||||||||||||||||
Fixed maturities, AFS |
||||||||||||||||||||||||||||
ABS |
$ | 401 | $ | (31 | ) | $ | 113 | $ | (15 | ) | $ | 18 | $ | 486 | $ | (31 | ) | |||||||||||
CDO |
1,922 | (168 | ) | 393 | (36 | ) | (31 | ) | 2,080 | (168 | ) | |||||||||||||||||
CMBS |
162 | (67 | ) | 96 | (3 | ) | 152 | 340 | (67 | ) | ||||||||||||||||||
Corporate |
4,386 | (13 | ) | 352 | 41 | (48 | ) | 4,718 | (14 | ) | ||||||||||||||||||
Foreign govt./govt. agencies |
52 | | 3 | (1 | ) | | 54 | | ||||||||||||||||||||
RMBS |
1,062 | (65 | ) | 150 | (102 | ) | (51 | ) | 994 | (65 | ) | |||||||||||||||||
States, municipalities and
political subdivisions |
179 | | 12 | 22 | 7 | 220 | | |||||||||||||||||||||
Fixed maturities, AFS |
8,164 | (344 | ) | 1,119 | (94 | ) | 47 | 8,892 | (345 | ) | ||||||||||||||||||
Equity securities, AFS |
25 | (1 | ) | | | | 24 | | ||||||||||||||||||||
Derivatives [5] |
||||||||||||||||||||||||||||
Variable annuity hedging
derivatives |
1,135 | (441 | ) | | 77 | | 771 | (234 | ) | |||||||||||||||||||
Other freestanding derivatives |
(241 | ) | 47 | 5 | 5 | | (184 | ) | 52 | |||||||||||||||||||
Total freestanding derivatives |
894 | (394 | ) | 5 | 82 | | 587 | (182 | ) | |||||||||||||||||||
Reinsurance recoverable for
U.S. GMWB [1] |
632 | (103 | ) | | 9 | | 538 | (103 | ) | |||||||||||||||||||
Separate accounts [6] |
673 | 40 | | 29 | (24 | ) | 718 | 34 | ||||||||||||||||||||
Supplemental Asset Information: |
||||||||||||||||||||||||||||
Total freestanding derivatives
used to hedge U.S. GMWB including those in Levels 1, 2 and 3 |
855 | (478 | ) | | 7 | | 384 | (478 | ) | |||||||||||||||||||
Liabilities |
||||||||||||||||||||||||||||
Other policyholder funds and
benefits payable |
||||||||||||||||||||||||||||
Guaranteed living benefits[1] |
$ | (4,367 | ) | $ | (30 | ) | $ | (100 | ) | $ | (62 | ) | $ | | $ | (4,559 | ) | $ | (30 | ) | ||||||||
Institutional notes |
2 | (9 | ) | | | | (7 | ) | (9 | ) | ||||||||||||||||||
Equity linked notes |
(6 | ) | (2 | ) | | | | (8 | ) | (2 | ) | |||||||||||||||||
Total other policyholder funds
and benefits payable |
(4,371 | ) | (41 | ) | (100 | ) | (62 | ) | | (4,574 | ) | (41 | ) | |||||||||||||||
Consumer notes |
(4 | ) | (1 | ) | | | | (5 | ) | (1 | ) | |||||||||||||||||
Supplemental Information: |
||||||||||||||||||||||||||||
Net U.S. GMWB (Embedded
derivatives, freestanding
derivatives including those in
Levels 1, 2 and 3 and
reinsurance recoverable) [7] |
(1,802 | ) | (198 | ) | | (21 | ) | | (2,021 | ) | (198 | ) | ||||||||||||||||
(1) | The Company classifies gains and losses on GMWB reinsurance derivatives and Guaranteed Living Benefit embedded derivatives and reinsured free standing derivatives as unrealized gains (losses) for purposes of disclosure in this table because it is impracticable to track on a contract-by-contract basis the realized gains (losses) for these derivatives and embedded derivatives. | |
(2) | All amounts in these columns are reported in net realized capital gains (losses). All amounts are before income taxes and amortization of deferred policy acquisition costs and present value of future profits (DAC). | |
(3) | All amounts are before income taxes and amortization of DAC. | |
(4) | Transfers in and/or (out) of Level 3 are attributable to a change in the availability of market observable information, as well as downgrades of CMBS. | |
(5) | Derivative instruments are reported in this table on a net basis for asset/(liability) positions and reported in the Condensed Consolidated Balance Sheets in other investments and other liabilities. | |
(6) | The realized/unrealized gains (losses) included in net income for separate account assets are offset by an equal amount for separate account liabilities, which results in a net zero impact on net income for the Company. | |
(7) | The net (loss) on U.S. GMWB since July 1, 2009 was primarily due to losses of $154 resulting from the Companys net market-based dynamic hedging positions, of which approximately $97 related to falling long-term risk-free interest rates and non-market-based assumption updates described above. |
20
Table of Contents
3. Fair Value Measurements (continued)
Roll-forward of Financial Instruments Measured at Fair Value on a Recurring Basis Using Significant
Unobservable Inputs (Level 3) for the nine months ended September 30, 2009:
Changes in unrealized | ||||||||||||||||||||||||||||
gains (losses) | ||||||||||||||||||||||||||||
Fair value | Total realized/unrealized | Purchases, | included in net income | |||||||||||||||||||||||||
as of | gains (losses) included in: | issuances, | Transfers in | Fair value | related to financial | |||||||||||||||||||||||
January 1, | Net income | and | and/or (out) | as of | instruments still held at | |||||||||||||||||||||||
Asset (Liability) | 2009 | [1], [2] | OCI [3] | settlements | of Level 3 [4] | September 30, 2009 | September 30, 2009 [2] | |||||||||||||||||||||
Assets |
||||||||||||||||||||||||||||
Fixed maturities, AFS |
||||||||||||||||||||||||||||
ABS |
$ | 429 | $ | (36 | ) | $ | 139 | $ | (13 | ) | $ | (33 | ) | $ | 486 | $ | (32 | ) | ||||||||||
CDO |
1,981 | (248 | ) | 460 | (82 | ) | (31 | ) | 2,080 | (247 | ) | |||||||||||||||||
CMBS |
263 | (85 | ) | 94 | (5 | ) | 73 | 340 | (75 | ) | ||||||||||||||||||
Corporate |
4,421 | (53 | ) | 599 | 194 | (443 | ) | 4,718 | (35 | ) | ||||||||||||||||||
Foreign govt./govt. agencies |
74 | | 1 | (8 | ) | (13 | ) | 54 | | |||||||||||||||||||
RMBS |
1,419 | (188 | ) | (101 | ) | (88 | ) | (48 | ) | 994 | (143 | ) | ||||||||||||||||
States, municipalities and
political subdivisions |
155 | | 7 | 21 | 37 | 220 | | |||||||||||||||||||||
Fixed maturities, AFS |
8,742 | (610 | ) | 1,199 | 19 | (458 | ) | 8,892 | (532 | ) | ||||||||||||||||||
Equity securities, AFS |
59 | (1 | ) | | (1 | ) | (33 | ) | 24 | | ||||||||||||||||||
Derivatives [5] |
||||||||||||||||||||||||||||
Variable annuity hedging
derivatives |
2,774 | (1,534 | ) | | (469 | ) | | 771 | (1,276 | ) | ||||||||||||||||||
Other freestanding derivatives |
(234 | ) | 43 | (5 | ) | 18 | (6 | ) | (184 | ) | 62 | |||||||||||||||||
Total freestanding derivatives |
2,540 | (1,491 | ) | (5 | ) | (451 | ) | (6 | ) | 587 | (1,214 | ) | ||||||||||||||||
Reinsurance recoverable for
U.S. GMWB [1] |
1,302 | (788 | ) | | 24 | | 538 | (788 | ) | |||||||||||||||||||
Separate accounts [6] |
786 | (82 | ) | | 139 | (125 | ) | 718 | (39 | ) | ||||||||||||||||||
Supplemental Asset Information: |
||||||||||||||||||||||||||||
Total freestanding derivatives
used to hedge U.S. GMWB including those in Levels 1, 2 and 3 |
2,664 | (1,878 | ) | | (402 | ) | | 384 | (1,878 | ) | ||||||||||||||||||
Liabilities |
||||||||||||||||||||||||||||
Other policyholder funds and
benefits payable [1] |
||||||||||||||||||||||||||||
Guaranteed living benefits |
$ | (9,206 | ) | $ | 4,731 | $ | 103 | $ | (187 | ) | $ | | $ | (4,559 | ) | $ | 4,731 | |||||||||||
Institutional notes |
(41 | ) | 34 | | | | (7 | ) | 34 | |||||||||||||||||||
Equity linked notes |
(8 | ) | | | | | (8 | ) | | |||||||||||||||||||
Total other policyholder
funds and benefits payable [1] |
(9,255 | ) | 4,765 | 103 | (187 | ) | | (4,574 | ) | 4,765 | ||||||||||||||||||
Consumer notes |
(5 | ) | | | | | (5 | ) | | |||||||||||||||||||
Supplemental Information: |
||||||||||||||||||||||||||||
Net U.S. GMWB (Embedded
derivatives, freestanding
derivatives including those in
Levels 1, 2 and 3 and
reinsurance recoverable) [7] |
(2,560 | ) | 1,017 | | (478 | ) | | (2,021 | ) | 1,017 | ||||||||||||||||||
(1) | The Company classifies gains and losses on GMWB reinsurance derivatives and Guaranteed Living Benefit embedded derivatives and reinsured free standing derivatives as unrealized gains (losses) for purposes of disclosure in this table because it is impracticable to track on a contract-by-contract basis the realized gains (losses) for these derivatives and embedded derivatives. | |
(2) | All amounts in these columns are reported in net realized capital gains (losses), except for $2, which is reported in benefits, losses and loss adjustment expenses. All amounts are before income taxes and amortization of DAC. | |
(3) | All amounts are before income taxes and amortization of DAC. | |
(4) | Transfers in and/or (out) of Level 3 are attributable to a change in the availability of market observable information and re-evaluation of the observability of pricing inputs for individual securities within respective categories. | |
(5) | Derivative instruments are reported in this table on a net basis for asset/(liability) positions and reported in the Condensed Consolidated Balance Sheets in other investments and other liabilities. | |
(6) | The realized/unrealized gains (losses) included in net income for separate account assets are offset by an equal amount for separate account liabilities which results in a net zero impact on net income for the Company. | |
(7) | The net gain on U.S. GMWB since January 1, 2009 was primarily due to the non-market-based assumption updates described above. |
21
Table of Contents
3. Fair Value Measurements (continued)
Roll-forward of Financial Instruments Measured at Fair Value on a Recurring Basis Using
Significant Unobservable Inputs (Level 3) for the three months ended September 30, 2008
Changes in unrealized | ||||||||||||||||||||||||||||
gains (losses) | ||||||||||||||||||||||||||||
Total realized/unrealized | Purchases, | included in net income | ||||||||||||||||||||||||||
Fair value | gains (losses) included in: | issuances, | Transfers in | Fair value | related to financial | |||||||||||||||||||||||
as of | Net income | and | and/or (out) | as of | instruments still held at | |||||||||||||||||||||||
Asset (Liability) | July 1, 2008 | [1], [2] | OCI [3] | settlements | of Level 3 [4] | September 30, 2008 | September 30, 2008 [2] | |||||||||||||||||||||
Assets |
||||||||||||||||||||||||||||
Fixed maturities, AFS |
$ | 12,264 | $ | (391 | ) | $ | (616 | ) | $ | 5 | $ | 887 | $ | 12,149 | $ | (389 | ) | |||||||||||
Equity securities, AFS |
508 | (73 | ) | 26 | (3 | ) | (10 | ) | 448 | (73 | ) | |||||||||||||||||
Derivatives [5] |
||||||||||||||||||||||||||||
Variable annuity hedging
derivatives |
793 | 437 | | 9 | | 1,239 | 394 | |||||||||||||||||||||
Other freestanding derivatives |
(260 | ) | (125 | ) | (4 | ) | 23 | | (366 | ) | (116 | ) | ||||||||||||||||
Total freestanding derivatives |
533 | 312 | (4 | ) | 32 | | 873 | 278 | ||||||||||||||||||||
Reinsurance recoverable for
U.S. GMWB [1] |
250 | 106 | | 82 | | 438 | 106 | |||||||||||||||||||||
Separate accounts [6] |
665 | (53 | ) | | (25 | ) | 426 | 1,013 | (34 | ) | ||||||||||||||||||
Supplemental Asset Information: |
||||||||||||||||||||||||||||
Total freestanding derivatives
used to hedge U.S. GMWB including those in Levels 1, 2, and 3 |
784 | 475 | | (106 | ) | | 1,153 | 475 | ||||||||||||||||||||
Liabilities |
||||||||||||||||||||||||||||
Other policyholder funds and
benefits payable |
||||||||||||||||||||||||||||
Guaranteed living benefits [1] |
$ | (2,126 | ) | $ | (1,113 | ) | $ | 1 | $ | (68 | ) | $ | | $ | (3,306 | ) | $ | (1,113 | ) | |||||||||
Institutional notes |
(21 | ) | 12 | | | | (9 | ) | 12 | |||||||||||||||||||
Equity linked notes |
(15 | ) | 3 | | | | (12 | ) | 3 | |||||||||||||||||||
Total other policyholder funds
and benefits payable |
(2,162 | ) | (1,098 | ) | 1 | (68 | ) | | (3,327 | ) | (1098 | ) | ||||||||||||||||
Consumer notes |
(3 | ) | 2 | | (5 | ) | | (6 | ) | 2 | ||||||||||||||||||
Supplemental Information: |
||||||||||||||||||||||||||||
Net U.S. GMWB (Embedded
derivatives, freestanding
derivatives including those in
Levels 1, 2 and 3 and
reinsurance recoverable) [7] |
(630 | ) | (116 | ) | | (60 | ) | | (806 | ) | (116 | ) | ||||||||||||||||
(1) | The Company classifies gains and losses on GMWB reinsurance derivatives and Guaranteed Living Benefit embedded derivatives and reinsured free standing derivatives as unrealized gains (losses) for purposes of disclosure in this table because it is impracticable to track on a contract-by-contract basis the realized gains (losses) for these derivatives and embedded derivatives. | |
(2) | All amounts in these columns are reported in net realized capital gains (losses), except for $2, which is reported in benefits, losses and loss adjustment expenses. All amounts are before income taxes and amortization of DAC. | |
(3) | All amounts are before income taxes and amortization of DAC. | |
(4) | Transfers in and/or (out) of Level 3 are attributable to a change in the availability of market observable information and re-evaluation of the observability of pricing inputs for individual securities within respective categories. | |
(5) | Derivative instruments are reported in this table on a net basis for asset/(liability) positions and reported on the Condensed Consolidated Balance Sheets in other investments and other liabilities. | |
(6) | The realized/unrealized gains (losses) included in net income for separate account assets are offset by an equal amount for separate account liabilities, which results in a net zero impact on net income for the Company. | |
(7) | The net loss on U.S. GMWB was primarily related to market-based hedge ineffectiveness in the third quarter due to extremely volatile capital markets in September. |
22
Table of Contents
3. Fair Value Measurements (continued)
Roll-forward of Financial Instruments Measured at Fair Value on a Recurring Basis Using
Significant Unobservable Inputs (Level 3) for the nine months ended September 30, 2008
Changes in unrealized | ||||||||||||||||||||||||||||
gains (losses) | ||||||||||||||||||||||||||||
Fair value | Total realized/unrealized | Purchases, | included in net income | |||||||||||||||||||||||||
as of | gains (losses) included in: | issuances, | Transfers in | Fair value | related to financial | |||||||||||||||||||||||
January 1, | Net income | and | and/or (out) | as of | instruments still held at | |||||||||||||||||||||||
Asset (Liability) | 2008 | [1], [2] | OCI [3] | settlements | of Level 3 [4] | September 30, 2008 | September 30, 2008 [2] | |||||||||||||||||||||
Assets |
||||||||||||||||||||||||||||
Fixed maturities, AFS |
$ | 13,558 | $ | (525 | ) | $ | (1,672 | ) | $ | 743 | $ | 45 | $ | 12,149 | $ | (506 | ) | |||||||||||
Equity securities, AFS |
563 | (77 | ) | (51 | ) | 26 | (13 | ) | 448 | (81 | ) | |||||||||||||||||
Derivatives [5] |
||||||||||||||||||||||||||||
Variable annuity hedging
derivatives |
673 | 500 | | 66 | | 1,239 | 453 | |||||||||||||||||||||
Other freestanding derivatives |
(303 | ) | (305 | ) | (2 | ) | 146 | 98 | (366 | ) | (211 | ) | ||||||||||||||||
Total freestanding derivatives |
370 | 195 | (2 | ) | 212 | 98 | 873 | 242 | ||||||||||||||||||||
Reinsurance recoverable for
U.S. GMWB [1] [7] |
238 | 108 | | 92 | | 438 | 108 | |||||||||||||||||||||
Separate accounts [6] |
701 | (109 | ) | | (5 | ) | 426 | 1,013 | (89 | ) | ||||||||||||||||||
Supplemental Asset Information: |
||||||||||||||||||||||||||||
Total freestanding derivatives
used to hedge U.S. GMWB including those in Levels 1, 2 and3 |
643 | 520 | | (10 | ) | | 1,153 | 520 | ||||||||||||||||||||
Liabilities |
||||||||||||||||||||||||||||
Other policyholder funds and
benefits payable |
||||||||||||||||||||||||||||
Guaranteed living benefits [1] |
$ | (1,692 | ) | $ | (1,430 | ) | $ | 3 | $ | (187 | ) | $ | | $ | (3,306 | ) | $ | (1,430 | ) | |||||||||
Institutional notes |
(24 | ) | 15 | | | | (9 | ) | 15 | |||||||||||||||||||
Equity linked notes |
(21 | ) | 9 | | | | (12 | ) | 9 | |||||||||||||||||||
Total other policyholder funds
and benefits payable |
(1,737 | ) | (1,406 | ) | 3 | (187 | ) | | (3,327 | ) | (1,406 | ) | ||||||||||||||||
Consumer notes |
(5 | ) | 4 | | (5 | ) | | (6 | ) | 4 | ||||||||||||||||||
Supplemental Information: |
||||||||||||||||||||||||||||
Net U.S. GMWB (Embedded
derivatives, freestanding
derivatives including those in
Levels 1, 2 and 3 and
reinsurance recoverable) (7) |
(552 | ) | (241 | ) | | (13 | ) | | (806 | ) | (241 | ) | ||||||||||||||||
(1) | The Company classifies gains and losses on GMWB reinsurance derivatives and Guaranteed Living Benefit embedded derivatives and reinsured free standing derivatives as unrealized gains (losses) for purposes of disclosure in this table because it is impracticable to track on a contract-by-contract basis the realized gains (losses) for these derivatives and embedded derivatives. | |
(2) | All amounts in these columns are reported in net realized capital gains (losses), except for $3, which is reported in benefits, losses and loss adjustment expenses. All amounts are before income taxes and amortization of DAC. | |
(3) | All amounts are before income taxes and amortization of DAC. | |
(4) | Transfers in and/or (out) of Level 3 are attributable to a change in the availability of market observable information and re-evaluation of the observability of pricing inputs for individual securities within respective categories. | |
(5) | Derivative instruments are reported in this table on a net basis for asset/(liability) positions and reported on the Condensed Consolidated Balance Sheets in other investments and other liabilities. | |
(6) | The realized/unrealized gains (losses) included in net income for separate account assets are offset by an equal amount for separate account liabilities, which results in a net zero impact on net income for the Company. | |
(7) | The net loss on U.S. GMWB since January 1, 2008 was primarily related to liability model assumption updates for mortality in the first quarter and market-based hedge ineffectiveness in the third quarter due to extremely volatile capital markets in September. |
23
Table of Contents
3. Fair Value Measurements (continued)
Financial Instruments Not Carried at Fair Value
The following include disclosures for other financial instruments not carried at fair value and not
included in above fair value discussion.
The carrying amounts and fair values of the Companys financial instruments not carried at fair
value, as of September 30, 2009 and December 31, 2008 were as follows:
September 30, | December 31, | |||||||||||||||
2009 | 2008 | |||||||||||||||
Carrying | Fair | Carrying | Fair | |||||||||||||
Amount | Value | Amount | Value | |||||||||||||
Assets |
||||||||||||||||
Policy loans |
$ | 2,156 | $ | 2,347 | $ | 2,154 | $ | 2,366 | ||||||||
Mortgage loans |
4,630 | 3,719 | 4,896 | 4,265 | ||||||||||||
Liabilities |
||||||||||||||||
Other policyholder funds and benefits payable [1] |
$ | 12,692 | 12,882 | $ | 14,421 | $ | 14,158 | |||||||||
Consumer Notes [2] |
1,193 | 1,268 | 1,210 | 1,188 | ||||||||||||
[1] | Excludes guarantees on variable annuities, group accident and health and universal life insurance contracts, including corporate owned life insurance. | |
[2] | Excludes amounts carried at fair value and included in disclosures above. |
The Company has not made any changes in its valuation methodologies for the following assets and
liabilities since December 31, 2008.
| Fair value for policy loans and consumer notes were estimated using discounted cash flow calculations using current interest rates. |
| Fair values for mortgage loans were estimated using discounted cash flow calculations based on current lending rates for similar type loans. Current lending rates reflect changes in credit spreads and the remaining terms of the loans. |
| Other policyholder funds and benefits payable, not carried at fair value, is determined by estimating future cash flows, discounted at the current market rate. |
24
Table of Contents
4. Investments and Derivative Instruments
Available-for-Sale Securities
The following table presents the Companys AFS securities by type.
September 30, 2009 | December 31, 2008 | |||||||||||||||||||||||||||||||||||
Cost or | Gross | Gross | Non- | Cost or | Gross | Gross | ||||||||||||||||||||||||||||||
Amortized | Unrealized | Unrealized | Fair | Credit | Amortized | Unrealized | Unrealized | Fair | ||||||||||||||||||||||||||||
Cost | Gains | Losses | Value | OTTI [1] | Cost | Gains | Losses | Value | ||||||||||||||||||||||||||||
ABS |
$ | 2,488 | $ | 43 | $ | (543 | ) | $ | 1,988 | $ | (27 | ) | $ | 2,790 | $ | 5 | $ | (819 | ) | $ | 1,976 | |||||||||||||||
CDOs |
3,377 | 23 | (1,286 | ) | 2,114 | (111 | ) | 3,692 | 2 | (1,713 | ) | 1,981 | ||||||||||||||||||||||||
CMBS |
7,496 | 99 | (1,922 | ) | 5,673 | 4 | 8,243 | 21 | (2,915 | ) | 5,349 | |||||||||||||||||||||||||
Corporate |
23,227 | 1,167 | (1,202 | ) | 23,192 | (10 | ) | 21,252 | 441 | (2,958 | ) | 18,735 | ||||||||||||||||||||||||
Foreign govt./govt. agencies |
492 | 40 | (7 | ) | 525 | | 2,094 | 86 | (33 | ) | 2,147 | |||||||||||||||||||||||||
RMBS |
4,200 | 74 | (965 | ) | 3,309 | (121 | ) | 4,423 | 57 | (882 | ) | 3,598 | ||||||||||||||||||||||||
States, municipalities and
political subdivisions |
961 | 10 | (171 | ) | 800 | | 917 | 8 | (220 | ) | 705 | |||||||||||||||||||||||||
U.S. Treasuries |
1,956 | 23 | (144 | ) | 1,835 | | 5,033 | 75 | (39 | ) | 5,069 | |||||||||||||||||||||||||
Total fixed maturities |
44,197 | 1,479 | (6,240 | ) | 39,436 | (265 | ) | 48,444 | 695 | (9,579 | ) | 39,560 | ||||||||||||||||||||||||
Equity securities |
464 | 28 | (83 | ) | 409 | | 614 | 4 | (184 | ) | 434 | |||||||||||||||||||||||||
Total AFS securities |
$ | 44,661 | $ | 1,507 | $ | (6,323 | ) | $ | 39,845 | $ | (265 | ) | $ | 49,058 | $ | 699 | $ | (9,763 | ) | $ | 39,994 | |||||||||||||||
[1] | Represents the amount of cumulative non-credit OTTI losses recognized in other comprehensive loss on securities that also had a credit impairment. These losses are included in gross unrealized losses as of September 30, 2009. |
The Company participates in securities lending programs to generate additional income.
Through these programs, certain domestic fixed income securities are loaned from the Companys
portfolio to qualifying third party borrowers in return for collateral in the form of cash or U.S.
Treasuries. As of September 30, 2009 and December 31, 2008, under terms of securities lending
programs, the fair value of loaned securities was approximately $209 and $1.8 billion,
respectively, which was included in fixed maturities in the Condensed Consolidated Balance Sheet.
As of September 30, 2009 and December 31, 2008, the Company held collateral associated with the
loaned securities in the amount of $213 and $1.8 billion, respectively. The decrease in both the
fair value of loaned securities and the associated collateral is attributable to the maturation of
the loans in the term lending program throughout 2009.
The following table presents the Companys fixed maturities by contractual maturity year.
September 30, 2009 | ||||||||
Maturity | Amortized Cost | Fair Value | ||||||
One year or less |
$ | 985 | $ | 1,017 | ||||
Over one year through five years |
7,672 | 7,864 | ||||||
Over five years through ten years |
7,356 | 7,329 | ||||||
Over ten years |
10,623 | 10,142 | ||||||
Subtotal |
26,636 | 26,352 | ||||||
Mortgage-backed and asset-backed securities |
17,561 | 13,084 | ||||||
Total fixed maturities |
$ | 44,197 | $ | 39,436 | ||||
Estimated maturities may differ from contractual maturities due to security call or prepayment
provisions. Due to the potential for variability in payment spreads (i.e. prepayments or
extensions), mortgage-backed and asset-backed securities are not categorized by contractual
maturity.
25
Table of Contents
4. Investments and Derivative Instruments (continued)
Net Realized Capital Losses
The following table presents the Companys net realized capital losses.
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
(Before-tax) | 2009 | 2008 | 2009 | 2008 | ||||||||||||
Gross gains on sales |
$ | 103 | $ | 34 | $ | 302 | $ | 102 | ||||||||
Gross losses on sales |
(57 | ) | (85 | ) | (588 | ) | (260 | ) | ||||||||
Net OTTI losses recognized in earnings |
(415 | ) | (1,310 | ) | (848 | ) | (1,624 | ) | ||||||||
Japanese fixed annuity contract hedges, net [1] |
(7 | ) | 36 | 28 | 13 | |||||||||||
Periodic net coupon settlements on credit derivatives/Japan |
(2 | ) | (9 | ) | (25 | ) | (26 | ) | ||||||||
Fair value measurement transition impact |
| | | (798 | ) | |||||||||||
Results of variable annuity hedge program |
||||||||||||||||
GMWB derivatives, net |
(191 | ) | (133 | ) | 1,053 | (257 | ) | |||||||||
Macro hedge program |
(328 | ) | 24 | (692 | ) | 29 | ||||||||||
Total results of variable annuity hedge program |
(519 | ) | (109 | ) | 361 | (228 | ) | |||||||||
GMIB/GMAB/GMWB reinsurance |
(420 | ) | (403 | ) | 1,012 | (549 | ) | |||||||||
Other, net [2] |
(195 | ) | (114 | ) | (260 | ) | (300 | ) | ||||||||
Net realized capital losses |
$ | (1,512 | ) | $ | (1,960 | ) | $ | (18 | ) | $ | (3,670 | ) | ||||
[1] | Relates to derivative hedging instruments, excluding periodic net coupon settlements, and is net of the Japanese fixed annuity product liability adjustment for changes in the dollar/yen exchange spot rate. | |
[2] | Consists of changes in fair value on non-qualifying derivatives, hedge ineffectiveness on qualifying derivative instruments, foreign currency gains and losses related to the internal reinsurance of the Japan variable annuity business, which is offset in AOCI, valuation allowances and other investment gains and losses. |
Net realized capital gains and losses from investment sales, after deducting the life and
pension policyholders share for certain products, are reported as a component of revenues and are
determined on a specific identification basis. Net realized capital losses reported for the three
and nine months ended September 30, 2009 related to AFS impairments and net losses on sales were
$369 and $1.1 billion, respectively, and were previously reported as unrealized losses in AOCI.
Proceeds from sales of AFS securities totaled $4.1 billion and $25.2 billion, respectively, for the
three and nine months ended September 30, 2009, and $1.6 billion and $6.1 billion, respectively,
for the three and nine months ended September 30, 2008.
Other-Than-Temporary Impairment Losses
The following table presents a roll-forward of the Companys cumulative credit impairments on debt
securities held as of September 30, 2009.
Three Months Ended | Six Months Ended | |||||||
September 30, 2009 | September 30, 2009 | |||||||
Balance as of beginning of period |
$ | (1,146 | ) | $ | (941 | ) | ||
Additions for credit impairments recognized on [1]: |
||||||||
Securities not previously impaired |
(273 | ) | (444 | ) | ||||
Securities previously impaired |
(105 | ) | (140 | ) | ||||
Reductions for credit impairments previously recognized on: |
||||||||
Securities that matured or were sold during the period |
22 | 22 | ||||||
Securities that the Company intends to sell or more
likely than not will be required to sell before
recovery |
| 1 | ||||||
Securities due to an increase in expected cash flows |
1 | 1 | ||||||
Balance as of September 30, 2009 |
$ | (1,501 | ) | $ | (1,501 | ) | ||
[1] | Total additions of $378 and $584 for the three and six months ended September 30, 2009, respectively, are included in the net OTTI losses recognized in earnings of $415 and $848, respectively, in the Condensed Consolidated Statements of Operations. |
26
Table of Contents
4. Investments and Derivative Instruments (continued)
Security Unrealized Loss Aging
The following tables present the Companys unrealized loss aging for AFS securities by type and
length of time the security was in a continuous unrealized loss position.
September 30, 2009 | ||||||||||||||||||||||||||||||||||||
Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||||||||||||||
Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | ||||||||||||||||||||||||||||
Cost | Value | Losses | Cost | Value | Losses | Cost | Value | Losses | ||||||||||||||||||||||||||||
ABS |
$ | 135 | $ | 89 | $ | (46 | ) | $ | 1,753 | $ | 1,256 | $ | (497 | ) | $ | 1,888 | $ | 1,345 | $ | (543 | ) | |||||||||||||||
CDOs |
1,119 | 949 | (170 | ) | 2,245 | 1,129 | (1,116 | ) | 3,364 | 2,078 | (1,286 | ) | ||||||||||||||||||||||||
CMBS |
1,080 | 827 | (253 | ) | 4,512 | 2,843 | (1,669 | ) | 5,592 | 3,670 | (1,922 | ) | ||||||||||||||||||||||||
Corporate |
2,174 | 1,813 | (361 | ) | 5,371 | 4,530 | (841 | ) | 7,545 | 6,343 | (1,202 | ) | ||||||||||||||||||||||||
Foreign govt./govt. agencies |
56 | 53 | (3 | ) | 39 | 35 | (4 | ) | 95 | 88 | (7 | ) | ||||||||||||||||||||||||
RMBS |
307 | 243 | (64 | ) | 1,979 | 1,078 | (901 | ) | 2,286 | 1,321 | (965 | ) | ||||||||||||||||||||||||
States, municipalities and political
subdivisions |
110 | 79 | (31 | ) | 680 | 540 | (140 | ) | 790 | 619 | (171 | ) | ||||||||||||||||||||||||
U.S. Treasuries |
1,010 | 866 | (144 | ) | | | | 1,010 | 866 | (144 | ) | |||||||||||||||||||||||||
Total fixed maturities |
5,991 | 4,919 | (1,072 | ) | 16,579 | 11,411 | (5,168 | ) | 22,570 | 16,330 | (6,240 | ) | ||||||||||||||||||||||||
Equity securities |
188 | 145 | (43 | ) | 135 | 95 | (40 | ) | 323 | 240 | (83 | ) | ||||||||||||||||||||||||
Total securities in an unrealized loss |
$ | 6,179 | $ | 5,064 | $ | (1,115 | ) | $ | 16,714 | $ | 11,506 | $ | (5,208 | ) | $ | 22,893 | $ | 16,570 | $ | (6,323 | ) | |||||||||||||||
December 31, 2008 | ||||||||||||||||||||||||||||||||||||
Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||||||||||||||
Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | ||||||||||||||||||||||||||||
Cost | Value | Losses | Cost | Value | Losses | Cost | Value | Losses | ||||||||||||||||||||||||||||
ABS |
$ | 873 | $ | 705 | $ | (168 | ) | $ | 1,790 | $ | 1,139 | $ | (651 | ) | $ | 2,663 | $ | 1,844 | $ | (819 | ) | |||||||||||||||
CDOs |
608 | 394 | (214 | ) | 3,068 | 1,569 | (1,499 | ) | 3,676 | 1,963 | (1,713 | ) | ||||||||||||||||||||||||
CMBS |
3,875 | 2,907 | (968 | ) | 3,978 | 2,031 | (1,947 | ) | 7,853 | 4,938 | (2,915 | ) | ||||||||||||||||||||||||
Corporate |
11,101 | 9,500 | (1,601 | ) | 4,757 | 3,400 | (1,357 | ) | 15,858 | 12,900 | (2,958 | ) | ||||||||||||||||||||||||
Foreign govt./govt. agencies |
788 | 762 | (26 | ) | 29 | 22 | (7 | ) | 817 | 784 | (33 | ) | ||||||||||||||||||||||||
RMBS |
564 | 415 | (149 | ) | 2,210 | 1,477 | (733 | ) | 2,774 | 1,892 | (882 | ) | ||||||||||||||||||||||||
States, municipalities and political
subdivisions |
524 | 381 | (143 | ) | 297 | 220 | (77 | ) | 821 | 601 | (220 | ) | ||||||||||||||||||||||||
U.S. Treasuries |
3,952 | 3,913 | (39 | ) | 38 | 38 | | 3,990 | 3,951 | (39 | ) | |||||||||||||||||||||||||
Total fixed maturities |
22,285 | 18,977 | (3,308 | ) | 16,167 | 9,896 | (6,271 | ) | 38,452 | 28,873 | (9,579 | ) | ||||||||||||||||||||||||
Equity securities |
433 | 296 | (137 | ) | 136 | 89 | (47 | ) | 569 | 385 | (184 | ) | ||||||||||||||||||||||||
Total securities in an unrealized loss |
$ | 22,718 | $ | 19,273 | $ | (3,445 | ) | $ | 16,303 | $ | 9,985 | $ | (6,318 | ) | $ | 39,021 | $ | 29,258 | $ | (9,763 | ) | |||||||||||||||
As of September 30, 2009, AFS securities in an unrealized loss position, comprised of 2,326
securities, primarily related to CMBS, CDOs, corporate securities primarily within the financial
services sector and RMBS which have experienced significant price deterioration. The Company
neither has an intention to sell nor does it expect to be required to sell the securities outlined
above.
27
Table of Contents
4. Investments and Derivative Instruments (continued)
Mortgage Loans
The following table presents the Companys mortgage loans by type.
September 30, 2009 | December 31, 2008 | |||||||||||||||||||||||
Amortized | Valuation | Carrying | Amortized | Valuation | Carrying | |||||||||||||||||||
Cost [1] | Allowance | Value | Cost [1] | Allowance | Value | |||||||||||||||||||
Agricultural |
$ | 426 | $ | | $ | 426 | $ | 446 | $ | (11 | ) | $ | 435 | |||||||||||
Commercial |
4,319 | (115 | ) | 4,204 | 4,463 | (2 | ) | 4,461 | ||||||||||||||||
Total mortgage loans |
$ | 4,745 | $ | (115 | ) | $ | 4,630 | $ | 4,909 | $ | (13 | ) | $ | 4,896 | ||||||||||
[1] | Amortized cost represents carrying value prior to valuation allowances, if any. |
The Company has a monitoring process that is overseen by a committee of investment and
accounting professionals that identifies mortgage loans for impairment. For those mortgage loans
that, based upon current information and events, it is probable that the Company will not be able
to collect all amounts due according to the contractual terms of the loan agreement, an impairment
is recognized and a valuation allowance is established with an offsetting charge to net realized
capital losses.
The following table presents the activity within the Companys valuation allowance for mortgage
loans for the nine months ended September 30, 2009.
Valuation Allowance | ||||
Balance at December 31, 2008 |
$ | (13 | ) | |
Additions |
(136 | ) | ||
Deductions |
34 | |||
Balance at September 30, 2009 |
$ | (115 | ) | |
The following tables present the Companys mortgage loans by region and property type.
Mortgage Loans by Region | ||||||||||||||||
September 30, 2009 | December 31, 2008 | |||||||||||||||
Carrying | Percent of | Carrying | Percent of | |||||||||||||
Value | Total | Value | Total | |||||||||||||
East North Central |
$ | 100 | 2.2 | % | $ | 121 | 2.5 | % | ||||||||
Middle Atlantic |
620 | 13.4 | % | 664 | 13.6 | % | ||||||||||
Mountain |
74 | 1.6 | % | 115 | 2.3 | % | ||||||||||
New England |
380 | 8.2 | % | 407 | 8.3 | % | ||||||||||
Pacific |
1,207 | 26.1 | % | 1,205 | 24.6 | % | ||||||||||
South Atlantic |
647 | 14.0 | % | 665 | 13.6 | % | ||||||||||
West North Central |
56 | 1.2 | % | 56 | 1.1 | % | ||||||||||
West South Central |
202 | 4.4 | % | 205 | 4.2 | % | ||||||||||
Other [1] |
1,344 | 28.9 | % | 1,458 | 29.8 | % | ||||||||||
Total mortgage loans |
$ | 4,630 | 100.0 | % | $ | 4,896 | 100.0 | % | ||||||||
[1] | Primarily represents multi-regional properties. |
Mortgage Loans by Property Type | ||||||||||||||||
September 30, 2009 | December 31, 2008 | |||||||||||||||
Carrying | Percent of | Carrying | Percent of | |||||||||||||
Value | Total | Value | Total | |||||||||||||
Agricultural |
$ | 426 | 9.2 | % | $ | 435 | 8.9 | % | ||||||||
Industrial |
786 | 17.0 | % | 790 | 16.1 | % | ||||||||||
Lodging |
377 | 8.1 | % | 383 | 7.8 | % | ||||||||||
Multifamily |
668 | 14.4 | % | 798 | 16.3 | % | ||||||||||
Office |
1,434 | 31.0 | % | 1,456 | 29.8 | % | ||||||||||
Retail |
682 | 14.7 | % | 764 | 15.6 | % | ||||||||||
Other |
257 | 5.6 | % | 270 | 5.5 | % | ||||||||||
Total mortgage loans |
$ | 4,630 | 100.0 | % | $ | 4,896 | 100.0 | % | ||||||||
28
Table of Contents
4. Investments and Derivative Instruments (continued)
Variable Interest Entities
The Company is involved with VIEs primarily as a collateral manager and as an investor through
normal investment activities. The Companys involvement includes providing investment management
and administrative services for a fee and holding ownership or other interests as an investor. The
Company also has involvement with VIEs as a means of accessing capital.
The following table presents the carrying value of assets and liabilities and the maximum exposure
to loss relating to VIEs for which the Company has concluded that it is the primary beneficiary and
therefore are consolidated in the Companys Condensed Consolidated Financial Statements.
September 30, 2009 | December 31, 2008 | |||||||||||||||||||||||
Maximum | Maximum | |||||||||||||||||||||||
Total | Total | Exposure | Total | Total | Exposure | |||||||||||||||||||
Assets | Liabilities [1] | to Loss [2] | Assets | Liabilities [1] | to Loss | |||||||||||||||||||
CLOs |
$ | 238 | $ | 45 | $ | 197 | $ | 339 | $ | 89 | $ | 237 | ||||||||||||
Limited partnerships |
32 | 14 | 18 | 151 | 72 | 79 | ||||||||||||||||||
Other investments |
75 | 41 | 32 | 249 | 103 | 166 | ||||||||||||||||||
Total |
$ | 345 | $ | 100 | $ | 247 | $ | 739 | $ | 264 | $ | 482 | ||||||||||||
[1] | Creditors have no recourse against the Company in the event of default by the VIE. Includes noncontrolling interest in limited partnerships and other investments of $43 and $154 as of September 30, 2009 and December 31, 2008, respectively, that is reported as a separate component of equity in the Companys Condensed Consolidated Balance Sheets. | |
[2] | The Companys maximum exposure to loss represents the maximum loss amount that the Company could recognize as a reduction in net investment income or as a realized capital loss and is the consolidated assets at cost net of liabilities. The Company has no implied or unfunded commitments to these VIEs. |
During the nine months ended September 30, 2009, the Company partially liquidated one limited
partnership and liquidated one other investment for which the Company had been the primary
beneficiary. As a result of the liquidations, the Company is no longer deemed to be the primary
beneficiary and accordingly, these VIEs were deconsolidated.
The following table presents the carrying value of assets and liabilities and the maximum exposure
to loss relating to VIEs for which the Company has a significant involvement with but has concluded
that it is not the primary beneficiary and therefore are not consolidated. Each of these
investments has been held by the Company for less than three years.
September 30, 2009 | December 31, 2008 | |||||||||||||||||||||||
Maximum | Maximum | |||||||||||||||||||||||
Exposure | Exposure | |||||||||||||||||||||||
Assets | Liabilities | to Loss | Assets | Liabilities | to Loss | |||||||||||||||||||
CLOs |
$ | 249 | $ | | $ | 264 | $ | 280 | $ | | $ | 316 | ||||||||||||
CDOs |
7 | | 8 | 3 | | 13 | ||||||||||||||||||
Total [1] |
$ | 256 | $ | | $ | 272 | $ | 283 | $ | | $ | 329 | ||||||||||||
[1] | Maximum exposure to loss represents the Companys investment in securities issued by CLOs/CDOs at cost. The Company has no implied or unfunded commitments to these VIEs. |
29
Table of Contents
4. Investments and Derivative Instruments (continued)
Derivative instruments
The Company utilizes a variety of over-the-counter and exchange traded derivative instruments as a
part of its overall risk management strategy as well as to enter into replication transactions.
Derivative instruments are used to manage risk associated with interest rate, equity market, credit
spread, issuer default, price, and currency exchange rate risk or volatility. Replication
transactions are used as an economical means to synthetically replicate the characteristics and
performance of assets that would otherwise be permissible investments under the Companys
investment policies. The Company also purchases and issues financial instruments and products that
either are accounted for as free-standing derivatives, such as certain reinsurance contracts, or
may contain features that are deemed to be embedded derivative instruments, such as the GMWB rider
included with certain variable annuity products.
The Company designates each derivative instrument as either a cash flow hedging instrument (cash
flow hedge), a fair value hedging instrument (fair value hedge), or not qualified as a hedging
instrument (non-qualifying strategies).
Cash flow hedges
Interest rate swaps
Interest rate swaps are primarily used to convert interest receipts on floating-rate fixed maturity
securities or interest payments on floating-rate guaranteed investment contracts to fixed rates.
These derivatives are predominantly used to better match cash receipts from assets with cash
disbursements required to fund liabilities.
The Company also enters into forward starting swap agreements to hedge the interest rate exposure
related to the purchase of fixed-rate securities or the anticipated future cash flows of
floating-rate fixed maturity securities due to changes in interest rates. These derivatives are
primarily structured to hedge interest rate risk inherent in the assumptions used to price certain
liabilities.
Foreign currency swaps
Foreign currency swaps are used to convert foreign denominated cash flows related to certain
investment receipts and liability payments to U.S. dollars in order to minimize cash flow
fluctuations due to changes in currency rates.
Fair value hedges
Interest rate swaps
Interest rate swaps are used to hedge the changes in fair value of certain fixed rate liabilities
and fixed maturity securities due to fluctuations in interest rates.
Foreign currency swaps
Foreign currency swaps are used to hedge the changes in fair value of certain foreign denominated
fixed rate liabilities due to changes in foreign currency rates by swapping the fixed foreign
payments to floating rate U.S. dollar denominated payments.
Non-qualifying strategies
Interest rate swaps, caps, floors, and futures
The Company uses interest rate swaps, caps, floors, and futures to manage duration between assets
and liabilities in certain investment portfolios. In addition, the Company enters into interest
rate swaps to terminate existing swaps, thereby offsetting the changes in value of the original
swap. As of September 30, 2009 and December 31, 2008, the notional amount of interest rate swaps
in offsetting relationships was $4.4 billion and $3.9 billion, respectively.
Foreign currency swaps and forwards
The Company enters into foreign currency swaps and forwards to convert the foreign currency
exposures to U.S. dollars in certain of its foreign denominated fixed maturity investments. The
Company also enters into foreign currency forward contracts that convert Euros to Yen in order to
economically hedge the foreign currency risk associated with certain assumed Japanese variable
annuity products.
Japan 3Win related foreign currency swaps
During the first quarter of 2009, the Company entered into foreign currency swaps to hedge the
foreign currency exposure related to the Japan 3Win product guaranteed minimum income benefit
(GMIB) fixed liability payments.
Japanese fixed annuity hedging instruments
The Company enters into currency rate swaps and forwards to mitigate the foreign currency exchange
rate and Yen interest rate exposures associated with the Yen denominated individual fixed annuity
product.
30
Table of Contents
4. Investments and Derivative Instruments (continued)
Credit derivatives that purchase credit protection
Credit default swaps are used to purchase credit protection on an individual entity or referenced
index to economically hedge against default risk and credit-related changes in value on fixed
maturity securities. These contracts require the Company to pay a periodic fee in exchange for
compensation from the counterparty should the referenced security issuers experience a credit
event, as defined in the contract.
Credit derivatives that assume credit risk
Credit default swaps are used to assume credit risk related to an individual entity, referenced
index, or asset pool, as a part of replication transactions. These contracts entitle the Company
to receive a periodic fee in exchange for an obligation to compensate the derivative counterparty
should the referenced security issuers experience a credit event, as defined in the contract. The
Company is also exposed to credit risk due to embedded derivatives associated with credit linked
notes.
Credit derivatives in offsetting positions
The Company enters into credit default swaps to terminate existing credit default swaps, thereby
offsetting the changes in value of the original swap going forward.
Equity index swaps, options, and futures
The Company offers certain equity indexed products, which may contain an embedded derivative that
requires bifurcation. The Company enters into S&P index swaps and options to economically hedge
the equity volatility risk associated with these embedded derivatives. In addition, the Company is
exposed to bifurcated options embedded in certain fixed maturity investments.
GMWB product derivatives
The Company offers certain variable annuity products with a GMWB rider in the U.S. and formerly in
the U.K. and Japan. The GMWB is a bifurcated embedded derivative that provides the policyholder
with a GRB if the account value is reduced to zero through a combination of market declines and
withdrawals. The GRB is generally equal to premiums less withdrawals. Certain contract provisions
can increase the GRB at contractholder election or after the passage of time. The notional value
of the embedded derivative is the GRB balance.
GMWB reinsurance contracts
The Company has entered into reinsurance arrangements to offset a portion of its risk exposure to
the GMWB for the remaining lives of covered variable annuity contracts. Reinsurance contracts
covering GMWB are accounted for as free-standing derivatives. The notional amount of the
reinsurance contracts is the GRB amount.
GMWB hedging instruments
The Company enters into derivative contracts to partially hedge exposure to the income volatility
associated with the portion of the GMWB liabilities which are not reinsured. These derivative
contracts include customized swaps, interest rate swaps and futures, and equity swaps, options, and
futures, on certain indices including the S&P 500 index, EAFE index, and NASDAQ index. As of
September 30, 2009, the notional amount related to the GMWB hedging instruments is $15.9 billion
and consists of $10.9 billion of customized swaps, $1.4 billion of interest rate swaps and futures,
and $3.6 billion of equity swaps, options, and futures.
Macro hedge program
The Company utilizes equity options, currency options, and equity futures contracts to partially
hedge the statutory reserve impact of equity risk and foreign currency risk arising primarily from
guaranteed minimum death benefit (GMDB) and GMWB obligations against a decline in the equity
markets or changes in foreign currency exchange rates. As of September 30, 2009, the notional
amount related to the macro hedge program is $18.1 billion and consists of $15.6 billion of equity
options, $2.1 billion of currency options, and $0.4 billion of equity futures. The $2.1 billion of
currency options include $1.1 billion of short put option contracts, therefore resulting in a net
notional amount for the macro hedge program of approximately $17.0 billion.
GMIB and guaranteed minimum accumulation benefit (GMAB) reinsurance contracts
The Company reinsured the GMIB and GMAB embedded derivatives for host variable annuity contracts
written by its affiliate, HLIKK, in Japan. The reinsurance contracts are accounted for as
free-standing derivative contracts. The notional amount of the reinsurance contracts is the Yen
denominated GRB balance value converted at the period-end Yen to U.S. dollar foreign spot exchange
rate.
Coinsurance and modified coinsurance reinsurance contract
During 2007, a subsidiary insurance company entered into a coinsurance with funds withheld and
modified coinsurance reinsurance agreement (Agreement) with an affiliate reinsurance company to
provide statutory surplus relief for certain life insurance policies. The Agreement is accounted
for as a financing transaction for GAAP and includes a compound embedded derivative.
31
Table of Contents
4. Investments and Derivative Instruments (continued)
Derivative Balance Sheet Classification
Derivative instruments are recorded in the Condensed Consolidated Balance Sheets at fair value.
The Company offsets the fair value amounts, income accruals, and cash collateral held, related to
derivative instruments executed in a legal entity and with the same counterparty under a master
netting agreement. The table below summarizes the balance sheet classification of the Companys
derivative related fair value amounts, as well as the gross asset and liability fair value amounts.
Derivatives in the Companys separate accounts are not included because the associated gains and
losses accrue directly to policyholders. The Companys derivative instruments are held for risk
management purposes, unless otherwise noted in the table below. The notional amount of derivative
contracts represents the basis upon which pay or receive amounts are calculated and is presented in
the table to quantify the volume of the Companys derivative activity. Notional amounts are not
necessarily reflective of credit risk.
Asset | Liability | |||||||||||||||||||||||||||||||
Net Derivatives | Derivatives | Derivatives | ||||||||||||||||||||||||||||||
Notional Amount | Fair Value | Fair Value | Fair Value | |||||||||||||||||||||||||||||
Sep. 30, | Dec. 31, | Sep. 30, | Dec. 31, | Sep. 30, | Dec. 31, | Sep. 30, | Dec. 31, | |||||||||||||||||||||||||
Hedge Designation/ Derivative Type | 2009 | 2008 | 2009 | 2008 | 2009 | 2008 | 2009 | 2008 | ||||||||||||||||||||||||
Cash flow hedges |
||||||||||||||||||||||||||||||||
Interest rate swaps |
$ | 8,743 | $ | 6,798 | $ | 174 | $ | 422 | $ | 249 | $ | 425 | $ | (75 | ) | $ | (3 | ) | ||||||||||||||
Foreign currency swaps |
491 | 1,005 | (6 | ) | (21 | ) | 44 | 126 | (50 | ) | (147 | ) | ||||||||||||||||||||
Total cash flow hedges |
$ | 9,234 | $ | 7,803 | $ | 168 | $ | 401 | $ | 293 | $ | 551 | $ | (125 | ) | $ | (150 | ) | ||||||||||||||
Fair value hedges |
||||||||||||||||||||||||||||||||
Interest rate swaps |
$ | 1,667 | $ | 2,138 | $ | (41 | ) | $ | (86 | ) | $ | 15 | $ | 41 | $ | (56 | ) | $ | (127 | ) | ||||||||||||
Foreign currency swaps |
696 | 696 | (9 | ) | (57 | ) | 53 | 48 | (62 | ) | (105 | ) | ||||||||||||||||||||
Total fair value hedges |
$ | 2,363 | $ | 2,834 | $ | (50 | ) | $ | (143 | ) | $ | 68 | $ | 89 | $ | (118 | ) | $ | (232 | ) | ||||||||||||
Non-qualifying strategies |
||||||||||||||||||||||||||||||||
Interest rate contracts |
||||||||||||||||||||||||||||||||
Interest rate swaps, caps, floors, and futures |
$ | 5,615 | $ | 5,269 | $ | (86 | ) | $ | (90 | ) | $ | 311 | $ | 687 | $ | (397 | ) | (777 | ) | |||||||||||||
Foreign exchange contracts |
||||||||||||||||||||||||||||||||
Foreign currency swaps and forwards |
937 | 648 | (15 | ) | 45 | 8 | 52 | (23 | ) | (7 | ) | |||||||||||||||||||||
Japan 3Win related foreign currency swaps |
2,740 | | 15 | | 36 | | (21 | ) | | |||||||||||||||||||||||
Japanese fixed annuity hedging instruments |
2,270 | 2,334 | 396 | 383 | 396 | 383 | | | ||||||||||||||||||||||||
Credit contracts |
||||||||||||||||||||||||||||||||
Credit derivatives that purchase credit protection |
2,228 | 2,633 | (31 | ) | 246 | 49 | 262 | (80 | ) | (16 | ) | |||||||||||||||||||||
Credit derivatives that assume credit risk [1] |
906 | 940 | (209 | ) | (309 | ) | | | (209 | ) | (309 | ) | ||||||||||||||||||||
Credit derivatives in offsetting positions |
3,023 | 1,453 | (40 | ) | (8 | ) | 115 | 85 | (155 | ) | (93 | ) | ||||||||||||||||||||
Equity contracts |
||||||||||||||||||||||||||||||||
Equity index swaps, options, and futures |
220 | 249 | (15 | ) | (14 | ) | 3 | 3 | (18 | ) | (17 | ) | ||||||||||||||||||||
Variable annuity hedge program |
||||||||||||||||||||||||||||||||
GMWB product derivatives [1] |
47,456 | 48,406 | (2,981 | ) | (6,590 | ) | | | (2,981 | ) | (6,590 | ) | ||||||||||||||||||||
GMWB reinsurance contracts |
11,035 | 11,798 | 524 | 1,268 | 538 | 1,302 | (14 | ) | (34 | ) | ||||||||||||||||||||||
GMWB hedging instruments |
15,870 | 18,620 | 384 | 2,664 | 584 | 2,697 | (200 | ) | (33 | ) | ||||||||||||||||||||||
Macro hedge program |
18,118 | 2,188 | 322 | 137 | 513 | 137 | (191 | ) | | |||||||||||||||||||||||
Other |
||||||||||||||||||||||||||||||||
GMIB and GMAB reinsurance contracts |
20,123 | 20,192 | (1,564 | ) | (2,582 | ) | | | (1,564 | ) | (2,582 | ) | ||||||||||||||||||||
Coinsurance and modified coinsurance reinsurance
contract |
1,359 | 1,068 | | | | | | | ||||||||||||||||||||||||
Total non-qualifying strategies |
$ | 131,900 | $ | 115,798 | $ | (3,300 | ) | $ | (4,850 | ) | $ | 2,553 | $ | 5,608 | $ | (5,853 | ) | $ | (10,458 | ) | ||||||||||||
Total cash flow hedges, fair value hedges, and
non-qualifying strategies |
$ | 143,497 | $ | 126,435 | $ | (3,182 | ) | $ | (4,592 | ) | $ | 2,914 | $ | 6,248 | $ | (6,096 | ) | $ | (10,840 | ) | ||||||||||||
Balance Sheet Location |
||||||||||||||||||||||||||||||||
Fixed maturities, available-for-sale |
$ | 170 | $ | 204 | $ | (8 | ) | $ | (3 | ) | $ | | $ | | $ | (8 | ) | $ | (3 | ) | ||||||||||||
Other investments |
40,716 | 12,197 | 1,242 | 1,122 | 1,843 | 1,576 | (601 | ) | (454 | ) | ||||||||||||||||||||||
Other liabilities |
22,515 | 32,442 | (382 | ) | 2,206 | 533 | 3,370 | (915 | ) | (1,164 | ) | |||||||||||||||||||||
Consumer notes |
64 | 70 | (5 | ) | (5 | ) | | | (5 | ) | (5 | ) | ||||||||||||||||||||
Reinsurance recoverables |
10,593 | 11,437 | 538 | 1,302 | 538 | 1,302 | | | ||||||||||||||||||||||||
Other policyholder funds and benefits payable |
69,439 | 70,085 | (4,567 | ) | (9,214 | ) | | | (4,567 | ) | (9,214 | ) | ||||||||||||||||||||
Total Derivatives |
$ | 143,497 | $ | 126,435 | $ | (3,182 | ) | $ | (4,592 | ) | $ | 2,914 | $ | 6,248 | $ | (6,096 | ) | $ | (10,840 | ) | ||||||||||||
[1] | The derivative instruments related to these hedging strategies are held for other investment purposes. |
32
Table of Contents
4. Investments and Derivative Instruments (continued)
Change in Notional Amount
The notional amount of derivatives increased since December 31, 2008, primarily related to
derivatives associated with the macro hedge program, while GMWB related derivatives decreased, as a
result of the Company rebalancing its risk management strategy to place a greater relative emphasis
on the protection of statutory surplus. Approximately $1.1 billion of the $15.9 billion increase
in the macro hedge notional amount represents short put option contracts therefore resulting in a
net increase in notional of approximately $14.8 billion.
Change in Fair Value
The increase in the total fair value of derivative instruments since December 31, 2008, was
primarily related to a net increase in GMIB and GMAB internal reinsurance derivatives and GMWB related
derivatives, partially offset by a decrease in the fair value of interest rate derivatives, and
credit derivatives.
| The net improvement in the fair value of all GMWB related derivatives is primarily due to lower implied market volatility and a general increase in long-term interest rates, partially offset by rising equity markets. Additional improvements in GMWB product derivatives beyond market impacts include the relative outperformance of the underlying actively managed funds as compared to their respective indices, liability model assumption updates, and changes in credit standing. For more information on the policyholder behavior and liability model assumption updates, refer to Note 3. |
| The fair value of GMIB and GMAB internal reinsurance derivatives improved primarily due to liability model assumption updates for credit standing, an increase in the Japan equity markets, an increase in interest rates, and a decline in Japan equity market volatility. For more information on the liability model assumption update, refer to Note 3. |
| The fair value of interest rate derivatives used in cash flow hedge relationships declined due to rising long-term interest rates. |
| The fair value related to credit derivatives that economically hedge fixed maturity securities decreased while the fair value related to credit derivatives that assume credit risk as a part of replication transactions increased, both resulting from credit spreads tightening. |
Cash Flow Hedges
For derivative instruments that are designated and qualify as cash flow hedges, the effective
portion of the gain or loss on the derivative is reported as a component of OCI and reclassified
into earnings in the same period or periods during which the hedged transaction affects earnings.
Gains and losses on the derivative representing hedge ineffectiveness are recognized in current
earnings. All components of each derivatives gain or loss were included in the assessment of
hedge effectiveness.
The following table presents the components of the gain or loss on derivatives that qualify as cash
flow hedges:
Derivatives in Cash Flow Hedging Relationships
Net Realized Capital Gains (Losses) | ||||||||||||||||||||||||||||||||
Gain (Loss) Recognized in OCI | Recognized in Income | |||||||||||||||||||||||||||||||
on Derivative (Effective Portion) | on Derivative (Ineffective Portion) | |||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||
September 30, | September 30, | September 30, | September 30, | |||||||||||||||||||||||||||||
2009 | 2008 | 2009 | 2008 | 2009 | 2008 | 2009 | 2008 | |||||||||||||||||||||||||
Interest rate swaps |
$ | 120 | $ | 71 | $ | (237 | ) | $ | 48 | $ | | $ | (1 | ) | $ | | $ | 3 | ||||||||||||||
Foreign currency swaps |
(21 | ) | 107 | (144 | ) | 79 | 17 | | 57 | (1 | ) | |||||||||||||||||||||
Total |
$ | 99 | $ | 178 | $ | (381 | ) | $ | 127 | $ | 17 | $ | (1 | ) | $ | 57 | $ | 2 | ||||||||||||||
33
Table of Contents
4. Investments and Derivative Instruments (continued)
Derivatives in Cash Flow Hedging Relationships
Gain (Loss) Reclassified from AOCI into | ||||||||||||||||||||
Income (Effective Portion) | ||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||
September 30, | September 30, | |||||||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||||||
Interest rate swaps |
Net realized capital gains (losses) | $ | | $ | | $ | | $ | | |||||||||||
Interest rate swaps |
Net investment income (loss) | 8 | (5 | ) | 20 | (19 | ) | |||||||||||||
Foreign currency swaps |
Net realized capital gains (losses) | (24 | ) | (19 | ) | (97 | ) | (59 | ) | |||||||||||
Foreign currency swaps |
Net investment income (loss) | | | 2 | | |||||||||||||||
Total |
$ | (16 | ) | $ | (24 | ) | $ | (75 | ) | $ | (78 | ) | ||||||||
As of September 30, 2009, the before-tax deferred net gains on derivative instruments recorded in
AOCI that are expected to be reclassified to earnings during the next twelve months are $27. This
expectation is based on the anticipated interest payments on hedged investments in fixed maturity
securities that will occur over the next twelve months, at which time the Company will recognize
the deferred net gains (losses) as an adjustment to interest income over the term of the investment
cash flows. The maximum term over which the Company is hedging its exposure to the variability of
future cash flows (for forecasted transactions, excluding interest payments on existing
variable-rate financial instruments) is four years.
For the three and nine months ended September 30, 2009 and 2008, the Company had $1 and $(4),
respectively, before-tax, of net reclassifications from AOCI to earnings resulting from the
discontinuance of cash flow hedges due to forecasted transactions that were no longer probable of
occurring.
Fair Value Hedges
For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss
on the derivative as well as the offsetting loss or gain on the hedged item attributable to the
hedged risk are recognized in current earnings. The Company includes the gain or loss on the
derivative in the same line item as the offsetting loss or gain on the hedged item. All components
of each derivatives gain or loss were included in the assessment of hedge effectiveness.
The Company recognized in income gains (losses) representing the ineffective portion of all fair
value hedges as follows:
Derivatives in Fair Value Hedging Relationships
Gain (Loss) Recognized in Income [1] | ||||||||||||||||||||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||||
September 30, | September 30, | |||||||||||||||||||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||||||||||||||||||
Derivative | Hedged Item |
Derivative | Hedged Item |
Derivative | Hedged Item |
Derivative | Hedged Item |
|||||||||||||||||||||||||
Interest rate swaps |
||||||||||||||||||||||||||||||||
Net realized capital gains (losses) |
$ | (15 | ) | $ | 15 | $ | (13 | ) | $ | 12 | $ | 51 | $ | (47 | ) | $ | (13 | ) | $ | 10 | ||||||||||||
Benefits, losses and loss adjustment expenses |
9 | (9 | ) | (11 | ) | 12 | (33 | ) | 35 | (12 | ) | 15 | ||||||||||||||||||||
Foreign currency swaps |
||||||||||||||||||||||||||||||||
Net realized capital gains (losses) |
(1 | ) | 1 | (74 | ) | 74 | 46 | (46 | ) | (50 | ) | 50 | ||||||||||||||||||||
Benefits, losses and loss adjustment expenses |
2 | (2 | ) | 25 | (25 | ) | 2 | (2 | ) | 5 | (5 | ) | ||||||||||||||||||||
Total |
$ | (5 | ) | $ | 5 | $ | (73 | ) | $ | 73 | $ | 66 | $ | (60 | ) | $ | (70 | ) | $ | 70 | ||||||||||||
[1] | The amounts presented do not include the periodic net coupon settlements of the derivative or the coupon income (expense) related to the hedged item. The net of the amounts presented represents the ineffective portion of the hedge. |
34
Table of Contents
4. Investments and Derivative Instruments (continued)
Non-qualifying Strategies
For non-qualifying strategies, including embedded derivatives that are required to be bifurcated
from their host contracts and accounted for as derivatives, the gain or loss on the derivative is
recognized currently in earnings within net realized capital gains (losses). The following table
presents the gain or loss recognized in income on non-qualifying strategies:
Non-qualifying Strategies
Gain (Loss) Recognized within Net Realized Capital Gains (Losses)
Gain (Loss) Recognized within Net Realized Capital Gains (Losses)
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Interest rate contracts |
||||||||||||||||
Interest rate swaps, caps, floors, and forwards |
$ | 3 | $ | (11 | ) | $ | 24 | $ | 7 | |||||||
Foreign exchange contracts |
||||||||||||||||
Foreign currency swaps and forwards |
(9 | ) | 37 | (49 | ) | 14 | ||||||||||
Japan 3Win hedging derivatives [1] |
128 | | 18 | | ||||||||||||
Japanese fixed annuity hedging instruments [2] |
178 | 28 | 60 | 69 | ||||||||||||
Credit contracts |
||||||||||||||||
Credit derivatives that purchase credit protection |
(71 | ) | 20 | (351 | ) | 72 | ||||||||||
Credit derivatives that assume credit risk |
45 | (114 | ) | 103 | (347 | ) | ||||||||||
Equity contracts |
||||||||||||||||
Equity index swaps, options, and futures |
2 | 2 | (2 | ) | 2 | |||||||||||
Variable annuity hedge program |
||||||||||||||||
GMWB product derivatives |
390 | (714 | ) | 3,719 | (1,621 | ) | ||||||||||
GMWB reinsurance contracts |
(110 | ) | 106 | (766 | ) | 218 | ||||||||||
GMWB hedging instruments |
(478 | ) | 475 | (1,878 | ) | 520 | ||||||||||
Macro hedge program |
(328 | ) | 24 | (692 | ) | 29 | ||||||||||
Other |
||||||||||||||||
GMIB and GMAB product reinsurance contracts |
(413 | ) | (399 | ) | 990 | (717 | ) | |||||||||
Total |
$ | (663 | ) | $ | (546 | ) | $ | 1,176 | $ | (1,754 | ) | |||||
[1] | The associated liability is adjusted for changes in dollar/yen exchange spot rates through realized capital gains and losses and was $(150) for the three months ended September 30, 2009 and $(10) for the nine months ended September 30, 2009. | |
[2] | The associated liability is adjusted for changes in dollar/yen exchange spot rates through realized capital gains and losses and was $(176) and $0 for the three months ended September 30, 2009 and 2008, respectively, and $(25) and $(82) for the nine months ended September 30, 2009 and 2008, respectively. |
The net realized capital loss for the three months ended and the net realized capital gain for the
nine months ended September 30, 2009, related to derivatives used in non-qualifying strategies was
primarily due to the following:
| The net loss on all GMWB related derivatives for the three months ended September 30, 2009, was primarily due to a general decrease in long-term interest rates, higher implied market volatility, and rising equity markets. Additional losses in the GMWB product related derivatives beyond market impacts include liability model assumption updates and changes in credit standing, partially offset by gains due to the relative outperformance of the underlying actively managed funds as compared to their respective indices. The net gain for the nine months ended September 30, 2009, was primarily due to lower implied market volatility and a general increase in long-term interest rates, partially offset by rising equity markets. Additional gains on GMWB product derivatives beyond market impacts include the relative outperformance of the underlying actively managed funds as compared to their respective indices, liability model assumption updates, and changes in credit standing. For more information on the policyholder behavior and liability model assumption updates, refer to Note 3. |
| The net loss for the three months ended September 30, 2009, on derivatives associated with GMIB and GMAB product reinsurance contracts, which are reinsured to a related party, was primarily due to changes in the credit market and liability model assumption updates for lapses and mortality. The net gain for the nine months ended September 30, 2009, was primarily due to liability model assumption updates for credit standing, an increase in the Japan equity markets, an increase in interest rates, and a decline in Japan equity market volatility. For more information on the liability model assumption update, refer to Note 3. |
| The net loss on the macro hedge program was primarily the result of an increase in the equity markets and the impact of trading activity. |
| The net gain on the Japanese fixed annuity and Japan 3Win hedging instruments for the three months ended September 30, 2009, was primarily due to weakening of the U.S. dollar against the Japanese Yen. |
| The net loss on credit derivatives that purchase credit protection to economically hedge fixed maturity securities and the net gain on credit derivatives that assume credit risk as a part of replication transactions resulted from credit spreads tightening. |
35
Table of Contents
4. Investments and Derivative Instruments (continued)
For the three and nine months ended September 30, 2008, the net realized capital loss of related to
non-qualifying strategies were primarily due to the following:
| The net losses on GMWB related derivatives were primarily related to liability model assumption updates for mortality in the first quarter and market-based hedge ineffectiveness in the third quarter due to extremely volatile capital markets. |
| The net loss related to GMIB product reinsurance contract derivatives, which are reinsured to a related party, was primarily due to a decline in the Japan equity markets. |
| The losses on credit derivatives that assume credit risk and the gains on credit derivatives that purchase credit protection were a result of credit spreads widening. |
| The gains on the Japanese fixed annuity hedging instruments for nine months ended September 30, 2008, were primarily due to the Japanese yen strengthening against the U.S. dollar. |
For the three and nine months ended September 30, 2008, the Company has incurred losses of $(39) on
derivative instruments due to counterparty default related to the bankruptcy of Lehman Brothers
Inc. These losses were a result of the contractual collateral threshold amounts and open collateral
calls in excess of such amounts immediately prior to the bankruptcy filing, as well as interest
rate and credit spread movements from the date of the last collateral call to the date of the
bankruptcy filing.
Refer to Note 9 for additional disclosures regarding contingent credit related features in
derivative agreements.
Credit Risk Assumed through Credit Derivatives
The Company enters into credit default swaps that assume credit risk from a single entity,
referenced index, or asset pool in order to synthetically replicate investment transactions. The
Company will receive periodic payments based on an agreed upon rate and notional amount and will
only make a payment if there is a credit event. A credit event payment will typically be equal to
the notional value of the swap contract less the value of the referenced security issuers debt
obligation. A credit event is generally defined as a default on contractually obligated interest
or principal payments or bankruptcy of the referenced entity. The credit default swaps in which
the Company assumes credit risk primarily reference investment grade single corporate issuers and
baskets, which include trades ranging from baskets of up to five corporate issuers to standard and
customized diversified portfolios of corporate issuers. The diversified portfolios of corporate
issuers are established within sector concentration limits and are typically divided into tranches
that possess different credit ratings.
The following tables present the notional amount, fair value, weighted average years to maturity,
underlying referenced credit obligation type and average credit ratings, and offsetting notional
amounts and fair value for credit derivatives in which the Company is assuming credit risk as of
September 30, 2009 and December 31, 2008.
As of September 30, 2009 | ||||||||||||||||||||||||||||
Underlying Referenced | ||||||||||||||||||||||||||||
Credit Obligation(s) [1] | ||||||||||||||||||||||||||||
Weighted | ||||||||||||||||||||||||||||
Average | Average | Offsetting | ||||||||||||||||||||||||||
Credit Derivative type by derivative | Notional | Fair | Years to | Credit | Notional | Offsetting | ||||||||||||||||||||||
risk exposure | Amount [2] | Value | Maturity | Type | Rating | Amount [3] | Fair Value [3] | |||||||||||||||||||||
Single name credit default swaps |
||||||||||||||||||||||||||||
Investment grade risk exposure |
$ | 466 | $ | 6 | 5 years | Corporate Credit/ Foreign Gov. |
A+ | $ | 454 | $ | (33 | ) | ||||||||||||||||
Below investment grade risk
exposure |
114 | (7 | ) | 4 years | Corporate Credit | B+ | 71 | (10 | ) | |||||||||||||||||||
Basket credit default swaps [4] |
||||||||||||||||||||||||||||
Investment grade risk exposure |
684 | 8 | 4 years | Corporate Credit | BBB+ | 634 | (9 | ) | ||||||||||||||||||||
Investment grade risk exposure |
353 | (91 | ) | 7 years | CMBS Credit | BBB+ | 353 | 91 | ||||||||||||||||||||
Below investment grade risk
exposure |
725 | (196 | ) | 5 years | Corporate Credit | BBB | | | ||||||||||||||||||||
Credit linked notes |
||||||||||||||||||||||||||||
Investment grade risk exposure |
76 | 68 | 2 years | Corporate Credit | BBB+ | | | |||||||||||||||||||||
Total |
$ | 2,418 | $ | (212 | ) | $ | 1,512 | $ | 39 | |||||||||||||||||||
36
Table of Contents
4. Investments and Derivative Instruments (continued)
As of December 31, 2008 | ||||||||||||||||||||||||||||
Underlying Referenced | ||||||||||||||||||||||||||||
Credit Obligation(s) [1] | ||||||||||||||||||||||||||||
Weighted | ||||||||||||||||||||||||||||
Average | Average | Offsetting | ||||||||||||||||||||||||||
Credit Derivative type by derivative | Notional | Fair | Years to | Credit | Notional | Offsetting | ||||||||||||||||||||||
risk exposure | Amount [2] | Value | Maturity | Type | Rating | Amount [3] | Fair Value [3] | |||||||||||||||||||||
Single name credit default swaps |
||||||||||||||||||||||||||||
Investment grade risk exposure |
$ | 47 | $ | | 4 years | Corporate Credit | A- | $ | 35 | $ | (9 | ) | ||||||||||||||||
Below investment grade risk
exposure |
46 | (12 | ) | 4 years | Corporate Credit | CCC+ | | | ||||||||||||||||||||
Basket credit default swaps [4] |
||||||||||||||||||||||||||||
Investment grade risk exposure |
1,139 | (196 | ) | 5 years | Corporate Credit | A- | 489 | 8 | ||||||||||||||||||||
Investment grade risk exposure |
203 | (70 | ) | 8 years | CMBS Credit | AAA | 203 | 70 | ||||||||||||||||||||
Below investment grade risk
exposure |
125 | (104 | ) | 6 years | Corporate Credit | BB+ | | | ||||||||||||||||||||
Credit linked notes |
||||||||||||||||||||||||||||
Investment grade risk exposure |
106 | 95 | 2 years | Corporate Credit | BBB+ | | | |||||||||||||||||||||
Total |
$ | 1,666 | $ | (287 | ) | $ | 727 | $ | 69 | |||||||||||||||||||
[1] | The average credit ratings are based on availability and the midpoint of the applicable ratings among Moodys, S&P, and Fitch. If no rating is available from a rating agency, then an internally developed rating is used. | |
[2] | Notional amount is equal to the maximum potential future loss amount. There is no specific collateral related to these contracts or recourse provisions included in the contracts to offset losses. | |
[3] | The Company has entered into offsetting credit default swaps to terminate certain existing credit default swaps, thereby offsetting the future changes in value of or losses paid related to the original swap. | |
[4] | Includes $1.6 billion and $1.3 billion as of September 30, 2009 and December 31, 2008, respectively, of standard market indices of diversified portfolios of corporate issuers referenced through credit default swaps. These swaps are subsequently valued based upon the observable standard market index. Also includes $175 as of September 30, 2009 and December 31, 2008, of customized diversified portfolios of corporate issuers referenced through credit default swaps. |
5. Deferred Policy Acquisition Costs and Present Value of Future Profits
Life
Unlock Results
During the second quarter of 2009, the Company revised its estimation of future gross profits using
a Reversion to Mean (RTM) estimation technique to estimate future separate account returns.
RTM is an estimation technique commonly used by insurance entities to project future separate
account returns. Through this estimation technique, the Companys DAC model will be adjusted to
reflect actual account values at the end of each quarter and through a consideration of recent
returns, we will adjust future projected returns over a five year period so that the account value
returns to the long-term expected rate of return, providing that those projected returns for the
next five years do not exceed certain caps or floors. This will result in a DAC Unlock, described
below, each quarter. However, benefits and assessments used in the determination of death benefits
and other insurance benefit reserves, on variable annuity and universal life contracts which are in
addition to the account value liability representing the policyholders funds, will be derived from
a set of stochastic scenarios that have been calibrated to our reversion to mean separate account
returns. Refer to Note 7 for further information on death benefits and other insurance benefit
reserves. In addition, at a minimum, annually during third quarter, the Company completes
non-market related assumptions studies and incorporates the results of those studies into its
projection of future gross profits.
37
Table of Contents
5. Deferred Policy Acquisition Costs and Present Value of Future Profits (continued)
The policy related in-force or account values at September 30, 2009 were used to project future
gross profits using the RTM separate account return estimate. During the third quarter of 2009,
the Company recorded an Unlock benefit of $62. This Unlock benefit included the effect of strong
equity market returns generating an Unlock benefit of $224, offset by changes in non-market related
assumptions generating an Unlock charge of $162. The Unlock benefit resulting from equity market
growth was less than that recorded in the second quarter of 2009 despite comparable returns of the
S&P 500. This decline was primarily due to actual Company separate account returns earning less
than in the second quarter and a slower decline in expected death benefits as policyholders become
less in-the- money. Unlock charges from non-market assumption changes were primarily driven by
the Companys estimate of higher assumed macro hedge program costs in 2010. Other significant
assumption changes included decreases in mortality, increases in credit loss estimates and
declines in net investment spread. The Company is continually evaluating various aspects of
policyholder behavior and may modify certain of its assumptions, including living benefit lapses
and withdrawal rates, if credible emerging data indicates that changes are warranted. The
following table displays the components, by segment, of the Companys third quarter Unlock.
Death | |||||||||||||||||||||||
and Other | |||||||||||||||||||||||
Unearned | Insurance | Sales | |||||||||||||||||||||
Segment | Revenue | Benefit | Inducement | ||||||||||||||||||||
After-tax (charge) benefit | DAC | Reserves | Reserves [1] | Assets | Total | ||||||||||||||||||
Retail |
$ | 14 | $ | (13 | ) | $ | 77 | $ | (9 | ) | $ | 69 | |||||||||||
Retirement Plans |
(1 | ) | | 1 | | | |||||||||||||||||
Individual Life |
(27 | ) | 7 | (4 | ) | | (24 | ) | |||||||||||||||
Institutional |
(1 | ) | | | | (1 | ) | ||||||||||||||||
Other |
7 | | 12 | (1 | ) | 18 | |||||||||||||||||
Total |
$ | (8 | ) | $ | (6 | ) | $ | 86 | $ | (10 | ) | $ | 62 | ||||||||||
[1] | As a result of the Unlock, reserves, in Retail, decreased $223, pre-tax, offset by a decrease of $105, pre-tax, in reinsurance recoverables. |
In addition, during the first quarter of 2009, the Company failed its quarterly tests resulting in
an Unlock of future estimated gross profits (the Unlock). The policy related in-force or account
values at March 31, 2009 were used to project future gross profits. The after-tax impact on the
Companys assets and liabilities as a result of the first quarter Unlock, based on our quantitative
and qualitative tests and the third quarter Unlock using the RTM estimation technique, for the nine
months ended September 30, 2009 was:
Death | |||||||||||||||||||||||
and Other | |||||||||||||||||||||||
Unearned | Insurance | Sales | |||||||||||||||||||||
Segment | Revenue | Benefit | Inducement | ||||||||||||||||||||
After-tax (charge) benefit | DAC | Reserves | Reserves [1] | Assets | Total | ||||||||||||||||||
Retail |
$ | (489 | ) | $ | 18 | $ | (153 | ) | $ | (39 | ) | $ | (663 | ) | |||||||||
Retirement Plans |
(54 | ) | | (1 | ) | (1 | ) | (56 | ) | ||||||||||||||
Institutional |
(1 | ) | | | | (1 | ) | ||||||||||||||||
Individual Life |
(91 | ) | 47 | (4 | ) | | (48 | ) | |||||||||||||||
Other [2] |
(67 | ) | 6 | (11 | ) | (9 | ) | (81 | ) | ||||||||||||||
Total |
$ | (702 | ) | $ | 71 | $ | (169 | ) | $ | (49 | ) | $ | (849 | ) | |||||||||
[1] | As a result of the Unlock, reserves, in Retail, increased $518, pre-tax, offset by an increase of $281, pre-tax, in reinsurance recoverables. | |
[2] | The most significant contributor to the Unlock amounts recorded during the first quarter of 2009 were as a result of actual separate account returns from the period ending October 1, 2008 to March 31, 2009 being significantly below our aggregated estimated return while the opposite was true for the second and third quarters of 2009. |
38
Table of Contents
5. Deferred Policy Acquisition Costs and Present Value of Future Profits (continued)
The after-tax impact on the Companys assets and liabilities as a result of the Unlock during the
third quarter 2008 was as follows:
Death and | |||||||||||||||||||||||
Other | |||||||||||||||||||||||
Unearned | Insurance | Sales | |||||||||||||||||||||
Segment | Revenue | Benefit | Inducement | ||||||||||||||||||||
After-tax (charge) benefit | DAC | Reserves | Reserves [1] | Assets | Total | ||||||||||||||||||
Retail |
$ | (648 | ) | $ | 18 | $ | (75 | ) | $ | (27 | ) | $ | (732 | ) | |||||||||
Retirement Plans |
(49 | ) | | | | (49 | ) | ||||||||||||||||
Individual Life |
(29 | ) | (12 | ) | (3 | ) | | (44 | ) | ||||||||||||||
Total |
$ | (726 | ) | $ | 6 | $ | (78 | ) | $ | (27 | ) | $ | (825 | ) | |||||||||
[1] | As a result of the Unlock, death benefit reserves, in Retail, increased $389, pre-tax, offset by an increase of $273, pre-tax, in reinsurance recoverables. |
Changes in deferred policy acquisition costs and present value of future profits were as follows:
2009 | 2008 | |||||||
Balance, January 1 |
9,944 | 8,601 | ||||||
Deferred costs |
537 | 991 | ||||||
Amortization Deferred policy acquisition costs and present value of future profits [1] |
(749 | ) | (265 | ) | ||||
Amortization Unlock, pre-tax |
(1,043 | ) | (1,118 | ) | ||||
Adjustments to unrealized gains and losses on securities, available-for-sale and other [3] |
(724 | ) | 811 | |||||
Effect of currency translation adjustment |
21 | (2 | ) | |||||
Effects of new accounting guidance for investments other-than-temporarily impaired [2] |
(54 | ) | | |||||
Balance, September 30 |
7,932 | 9,018 | ||||||
[1] | The increase in amortization from the prior year period is due to lower actual gross profits in 2008 resulting from increased realized capital losses primarily from the adoption of new accounting guidance for fair values at the beginning of the first quarter of 2008. | |
[2] | The adjustment reflects the effect of credit spreads tightening, resulting in unrealized gains on securities in 2009. | |
[3] | The effect of adopting new accounting guidance for investments other-than-temporarily impaired resulted in an increase to retained earnings and as a result a DAC charge of $54. In addition, an offsetting amount was recorded in unrealized losses as unrealized losses increased upon adoption of new accounting guidance for investments other-than-temporarily impaired. |
6. Goodwill
The carrying amount of goodwill allocated to the Companys reporting units as of September 30, 2009
and December 31, 2008 is shown below.
September 30, | December 31, | |||||||
Reporting Unit | 2009 | 2008 | ||||||
Retail Other |
$ | 159 | $ | 159 | ||||
Retirement |
87 | 79 | ||||||
Individual Life |
224 | 224 | ||||||
Total |
$ | 470 | $ | 462 | ||||
In accordance with Goodwill and Other Intangible Assets, the Company performed a goodwill
impairment test on its reporting units in the first quarter of 2009. No goodwill impairment
charges were recorded as a result of that test.
39
Table of Contents
7. Separate Accounts, Death Benefits and Other Insurance Benefit Features
The Company records the variable portion of individual variable annuities, 401(k), institutional,
403(b)/457, private placement life and variable life insurance products within separate account
assets and liabilities. Separate account assets are reported at fair value. Separate account
liabilities are set equal to separate account assets. Separate account assets are segregated from
other investments. Investment income and gains and losses from those separate account assets, which
accrue directly to, and whereby investment risk is borne by the policyholder, are offset by the
related liability changes within the same line item in the condensed consolidated statements of
operations. The fees earned for administrative and contract holder maintenance services performed
for these separate accounts are included in fee income. For the nine months ended September 30,
2009 and 2008, there were no gains or losses on transfers of assets from the general account to the
separate account.
Many of the variable annuity and universal life (UL) contracts issued by the Company offer death
benefits and other insurance benefit features including guaranteed minimum death benefits (GMDB),
guaranteed minimum income benefit (GMIB), and UL secondary guarantee benefits. UL secondary
guarantee benefits ensure that the policy will not terminate, and will continue to provide a death
benefit, even if there is insufficient policy value to cover the monthly deductions and charges.
GMDBs are offered in various forms as described in further detail throughout this Note 7. These
death benefits and other insurance benefit features require an additional liability be held above
the account value liability representing the policy holders funds. The Company reinsures a portion
of the GMDBs and UL secondary guarantees associated with its in-force block of business. The
Company also assumes, through reinsurance, GMDB, GMIB, GMWB, and GMAB offered by an affiliate. For
additional information related to the risk associated with the affiliate reinsurance of the GMIB,
GMWB, and GMAB, see Note 3.
Changes in the gross GMDB and UL secondary guarantee benefits sold with annuity and/or UL products
are as follows:
UL Secondary | ||||||||
GMDB [1] | Guarantees [1] | |||||||
Liability balance as of January 1, 2009 |
882 | 40 | ||||||
Incurred |
293 | 21 | ||||||
Unlock |
537 | 5 | ||||||
Paid |
(417 | ) | | |||||
Liability balance as of September 30, 2009 |
1,295 | 66 | ||||||
[1] | The reinsurance recoverable asset related to the GMDB was $802 as of September 30, 2009. The reinsurance recoverable asset related to the UL Secondary Guarantees was $20 as of September 30, 2009. |
UL Secondary | ||||||||
GMDB [1] | Guarantees [1] | |||||||
Liability balance as of January 1, 2008 |
531 | 19 | ||||||
Incurred |
135 | 16 | ||||||
Unlock |
389 | | ||||||
Paid |
(127 | ) | | |||||
Liability balance as of September 30, 2008 |
928 | 35 | ||||||
[1] | The reinsurance recoverable asset related to the GMDB was $611 as of September 30, 2008. The reinsurance recoverable asset related to the UL Secondary Guarantees was $14 as of September 30, 2008. |
The net death benefit and other insurance benefit reserves are established by estimating the
expected value of net reinsurance costs and death benefits in excess of the projected account
balance. The additional death benefits and net reinsurance costs are recognized ratably over the
accumulation period based on total expected assessments. The death benefit and other insurance
benefit reserves are recorded in reserve for future policy benefits in the Companys condensed
consolidated balance sheets. Changes in the death benefit and other insurance benefit reserves are
recorded in benefits, losses and loss adjustment expenses in the Companys condensed consolidated
statements of operations. In a manner consistent with the Companys accounting policy for deferred
acquisition costs, the Company regularly evaluates estimates used and adjusts the additional
liability balances, with a related charge or credit to benefit expense if actual experience or
other evidence suggests that earlier assumptions should be revised.
40
Table of Contents
7. Separate Accounts, Death Benefits and Other Insurance Benefit Features (continued)
The following table provides details concerning GMDB exposure directly written by the Company:
Breakdown of Variable Annuity Account Value by GMDB Type at September 30, 2009
Retained Net | Weighted Average | |||||||||||||||
Account | Net amount | Amount | Attained Age of | |||||||||||||
Maximum anniversary value (MAV) [1] | Value | at Risk [8] | at Risk [8] | Annuitant | ||||||||||||
MAV only |
$ | 27,380 | $ | 9,565 | $ | 2,929 | 66 | |||||||||
With 5% rollup [2] |
1,991 | 802 | 306 | 66 | ||||||||||||
With Earnings Protection Benefit Rider (EPB) [3] |
5,880 | 1,490 | 159 | 63 | ||||||||||||
With 5% rollup & EPB |
784 | 257 | 51 | 66 | ||||||||||||
Total MAV |
36,035 | 12,114 | 3,445 | |||||||||||||
Asset Protection Benefit (APB) [4] |
28,303 | 6,480 | 4,158 | 64 | ||||||||||||
Lifetime Income Benefit (LIB) [5] |
1,299 | 260 | 260 | 62 | ||||||||||||
Reset [6] (5-7 years) |
3,715 | 604 | 604 | 67 | ||||||||||||
Return of Premium [7] /Other |
20,724 | 1,898 | 1,751 | 64 | ||||||||||||
Subtotal Account Value Subject to U.S. Guaranteed
Minimum Death Benefits [9] |
$ | 90,076 | $ | 21,356 | $ | 10,218 | 65 | |||||||||
Less: General Account Value Subject to U.S.
Guaranteed Minimum Death Benefits |
6,858 | |||||||||||||||
Subtotal Separate Account Liabilities Subject to
U.S. Guaranteed Minimum Death Benefits |
83,218 | |||||||||||||||
Separate Account Liabilities Not Subject to U.S.
Guaranteed Minimum Death Benefits |
72,726 | |||||||||||||||
Total Separate Account Liabilities |
155,944 | |||||||||||||||
Note: | This table does not include assumed GMDB reinsurance from HLIKK with net amount at risk of $3.1 billion as of September 30, 2009 | |
[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 contracts growth. The contracts 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] | LIB: the death benefit is the greatest of current account value, net premiums paid, or for certain contracts a benefit amount that ratchets over time, generally based on market performance. | |
[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. | |
[8] | Net amount at risk is defined as the guaranteed benefit in excess of the current account value. Retained net amount at risk is net amount at risk reduced by that amount which has been reinsured to third parties. Net amount at risk and retained net amount at risk are highly sensitive to equity market movements. For example, as equity market declines, net amount at risk and retained net amount at risk will generally increase. | |
[9] | Account value includes the contractholders investment in the separate account and the general account. |
See Note 3 for a description of the Companys guaranteed living benefits that are accounted for at
fair value.
Account balances of contracts with guarantees were invested in variable separate accounts as
follows:
Asset type | September 30, 2009 | December 31, 2008 | ||||||
Equity securities |
$ | 73,808 | $ | 63,114 | ||||
Cash and cash equivalents |
9,410 | 10,174 | ||||||
Total |
$ | 83,218 | $ | 73,288 | ||||
As of September 30, 2009 and December 31, 2008, approximately 15% and 16%, respectively, of the
equity securities above were invested in fixed income securities through these funds and
approximately 85% and 84%, respectively, were invested in equity securities.
41
Table of Contents
8. Sales Inducements
The Company currently offers enhanced crediting rates or bonus payments to contract holders on
certain of its individual and group annuity products. 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. Consistent with the Companys Unlocks in the
nine months ended September 30, 2009, the Company Unlocked the amortization of the sales inducement
asset. See Note 5, for more information concerning the Unlocks.
Changes in deferred sales inducement activity were as follows for the nine months ended September
30:
2009 | 2008 | |||||||
Balance, January 1 |
$ | 533 | $ | 459 | ||||
Sales inducements deferred |
37 | 121 | ||||||
Amortization Unlock |
(70 | ) | (43 | ) | ||||
Amortization |
(95 | ) | 13 | |||||
Balance, end of period |
$ | 405 | $ | 550 | ||||
9. Commitments and Contingencies
Litigation
The Company is involved in claims litigation arising in the ordinary course of business, both as a
liability insurer defending or providing indemnity for third-party claims brought against insureds
and as an insurer defending coverage claims brought against it. The Company accounts for such
activity through the establishment of unpaid loss and loss adjustment expense reserves. Management
expects that the ultimate liability, if any, with respect to such ordinary-course claims
litigation, after consideration of provisions made for potential losses and costs of defense, will
not be material to the consolidated financial condition, results of operations or cash flows of the
Company.
The Company is also involved in other kinds of legal actions, some of which assert claims for
substantial amounts. These actions include, among others, putative state and federal class actions
seeking certification of a state or national class. Such putative class actions have alleged, for
example, improper sales practices in connection with the sale of life insurance and other
investment products; and improper fee arrangements in connection with investment products and
structured settlements. The Company also is involved in individual actions in which punitive
damages are sought, such as claims alleging bad faith in the handling of insurance claims.
Management expects that the ultimate liability, if any, with respect to such lawsuits, after
consideration of provisions made for estimated losses, will not be material to the consolidated
financial condition of the Company. Nonetheless, given the large or indeterminate amounts sought in
certain of these actions, and the inherent unpredictability of litigation, an adverse outcome in
certain matters could, from time to time, have a material adverse effect on the Companys
consolidated results of operations or cash flows in particular quarterly or annual periods.
Broker Compensation Litigation -
Following the New York Attorney Generals filing of a civil complaint against Marsh & McLennan
Companies, Inc., and Marsh, Inc. (collectively, Marsh) in October 2004 alleging 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, private plaintiffs brought several lawsuits against the Company predicated
on the allegations in the Marsh complaint, to which the Company was not party. Among these is a
multidistrict litigation in the United States District Court for the District of New Jersey. There
are two consolidated amended complaints filed in the multidistrict litigation, one related to
conduct in connection with the sale of property-casualty insurance and the other related to alleged
conduct in connection with the sale of group benefits products. The Company and various of its
subsidiaries are named in both complaints. The complaints assert, on behalf of a putative class of
persons who purchased insurance through broker defendants, claims under the Sherman Act, the
Racketeer Influenced and Corrupt Organizations Act (RICO), state law, and in the case of the
group benefits complaint, claims under the Employee Retirement Income Security Act of 1974
(ERISA). The claims are predicated upon allegedly undisclosed or otherwise improper payments of
contingent commissions to the broker defendants to steer business to the insurance company
defendants. The district court has dismissed the Sherman Act and RICO claims in both complaints
for failure to state a claim and has granted the defendants motions for summary judgment on the
ERISA claims in the group-benefits products complaint. The district court further has declined to
exercise supplemental jurisdiction over the state law claims, has dismissed those state law claims
without prejudice, and has closed both cases. The plaintiffs have appealed the dismissal of the
claims in both consolidated amended complaints, except the ERISA claims.
Structured Settlement Class Action Litigation - In October 2005, a putative nationwide class action
was filed in the United States District Court for the District of Connecticut against the Company
and several of its subsidiaries on behalf of persons who had asserted claims against an insured of
a Hartford property & casualty insurance company that resulted in a settlement in which some or all
of the
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9. Commitments and Contingencies
settlement amount was structured to afford a schedule of future payments of specified amounts
funded by an annuity from a Hartford life insurance company (Structured Settlements). The
operative complaint alleges that since 1997 the Company has systematically deprived the settling
claimants of the value of their damages recoveries by secretly deducting 15% of the annuity premium
of every Structured Settlement to cover brokers commissions, other fees and costs, taxes, and a
profit for the annuity provider, and asserts claims under the Racketeer Influenced and Corrupt
Organizations Act (RICO) and state law. The plaintiffs seek compensatory damages, punitive
damages, pre-judgment interest, attorneys fees and costs, and injunctive or other equitable
relief. The Company vigorously denies that any claimant was misled or otherwise received less
than the amount specified in the structured-settlement agreements. In March 2009, the district
court certified a class for the RICO and fraud claims composed of all persons, other than those
represented by a plaintiffs broker, who entered into a Structured Settlement since 1997 and
received certain written representations about the cost or value of the settlement. The district
court declined to certify a class for the breach-of-contract and unjust-enrichment claims. The
Companys petition to the United States Court of Appeals for the Second Circuit for permission to
file an interlocutory appeal of the class-certification ruling was denied in October 2009.
Derivative Commitments
Certain of the Companys derivative agreements contain provisions that are tied to the financial
strength ratings of the individual legal entity that entered into the derivative agreement as set
by nationally recognized statistical rating agencies. If the insurance operating entitys
financial strength were to fall below certain ratings, the counterparties to the derivative
agreements could demand immediate and ongoing full collateralization and in certain instances
demand immediate settlement of all outstanding derivative positions traded under each impacted
bilateral agreement. The settlement amount is determined by netting the derivative positions
transacted under each agreement. If the termination rights were to be exercised by the
counterparties, it could impact the insurance operating entitys ability to conduct hedging
activities by increasing the associated costs and decreasing the willingness of counterparties to
transact with the insurance operating entity. The aggregate fair value of all derivative
instruments with credit-risk-related contingent features that are in a net liability position as of
September 30, 2009, is $578. Of this $578, the insurance operating entities have posted collateral
of $577 in the normal course of business. Based on derivative market values as of September 30,
2009, a downgrade of one level below the current financial strength ratings by either Moodys or
S&P could require approximately an additional $17 to be posted as collateral. These collateral
amounts could change as derivative market values change, as a result of changes in our hedging
activities or to the extent changes in contractual terms are negotiated. The nature of the
collateral that we may be required to post is primarily in the form of U.S. Treasury bills and U.S.
Treasury notes.
10. Stock Compensation Plans
Hartford Lifes employees are included in The Hartford 2005 Incentive Stock Plan and The Hartford
Employee Stock Purchase Plan and The Hartford Deferred Stock Unit Plan.
The Hartford has two primary stock-based compensation plans. Shares issued in satisfaction of
stock-based compensation may be made available from authorized but unissued shares, shares held by
The Hartford in treasury or from shares purchased in the open market. The Hartford typically
issues shares from treasury in satisfaction of stock-based compensation. The Company was allocated
compensation expense of $9 and $3 for the three months ended September 30, 2009 and 2008 and $15
and $14 for the nine months ended September 30, 2009 and 2008, respectively. The Companys income
tax benefit recognized for stock-based compensation plans was $2 and $1 for the three months ended
September 30, 2009 and 2008 and $4 and $4 for the nine months ended September 30, 2009 and 2008,
respectively. The Company did not capitalize any cost of stock-based compensation.
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11. Transactions with Affiliates
Transactions of the Company with Hartford Fire Insurance Company, Hartford Holdings and its
affiliates relate principally to tax settlements, reinsurance, insurance coverage, rental and
service fees, payment of dividends and capital contributions. In addition, an affiliated entity
purchased group annuity contracts from the Company to fund structured settlement periodic payment
obligations assumed by the affiliated entity as part of claims settlements with property casualty
insurance companies and self-insured entities. As of September 30, 2009 and December 31, 2008 the
Company had $49 and $49, respectively of claim annuities purchased from an affiliated entity.
Substantially all general insurance expenses related to the Company, including rent and employee
benefit plan expenses are initially paid by The Hartford. Direct expenses are allocated to the
Company using specific identification, and indirect expenses are allocated using other applicable
methods. Indirect expenses include those for corporate areas which, depending on type, are
allocated based on either a percentage of direct expenses or on utilization.
Hartford Life sold fixed market value adjusted (MVA) annuity products to customers in Japan. The
yen based MVA product was written by the Hartford Life Insurance KK (HLIKK), a wholly owned
Japanese subsidiary of Hartford Life and subsequently reinsured to the Company. As of September
30, 2009 and December 31, 2008, $ 2.7 billion and $2.8 billion, respectively, of the account value
had been assumed by the Company.
Effective August 31, 2005, a subsidiary of the Company, Hartford Life and Annuity Insurance Company
(HLAI), entered into a reinsurance agreement with HLIKK. Through this agreement, HLIKK agreed to
cede and HLAI agreed to reinsure 100% of the risks associated with the in-force and prospective
GMIB riders issued by HLIKK on its variable annuity business. Effective July 31, 2006, the
agreement was modified to include the GMDB on covered contracts that have an associated GMIB rider.
The modified reinsurance agreement applies to all contracts, GMIB riders and GMDB riders in-force
and issued as of July 31, 2006 and prospectively, except for policies and GMIB riders issued prior
to April 1, 2005, which were recaptured. Additionally, a tiered reinsurance premium structure was
implemented. On the date of recapture, HLAI forgave the reinsurance derivative asset of $110 and
paid HLIKK $38. The net result of the recapture was recorded as a dividend of $93, after-tax. GMIB
riders issued by HLIKK subsequent to April 1, 2005 continue to be reinsured by HLAI. While the form
of the agreement between HLAI and HLIKK for GMIB business is reinsurance, in substance and for
accounting purposes the agreement is a free standing derivative. As such, the reinsurance agreement
for GMIB business is recorded at fair value on the Companys balance sheet, with prospective
changes in fair value recorded in net realized capital gains (losses) in net income. The fair value
of GMIB liability at September 30, 2009 and December 31, 2008 is $1.6 billion and $2.6 billion (of
which $148 relates to the adoption of fair value), respectively. HLIKK ceased issuing new business
effective June 1, 2009. For additional information regarding GMIB liability, see Note 3 of Notes to
Condensed Consolidated Financial Statements.
Effective September 30, 2007, HLAI entered into another reinsurance agreement where HLIKK agreed to
cede and HLAI agreed to reinsure 100% of the risks associated with the in-force and prospective
GMAB, GMIB and GMDB riders issued by HLIKK on certain of its variable annuity business. The
reinsurance of the GMAB riders is accounted for as a free-standing derivative recorded at fair
value on the Companys balance sheet, with prospective changes in fair value recorded in net
realized capital gains (losses) in net income. The fair value of the GMAB is a liability of $1 and
$1 at September 30, 2009 and December 31, 2008, respectively. This treaty covered HLIKKs 3 Win
annuity. This product contains a GMIB feature that triggers at a float value of 80% of original
premium and gives the policyholder an option to receive either an immediate withdrawal of account
value without surrender charges or a payout annuity of the original premium over time. As a result
of capital markets underperformance, 97% of contracts, a total of $3.1 billion triggered during the
fourth quarter of 2008, and of this amount $2.2 billion have elected the payout annuity. The
Company received the proceeds of this triggering impact, net of the first annuity payout, through a
structured financing transaction with HLIKK and will pay the associated benefits to HLIKK over a
12-year payout.
Effective February 29, 2008, HLAI entered into another reinsurance agreement where HLIKK agreed to
cede and HLAI agreed to reinsure 100% of the risks associated with the in-force and prospective
GMWB riders issued by HLIKK on certain variable annuity business. The reinsurance of the GMWB
riders is accounted for as a free-standing derivative recorded at fair value on the Companys
balance sheet, with prospective changes in fair value recorded in net realized capital gains
(losses) in net income. The fair value of the GMWB was a liability of $14 and $34 at September 30,
2009 and December 31, 2008, respectively.
The Reinsurance Agreement for GMDB business is accounted for as a Death Benefit and Other Insurance
Benefit Reserves which is not reported at fair value. As of September 30, 2009 the liability for
the assumed reinsurance of the GMDB and the net amount at risk was $50 and $ 3.1 billion,
respectively. As of December 31, 2008 the liability for the assumed reinsurance of the GMDB and the
net amount at risk was $14 and $4.3 billion, respectively.
The Company has issued a guarantee to retirees and vested terminated employees (Retirees) of The
Hartford Retirement Plan for U.S. Employees (the Plan) who retired or terminated prior to
January 1, 2004. The Plan is sponsored by The Hartford. The guarantee is an irrevocable commitment
to pay all accrued benefits which the Retiree or the Retirees designated beneficiary is entitled
to receive under the Plan in the event the Plan assets are insufficient to fund those benefits and
The Hartford is unable to provide sufficient assets to fund those benefits. The Company believes
that the likelihood that payments will be required under this guarantee is remote.
Effective November 1, 2007, a subsidiary of the Company (Ceding Company) entered into a
coinsurance with funds withheld and modified coinsurance reinsurance agreement (Agreement) with
an affiliate reinsurance company (Reinsurer) to provide statutory surplus relief for certain life
insurance policies. The Agreement is accounted for as a financing transaction for GAAP. A standby
unaffiliated third party Letter of Credit (LOC) supports a portion of the statutory reserves that
have been ceded to the Reinsurer.
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12. Equity
Noncontrolling Interests
Noncontrolling interest includes VIEs in which the Company has concluded that it is the primary
beneficiary; see Note 4 for further discussion of the Companys involvement in VIEs, and general
account mutual funds where the Company holds the majority interest in seed money investments. The
Company records noncontrolling interest as a component of equity. The noncontrolling interest
within these entities is likely to change, as these entities represent investment vehicles whereby
investors may frequently redeem or contribute to these investments. As such, the change in
noncontrolling ownership interest represented in the Companys Condensed Consolidated Statement of
Changes in Equity will primarily represent redemptions and additional subscriptions within these
investment vehicles.
The following table represents the change in noncontrolling ownership interest recorded in the
Companys Condensed Consolidated Statement of Changes in Equity for the VIEs and mutual fund seed
investments for the nine months ended September 30, 2009 and 2008:
September 30, | ||||||||
2009 | 2008 | |||||||
Redemptions of The Hartfords interest in VIEs and mutual fund
seed investments resulting in deconsolidation (1) |
$ | (48 | ) | $ | (22 | ) | ||
Net (redemptions) and subscriptions from noncontrolling interests |
$ | (69 | ) | $ | 72 | |||
Total change in noncontrolling interest ownership |
$ | (117 | ) | $ | 50 | |||
(1) | The redemptions of the The Hartfords interest in VIEs and mutual fund seed investments for the nine months ended September 30, 2009 and 2008 resulted in a loss of $6 and a gain of $1, respectively, which were recognized in realized capital gains (losses). |
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13. Restructuring, Severance and Other Costs
In the second quarter of 2009, we completed a review of several strategic alternatives with a goal
of preserving capital, reducing risk and stabilizing our ratings. These alternatives included the
potential restructuring, discontinuation or disposition of various business lines. Following that
review, the Company announced that it would suspend all new sales in the Europeans operations and
that it was evaluating strategic options with respect to its Institutional Markets businesses. The
Company has also initiated plans to change the management structure of the organization and
fundamentally reorganize the nature and focus of the Companys operations. These plans will result
in termination benefits to current employees, costs to terminate leases and other contracts and
asset impairment charges. The Company intends to complete these restructuring activities and
execute final payment by December 2010.
Termination benefits related to workforce reductions, asset impairment charges and lease and other
contract terminations have been accrued through September 30, 2009. No significant additional
costs are expected.
The following pre-tax charges were incurred during the nine months ended September 30, 2009 in
connection with the restructuring initiatives previously announced:
Total restructuring costs |
||||
Other severance benefits |
$ | 19 | ||
Asset impairment charges |
$ | 26 | ||
Other contract termination charges |
$ | 5 | ||
Total restructuring, severance and other costs for the three months
ended September 30, 2009 |
$ | 50 | ||
As of September 30, 2009 the liability for other contract termination charges was $5 as there were
no payments made during the three months ended September 30, 2009 for these charges. Amounts
incurred during the three months ended September 30, 2009 were recorded in the Life Other segment
as other expenses.
14. Subsequent Events
On October 29, 2009 approval was received from the domiciliary state for a subsidiary of HLIC to
enter into one or more reinsurance agreements with an affiliated captive reinsurance company to
cede both in-force and future U.S. and assumed Japan variable annuity business. The arrangement
includes both modified coinsurance and coinsurance with funds withheld components.
In ceding this business, future profits of these contracts will be transferred to the affiliated
captive reinsurance company. This transfer of future profits will result in a reduction of DAC and
a corresponding charge to Net Income. Partially offsetting this will be a reduction in the fair
value associated with guaranteed living benefit riders on the contracts being reinsured. This
reduction in liability will result in an increase to HLICs equity. The combination of these two
components as well as capital anticipated to be contributed to the affiliated entity is expected to
reduce HLICs consolidated GAAP equity between $700 and $1.3 billion dollars.
The purpose of this transaction is to reduce the volatility associated with statutory risk based
capital requirements.
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Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollar amounts in millions, unless otherwise stated)
Managements 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, Life or the Company) as of September 30, 2009, compared
with December 31, 2008, and its results of operations for the three and nine months ended September
30, 2009 compared to the equivalent 2008 periods. This discussion should be read in conjunction
with the MD&A in Hartford Life Insurance Companys 2008 Form 10-K Annual Report and the Current
Report on Form 8-K filed on April 30, 2009.
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 uncertainties
that are, in many instances, beyond the Companys control and have been made based upon
managements 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
managements 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, including, but not limited to, those set
forth in Part II, Item 1A, Risk Factors as well as Part II, Item 1A, Risk Factors of the Companys
Quarterly Report on Form 10-Q for the quarter ended March 31, 2009, and Part I, Item 1A, Risk
Factors in the Company Form 10-K Annual Report and the Current Report on Form 8-K filed on April
30, 2009. These important risks and uncertainties include, without limitation, uncertainties
related to the depth and duration of the current recession and financial market conditions which
could continue to pressure our capital position and adversely affect the Companys business and
results; the extent of the impact on the Companys results and prospects of recent downgrades in
the Companys financial strength ratings and the impact of further downgrades on the Companys
business and results; the success of management initiatives to stabilize the Companys ratings and
mitigate and reduce risks associated with various business lines, the additional restrictions,
oversight, costs and other potential consequences of The Hartfords participation in the Capital
Purchase Program under the Emergency Economic Stabilization Act of 2008; changes in financial and
capital markets, including changes in interest rates, credit spreads, equity prices and foreign
exchange rates; the inability to effectively mitigate the impact of equity market volatility on the
Companys financial position and results of operations arising from obligations under annuity
product guarantees; the amount of statutory capital that the Company has, changes to the statutory
reserves and/or risk based capital requirements, and the Companys ability to hold and protect
sufficient statutory capital to maintain financial strength and credit ratings; the incidence and
severity of catastrophes, both natural and man-made; losses due to nonperformance or defaults by
others; the potential for differing interpretations of the methodologies, estimations and
assumptions that underlie the valuation of the Companys financial instruments that could result in
changes to investment valuations; the subjective determinations that underlie the Companys
evaluation of other-than-temporary impairments on available-for-sale securities; the potential for
further acceleration of DAC amortization; the potential for further impairment of our goodwill; 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; stronger than anticipated competitive activity; unfavorable judicial or legislative
developments; the potential effect of domestic and foreign regulatory developments, including those
which could increase the Companys business costs and required capital levels; the Companys
ability to distribute its products through distribution channels, both current and future; the
ability to recover the Companys systems and information in the event of a disaster or other
unanticipated event; potential for difficulties arising from outsourcing relationships; potential
changes in federal or state tax laws, including changes impacting the availability of the separate
account dividend received deduction; the Companys ability to protect its intellectual property and
defend against claims of infringement; and other factors described in such forward-looking
statements.
INDEX
Overview
|
47 | Other | 75 | |||
Critical Accounting Estimates
|
48 | Investment Credit Risk | 76 | |||
Consolidated Results of Operations
|
66 | Capital Resources and Liquidity | 91 | |||
Retail
|
68 | Accounting Standards | 94 | |||
Individual Life
|
70 | |||||
Retirement Plans |
72 | |||||
Institutional |
74 |
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CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements, in conformity with accounting principles generally
accepted in the United States of America (U.S. 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: estimated gross profits used in
the valuation and amortization of assets and liabilities associated with variable annuity and other
universal life-type contracts; living benefits required to be fair valued; valuation of investments
and derivative instruments; evaluation of other-than-temporary impairments on available-for-sale
securities and contingencies relating to corporate litigation, goodwill and regulatory matters
certain of these estimates are particularly sensitive to market conditions, and deterioration
and/or volatility in the worldwide debt or equity markets could have material impact on the
condensed consolidated financial statements. 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. For discussion of the critical accounting estimates not discussed below,
see MD&A in the Companys 2008 Form 10-K Annual Report and the current report on Form 8-K filed on
April 30, 2009.
Life Estimated Gross Profits Used in the Valuation and Amortization of Assets and Liabilities
Associated with Variable Annuity and Other Universal Life-Type Contracts
Accounting Policy and Assumptions
The deferred policy acquisition costs asset and present value of future profits (PVFP) intangible
asset (hereafter, referred to collectively as DAC) related to investment contracts and universal
life-type contracts (including variable annuities) are amortized in the same way, over the
estimated life of the contracts acquired using the retrospective deposit method. Under the
retrospective deposit method, acquisition costs are amortized in proportion to the present value of
estimated gross profits (EGPs). EGPs are also used to amortize other assets and liabilities on
the Companys balance sheet, such as sales inducement assets and unearned revenue reserves (URR).
Components of EGPs are used to determine reserves for guaranteed minimum death, income and
universal life secondary guarantee benefits accounted for and collectively referred to as the death
benefit and other insurance benefit reserves. At September 30, 2009 and December 31, 2008, the
carrying value of the Companys DAC asset was $7.9 billion and $9.9 billion, respectively. At
September 30, 2009, the sales inducement asset, unearned revenue reserves, and the death benefit
and other insurance benefit reserve balances were $405, $1.3 billion and $1.4 billion,
respectively. At December 31, 2008, the sales inducement asset, unearned revenue reserves and the
death benefit and other insurance benefit reserves were $533, $1.5 billion and $925, respectively.
For most contracts, the Company estimates gross profits over a 20-year horizon as estimated profits
emerging subsequent to that timeframe are immaterial. The Company uses other amortization bases for
amortizing DAC, such as gross costs (net of reinsurance), as a replacement for EGPs when EGPs are
expected to be negative for multiple years of the contracts life. Actual gross profits, in a given
reporting period, that vary from managements initial estimates result in increases or decreases in
the rate of amortization, commonly referred to as a true-up, which are recorded in the current
period.
Products sold in a particular year are aggregated into cohorts. Future gross profits for each
cohort are projected over the estimated lives of the underlying contracts, and are, to a large
extent, a function of future account value projections for variable annuity products and to a
lesser extent for variable universal life products. The projection of future account values
requires the use of certain assumptions. The assumptions considered to be important in the
projection of future account value, and hence the EGPs, include separate account fund performance,
which is impacted by separate account fund mix, less fees assessed against the contract holders
account balance, surrender and lapse rates, interest margin, mortality, and hedging costs. The
assumptions are developed as part of an on-going process and are dependent upon the Companys
current best estimates of future events.
Through March 31, 2009, the Company estimated gross profits using the mean of EGPs derived from a
set of stochastic scenarios that had been calibrated to our estimated separate account return.
Beginning in the second quarter of 2009, the Company estimated gross profits from a single
deterministic reversion-to-mean (RTM) separate account return projection. RTM is an estimation
technique commonly used by insurance entities to project future separate account returns. Through
this estimation technique, the Companys DAC model will be adjusted to reflect actual account
values at the end of each quarter and through a consideration of recent returns, we will adjust
future projected returns over a five year period so that the account value grows to the long-term
expected rate of return, providing that those projected returns for the next five years do not
exceed certain caps or floors. This will result in a DAC Unlock, describe below, each quarter.
However, benefits and assessments used in the determination of the death benefit and other
insurance benefit reserves will be derived from a set of stochastic scenarios that have been
calibrated to our reversion to mean separate account returns. Under RTM, the Company makes the
following assumptions about the asset categories that comprise separate accounts:
| Equities: The reversion period combines a five-year prospective period and a look-back period to April 1, 2009 intended to reflect the results of recent historical market experience. The expected long-term equity rate of return on the U.S. equity asset classes is 9.5%, subject to a 15% cap. |
| Fixed Income: The expected long-term rate of return on the U.S. fixed income asset class is 6.0%. |
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The following table summarizes the general impacts to individual variable annuity EGPs and earnings
for DAC amortization caused by changes in separate account returns, mortality and future lapse rate
assumptions:
Impact on Earnings | ||||
for DAC | ||||
Assumption | Impact to EGPs | Amortization | ||
Expected long-term rates of return increases
|
Increase: As expected fee income would increase and expected claims would decrease. | Benefit | ||
Expected long-term rates of return decreases
|
Decrease: As expected fee income would decrease and expected claims would increase. | Charge | ||
Future mortality increases
|
Decrease: As expected fee income would decrease because the time period in which fees would be collected would be reduced and claims would increase. | Charge | ||
Future mortality decreases
|
Increase: As expected fee income would increase because the time period in which fees would be collected would increase and claims would decrease. | Benefit | ||
Future lapse rate increases
|
Decrease: As expected fee income would decrease because the time period in which fees would be collected would be reduced at a greater rate than claims would decrease. (1) | Charge (1) | ||
Future lapse rate decreases
|
Increase: As expected fee income would increase because the time period in which fees would be collected would increase at a greater rate than claims would increase. (1) | Benefit (1) |
(1) | If a contract is significantly in-the-money such that expected lifetime claims exceed lifetime fee income, this relationship would reverse. | |
In addition to changes to the assumptions described above, changes to other policyholder behaviors such as resets, partial surrenders, reaction to price increases, and asset allocations could cause EGPs to fluctuate. |
Estimating future gross profits is complex and requires considerable judgment and the forecasting
of events well into the future. Even though the Company has adopted a RTM estimation technique for
determining future separate account returns, the Company will continue to complete a comprehensive
assumption study and refine its estimate of future gross profits, as a result of that study,
during the third quarter of each year. Upon completion of an assumption study, the Company revises
its assumptions to reflect its current best estimate, thereby changing its estimate of projected
account values and the related EGPs in the DAC, sales inducement and unearned revenue reserve
amortization models as well as the death benefit and other insurance benefit reserving models. The
DAC asset, as well as the sales inducement asset, unearned revenue reserves and the death benefit
and other insurance benefit reserves are adjusted with an offsetting benefit or charge to income to
reflect such changes in the period of the revision. All assumption changes that affect the estimate
of future EGPs including the update of current account values, the use of the RTM estimation
technique or policyholder behavior assumptions are considered an Unlock in the period of revision.
An Unlock that results in an after-tax benefit generally occurs as a result of actual experience or
future expectations of product profitability being favorable compared to previous estimates. An
Unlock that results in an after-tax charge generally occurs as a result of actual experience or
future expectations of product profitability being unfavorable compared to previous estimates.
Prior to adopting the RTM estimation technique for determining future separate account returns, in
addition to the comprehensive assumption study performed in the third quarter of each year,
revisions to best estimate assumptions used to estimate future gross profits were also necessary
when the EGPs in the Companys models fell outside of an independently determined reasonable range
of EGPs. In addition, the Company considered, on a quarterly basis, other qualitative factors such
as product, regulatory and policyholder behavior trends and would also revise EGPs if those trends
were expected to be significant and were not or could not be included in the statistically
significant ranges of reasonable EGPs. After reviewing both the quantitative test results and
certain qualitative factors as of March 31, 2009, the Company determined an interim Unlock was
necessary.
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Unlock
During the third quarter of 2009, the Company recorded an Unlock benefit of $62. This Unlock
benefit included the effect of strong equity market returns generating an Unlock benefit of $224
offset by changes in non-market related assumptions generating an Unlock charge of $162. The
Unlock benefit resulting from equity market growth was less than that recorded in the second
quarter of 2009 despite comparable returns of the S&P 500. This decline was primarily due to
actual Company separate account returns earnings less than in the second quarter and a slower
decline in expected death benefits as policyholders become less in-the-money. Unlock charges
from non-market assumption changes were primarily driven by the Companys estimate of higher
assumed macro hedge program costs in 2010. Other significant assumption changes included decreases
in mortality, increases in credit loss estimates and declines in net investment spread. The
Company is continually evaluating various aspects of policyholder behavior and may modify certain
of its assumptions, including living benefit lapses and withdrawal rates, if credible emerging data
indicates that changes are warranted. The following table displays the components, by segment, of
the Companys third quarter Unlock.
Death | |||||||||||||||||||||||
and Other | |||||||||||||||||||||||
Unearned | Insurance | Sales | |||||||||||||||||||||
Segment | Revenue | Benefit | Inducement | ||||||||||||||||||||
After-tax (charge) benefit | DAC | Reserves | Reserves [1] | Assets | Total | ||||||||||||||||||
Retail |
$ | 14 | $ | (13 | ) | $ | 77 | $ | (9 | ) | $ | 69 | |||||||||||
Retirement Plans |
(1 | ) | | 1 | | | |||||||||||||||||
Individual Life |
(27 | ) | 7 | (4 | ) | | (24 | ) | |||||||||||||||
Institutional |
(1 | ) | | | | (1 | ) | ||||||||||||||||
Other |
7 | | 12 | (1 | ) | 18 | |||||||||||||||||
Total |
$ | (8 | ) | $ | (6 | ) | $ | 86 | $ | (10 | ) | $ | 62 | ||||||||||
[1] | As a result of the Unlock, reserves, in Retail, decreased $223, pre-tax, offset by a decrease of $105, pre-tax, in reinsurance recoverables. |
The after-tax impact on the Companys assets and liabilities as a result of the Unlock in the first
quarter based on our quantitative and qualitative tests and the third quarter, based on the RTM
estimation technique, for the nine months ended September 30, 2009 was:
Death | |||||||||||||||||||||||
and Other | |||||||||||||||||||||||
Unearned | Insurance | Sales | |||||||||||||||||||||
Segment | Revenue | Benefit | Inducement | ||||||||||||||||||||
After-tax (charge) benefit | DAC | Reserves | Reserves [1] | Assets | Total | ||||||||||||||||||
Retail |
$ | (489 | ) | $ | 18 | $ | (153 | ) | $ | (39 | ) | $ | (663 | ) | |||||||||
Retirement Plans |
(54 | ) | | (1 | ) | (1 | ) | (56 | ) | ||||||||||||||
Individual Life |
(91 | ) | 47 | (4 | ) | | (48 | ) | |||||||||||||||
Institutional |
(1 | ) | | | | (1 | ) | ||||||||||||||||
Other [2] |
(67 | ) | 6 | (11 | ) | (9 | ) | (81 | ) | ||||||||||||||
Total |
$ | (702 | ) | $ | 71 | $ | (169 | ) | $ | (49 | ) | $ | (849 | ) | |||||||||
[1] | As a result of the Unlock, reserves, in Retail, increased $518, pre-tax, offset by an increase of $281, pre-tax, in reinsurance recoverables. | |
[2] | The most significant contributor to the Unlock amounts recorded during the first quarter of 2009 were as a result of actual separate account returns from the period ending October 1, 2008 to March 31, 2009 being significantly below our aggregated estimated return. |
The after-tax impact on the Companys assets and liabilities as a result of the Unlock during the
third quarter 2008 was as follows:
Death | |||||||||||||||||||||||
and Other | |||||||||||||||||||||||
Unearned | Insurance | Sales | |||||||||||||||||||||
Segment | Revenue | Benefit | Inducement | ||||||||||||||||||||
After-tax (charge) benefit | DAC | Reserves | Reserves [1] | Assets | Total | ||||||||||||||||||
Retail |
$ | (648 | ) | $ | 18 | $ | (75 | ) | $ | (27 | ) | $ | (732 | ) | |||||||||
Retirement Plans |
(49 | ) | | | | (49 | ) | ||||||||||||||||
Individual Life |
(29 | ) | (12 | ) | (3 | ) | | (44 | ) | ||||||||||||||
Total |
$ | (726 | ) | $ | 6 | $ | (78 | ) | $ | (27 | ) | $ | (825 | ) | |||||||||
[1] | As a result of the Unlock, death benefit reserves, in Retail, increased $389, pre-tax, offset by an increase of $273, pre-tax, in reinsurance recoverables. |
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An Unlock only revises EGPs to reflect current best estimate assumptions. With or without an
Unlock, and even after an Unlock occurs, the Company must also test the aggregate recoverability of
the DAC and sales inducement assets by comparing the existing DAC balance to the present value of
future EGPs. In addition, the Company routinely stress tests its DAC and sales inducement assets
for recoverability against severe declines in its separate account assets, which could occur if the
equity markets experienced a significant sell-off, as the majority of policyholders funds in the
separate accounts is invested in the equity market. The Companys decision to suspend its U.K.
variable annuity sales negatively impacted the loss recognition testing on the DAC and sales
inducement assets. As a result, a $49 loss was reported within the earnings of the Other segment
during the second quarter of 2009 and included in the Unlock results in the tables above. As of
September 30, 2009, the Company believed individual variable annuity EGPs could fall, through a
combination of negative market returns, lapses and mortality, by at least 22% before portions of
its DAC and sales inducement assets would be unrecoverable as compared to 23% as of June 30, 2009.
Valuation of Investments and Derivative Instruments
The Companys investments in fixed maturities include bonds, redeemable preferred stock and
commercial paper. These investments, along with certain equity securities, which include common
and non-redeemable preferred stocks, are classified as available-for-sale (AFS) and are carried
at fair value. The after-tax difference from cost or amortized cost is reflected in stockholders
equity as a component of Other Comprehensive Income (Loss), after adjustments for the effect of
deducting the life and pension policyholders share of the immediate participation guaranteed
contracts and certain life and annuity deferred policy acquisition costs and reserve adjustments.
The equity investments associated with the variable annuity products offered in the U.K. are
recorded at fair value and are classified as trading with changes in fair value recorded in net
investment income. Policy loans are carried at outstanding balance. Mortgage loans are recorded
at the outstanding principal balance adjusted for amortization of premiums or discounts and net of
valuation allowances. Short-term investments are carried at amortized cost, which approximates
fair value. Limited partnerships and other alternative investments are reported at their carrying
value with the change in carrying value accounted for under the equity method and accordingly the
Companys share of earnings are included in net investment income. Recognition of limited
partnerships and other alternative investment income is delayed due to the availability of the
related financial statements, as private equity and other funds are generally on a three-month
delay and hedge funds are on a one-month delay. Accordingly, income for the three and nine months
ended September 30, 2009 may not include the full impact of current year changes in valuation of
the underlying assets and liabilities, which are generally obtained from the limited partnership
and other alternative investments general partners. Other investments primarily consist of
derivatives instruments which are carried at fair value.
Available-for-Sale Securities and Short-term Investments
The fair value of AFS securities and short-term investments in an active and orderly market (i.e.
not distressed or forced liquidation) is determined by management after considering one of three
primary sources of information: third party pricing services, independent broker quotations or
pricing matrices. Security pricing is applied using a waterfall approach whereby prices are
first sought from third party pricing services, the remaining unpriced securities are submitted to
independent brokers for prices, or lastly, securities are priced using a pricing matrix. Typical
inputs used by these pricing methods include, but are not limited to, reported trades, benchmark
yields, issuer spreads, bids, offers, and/or estimated cash flows and prepayments speeds. Based on
the typical trading volumes and the lack of quoted market prices for fixed maturities, third party
pricing services will normally derive the security prices through recent reported trades for
identical or similar securities making adjustments through the reporting date based upon available
market observable information as outlined above. If there are no recent reported trades, the third
party pricing services and brokers may use matrix or model processes to develop a security price
where future cash flow expectations are developed based upon collateral performance and discounted
at an estimated market rate. For further discussion, see the Available-for-Sale and Short-term
Investments Section in Note 3 of the Notes to the Condensed Consolidated Financial Statements.
The Company has analyzed the third party pricing services valuation methodologies and related
inputs, and has also evaluated the various types of securities in its investment portfolio to
determine an appropriate fair value hierarchy level based upon trading activity and the
observability of market inputs. For further discussion of fair value measurement, see Note 3 of
the Notes to the Condensed Consolidated Financial Statements.
51
Table of Contents
The following table presents the fair value of AFS securities and short-term investments by pricing
source and hierarchy level as of September 30, 2009.
Quoted Prices in | ||||||||||||||||
Active Markets | Significant | |||||||||||||||
for Identical | Significant | Unobservable | ||||||||||||||
Assets | Observable Inputs | Inputs | ||||||||||||||
(Level 1) | (Level 2) | (Level 3) | Total | |||||||||||||
Priced via third party pricing services [1] |
$ | 279 | $ | 30,613 | $ | 1,595 | $ | 32,487 | ||||||||
Priced via independent broker quotations |
| | 3,016 | 3,016 | ||||||||||||
Priced via matrices |
| | 4,092 | 4,092 | ||||||||||||
Priced via other methods [2] |
| 37 | 213 | 250 | ||||||||||||
Short-term investments |
4,051 | 1,850 | | 5,901 | ||||||||||||
Total |
$ | 4,330 | $ | 32,500 | $ | 8,916 | $ | 45,746 | ||||||||
% of Total |
9.5 | % | 71.0 | % | 19.5 | % | 100.0 | % | ||||||||
[1] | Includes index pricing | |
[2] | Represents securities for which adjustments were made to reduce prices received from third parties and certain private equity investments that are carried at the Companys determination of fair value from inception. |
The fair value is the amount at which the security could be exchanged in a current transaction
between knowledgeable, unrelated willing parties using inputs, including assumptions and estimates,
a market participant would utilize. As the estimated fair value of a security utilizes assumptions
and estimates, the amount that may be realized may differ significantly.
Valuation of Derivative Instruments, excluding embedded derivatives within liability contracts
Derivative instruments are reported in the Condensed Consolidated Balance Sheets at fair value and
are reported in Other Investments and Other Liabilities. Derivative instruments are fair valued
using pricing valuation models, which utilize market data inputs or independent broker quotations.
Excluding embedded and reinsurance related derivatives, as of September 30, 2009 and December 31,
2008, 96% and 95% of derivatives, respectively, based upon notional values, were priced by
valuation models, which utilize independent market data. The remaining derivatives were priced by
broker quotations. The derivatives are valued using mid-market level inputs, with the exception of
the customized swap contracts that hedge GMWB liabilities, that are predominantly observable in the
market. Inputs used to value derivatives include, but are not limited to, interest swap rates,
foreign currency forward and spot rates, credit spreads and correlations, interest and equity
volatility and equity index levels. The Company performs a monthly analysis on derivative
valuations which includes both quantitative and qualitative analysis. Examples of procedures
performed include, but are not limited to, review of pricing statistics and trends, back testing
recent trades, analyzing the impacts of changes in the market environment, and review of changes in
market value for each derivative including those derivatives priced by brokers.
The following table presents the notional value and net fair value of derivatives instruments by
hierarchy level as of September 30, 2009.
Notional Value | Fair Value | |||||||
Quoted prices in active markets for identical assets (Level 1) |
$ | 1,736 | $ | | ||||
Significant observable inputs (Level 2) |
26,831 | 273 | ||||||
Significant unobservable inputs (Level 3) |
34,663 | 587 | ||||||
Total |
$ | 63,230 | $ | 860 | ||||
The following table presents the notional value and net fair value of the derivative instruments
within the Level 3 securities classification as of September 30, 2009.
Notional Value | Fair Value | |||||||
Credit derivatives |
$ | 2,798 | $ | (189 | ) | |||
Interest derivatives |
2,842 | 5 | ||||||
Equity derivatives |
28,999 | 771 | ||||||
Other |
24 | | ||||||
Total Level 3 |
$ | 34,663 | $ | 587 | ||||
Derivative instruments classified as Level 3 include complex derivatives, primarily consisting of
equity options and swaps, interest rate derivatives which have interest rate optionality, certain
credit default swaps, and long-dated interest rate swaps. These derivative instruments are valued
using pricing models which utilize both observable and unobservable inputs and, to a lesser extent,
broker quotations. A derivative instrument that is priced using both observable and unobservable
inputs will be classified as a Level 3 financial instrument in its entirety if the unobservable
input is significant in developing the price. The Company utilizes derivative instruments to
manage the risk associated with certain assets and liabilities. However, the derivative instrument
may not be classified with the same fair value hierarchy level as the associated assets and
liabilities.
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Table of Contents
Evaluation of Other-Than-Temporary Impairments on Available-for-Sale Securities
One of the significant estimates related to AFS securities is the evaluation for
other-than-temporary impairments (impairment). The Company has a security monitoring process
overseen by a committee of investment and accounting professionals that identifies AFS securities
that are subjected to an enhanced evaluation on a quarterly basis to determine if an impairment is
present. This evaluation is a quantitative and qualitative process, which is subject to risks and
uncertainties and is intended to determine whether declines in the fair value of AFS securities
should be recognized in current period earnings. For further discussion of the accounting policy,
see the Recognition and Presentation of Other-Than-Temporary Impairments Section of Note 1 of the
Notes to the Condensed Consolidated Financial Statements. For a discussion of results, see the
Other-Than-Temporary Impairments section of the MD&A.
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Table of Contents
Outlook
Life
Retail
In the long-term, management continues to believe the market for retirement products will expand as
individuals increasingly save and plan for retirement. Demographic trends suggest that as the
baby boom generation matures, a significant portion of the United States population will allocate
a greater percentage of their disposable incomes to saving for their retirement years due to
uncertainty surrounding the Social Security system and increases in average life expectancy.
Near-term, the Company is continuing to experience lower variable annuity sales as a result of
market disruption and the competitiveness of the Companys current product offerings. Despite the
partial equity market recovery over the past six months, the current market level and market
volatility have resulted in higher claim costs, and have increased the cost and volatility of
hedging programs, and the level of capital needed to support living benefit guarantees. Many
competitors have responded to recent market turbulence by increasing the price of their guaranteed
living benefits and changing the amount of the guarantee offered. Management believes that the
most significant industry de-risking changes have occurred. In the first six months of 2009, the
Company adjusted pricing levels and took other actions to de-risk its variable annuity product
features in order to address the risks and costs associated with variable annuity benefit features
in the current economic environment and continues to explore other risk limiting techniques such as
changes to hedging or other reinsurance structures. The Company will continue to evaluate the
benefits offered within its variable annuities and launched a new variable annuity product in
October 2009 that responds to customer needs for growth and income within the risk tolerances of
The Hartford.
Continued equity market volatility or significant declines in interest rates are also likely to
continue to impact the cost and effectiveness of our GMWB hedging program and could result in
material losses in our hedging program. For more information on the GMWB hedging program, see the
Life Equity Product Risk Management section within Capital Markets Risk Management.
The Companys fixed annuity sales have declined throughout 2009 as a result of lower interest rates
and the transition to a new product. Management expects fixed annuity sales to continue to be
challenged until interest rates increase. In the third quarter of 2009, the Company has continued,
but moderated, its policy of offering higher crediting rates available to renewals of its market
value adjusted (MVA) fixed annuity business. This higher crediting rate strategy for MVA
renewals is expected to continue for some time, which will strain earnings on this renewal
business. The Company actively monitors this strategy and will continue to adjust crediting rates
in response to market conditions and the Companys capital position.
For the retail mutual fund business, net sales can vary significantly depending on market
conditions, as was experienced in the first nine months of 2009. The continued declines in equity
markets in the first quarter of 2009 helped drive declines in the Companys mutual fund deposits
and assets under management. During the second and third quarter, the equity markets improved from
the first quarter and as a result the Companys mutual fund assets under management and deposits
have increased correspondingly. As this business continues to evolve, success will be driven by
diversifying net sales across the mutual fund platform, delivering superior investment performance
and creating new investment solutions for current and future mutual fund shareholders.
The decline in assets under management as compared to 2008 is the result of continued depressed
values of the equity markets in 2009 as compared to 2008, which has decreased the extent of the
scale efficiencies that Retail has benefited from in recent years. The significant reduction in
assets under management has resulted in revenues declining faster than expenses causing lower
earnings during the first three quarters of 2009 and management expects this strain to continue in
the fourth quarter. Individual Annuity net investment spread has been impacted by losses on
limited partnership and other alternative investments, lower yields on fixed maturities and an
increase in crediting rates on renewals for MVA annuities. Management expects these conditions to
persist in the fourth quarter of 2009 and beyond. Management has evaluated, and will continue to
actively evaluate, its expense structure to ensure the business is controlling costs while
maintaining an appropriate level of service to our customers.
Individual Life
Future sales for all products will be influenced by the Companys ratings, as published by the
various ratings agencies, and active management of current distribution relationships, responding
to the impact of recent merger and consolidation activity on existing distribution relationships
and the development of new sources of distribution, while offering competitive and innovative
products and product features. The current economic environment poses challenges for future sales;
while life insurance products respond well to consumer demand for financial security and wealth
accumulation solutions, individuals may be reluctant to transfer funds when market volatility has
recently resulted in significant declines in investment values. In addition, the availability and
terms of capital solutions in the marketplace, as discussed below, to support universal life
products with secondary guarantees, may reduce future growth in these products.
Even considering the previous six months of partial equity market recovery, sales and account
values for variable universal life products have been under pressure due to continued equity market
volatility and declines. For the three and nine months ended September 30, 2009, variable
universal life sales decreased 64% and 66%, respectively, and account values decreased 5% compared
to prior year. Continued volatility and declines in the equity markets may reduce the
attractiveness of variable universal life products and put additional strain on future earnings as
variable life fees earned by the Company are driven by the level of assets under management. The
variable universal life mix was 39% of total life insurance in-force as of September 30, 2009.
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Table of Contents
Individual Life has reinsured the policy liability related to statutory reserves in universal life
with secondary guarantees to a captive reinsurance affiliate. An unaffiliated standby third party
letter of credit supports a portion of the statutory reserves that have been ceded to this
affiliate. As of September 30, 2009, the transaction provided approximately $490 of statutory
capital relief associated with the Companys universal life products with secondary guarantees.
For the three and nine months ended September 30, 2009 and 2008, the use of the letter of credit
resulted in a decline in net investment income and increased expenses. At the current level of
sales, the Company expects this transaction to accommodate future statutory capital needs for
in-force business and new business written through 2009 and into 2010. Under the terms of the
letter of credit, the issuer has the right to require The Hartford to terminate the reinsurance
agreement with the captive reinsurance affiliate, as it applies to new business, at any time after
September 30, 2009. The Company is currently in discussions with the issuer of the letter of
credit regarding the possible modification of terms of the letter of credit for business written
after September 30, 2009. The modification of terms could lead to increased costs for Individual
Life. Management is currently reviewing product design with the objective of developing a competitively
priced product that meets the Companys capital efficiency objectives.
For risk management purposes, Individual Life accepts and retains up to $10 in risk on any one
life. Individual Life uses reinsurance where appropriate to protect against the severity of losses
on individual claims; however, death claim experience may continue to lead to periodic short-term
earnings volatility. In the fourth quarter of 2008, Individual Life began ceding insurance under a
new reinsurance structure for all new business excluding term life insurance. The new reinsurance
structure allows Individual Life greater flexibility in writing larger policies, while retaining
less of the overall risk associated with individual insured lives. This new reinsurance structure
will help balance the overall profitability of Individual Lifes business. The financial results
of the new structure will be recognized over time as new business subject to the structure grows as
a percentage of Individual Lifes total in-force. As a result of the new reinsurance structure,
Individual Life will recognize increasing reinsurance premiums while reducing earnings volatility
associated with mortality experience.
Individual Life continues to face uncertainty surrounding estate tax legislation, aggressive
competition from other life insurance providers, reduced availability and higher price of
reinsurance, and the current regulatory environment related to reserving for term life insurance
and universal life products with no-lapse guarantees. These risks may have a negative impact on
Individual Lifes future sales and earnings.
Retirement Plans
The future financial results of the Retirement Plans segment will depend on Lifes ability to
increase assets under management across all businesses, achieve scale in areas with a high degree
of fixed costs and maintain its investment spread earnings on the general account products sold
largely in the 403(b)/457 business. Disciplined expense management will continue to be a focus of
the Retirement Plans segment as necessary investments in service and technology are made to effect
the integration of the acquisitions described below.
During 2008, the Company completed three Retirement Plans acquisitions. The acquisition of part of
the defined contribution record keeping business of Princeton Retirement Group gives Life a
foothold in the business of providing recordkeeping services to large financial firms which offer
defined contribution plans to their clients and at acquisition added $2.9 billion in mutual funds
to Retirement Plans assets under management and $5.7 billion of assets under administration. The
acquisition of Sun Life Retirement Services, Inc., at acquisition added $15.8 billion in Retirement
Plans assets under management across 6,000 plans and provides new service locations in Boston,
Massachusetts and Phoenix, Arizona. The acquisition of TopNoggin LLC, provides web-based technology
to address data management, administration and benefit calculations. These three acquisitions were
not accretive to 2008 net income. Furthermore, return on assets has been lower in 2009 reflecting
a full year of the new business mix represented by the acquisitions, which includes larger, more
institutionally priced plans, predominantly executed on a mutual fund platform, and the cost of
maintaining multiple technology platforms during the integration period.
Given the market declines in the fourth quarter of 2008 and first quarter of 2009 and increased
market volatility, the Company has seen and expects that growth in Retirement Plans deposits have
been, and will continue to be, negatively affected if businesses reduce their workforces and offer
more modest salary increases and as workers potentially allocate less to retirement accounts in the
near term. The impact of the partial equity markets recovery over the last six months has been
offset by a few large case surrenders, resulting in an overall decline in assets under management
compared to 2008. The reduction in assets under management has strained net income over the past
three quarters, and this earnings strain is expected to continue until average account value
exceeds the level seen in the first half of 2008.
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Institutional
The Company has completed the strategic review of the Instutional businesses and has decided to
exit several businesses that have been determined to be outside of the Companys core business
model. Several lines institutional mutual funds, private placement life insurance, income
annuities and certain institutional annuities will continue to be managed for growth. The
remaining businesses, Structured Settelements, Guaranteed Investment Products, and most
Institutional Annuities will be managed in conjunction with other businesses that the Company has
previously decided will not be actively marketed. Certain Guaranteed
Investment Products may be offered on a selective basis.
The net income of this segment depends on Institutionals ability to retain assets under
management, the relative mix of business, and net investment spread. Net investment spread, as
discussed in the Performance Measures section of this MD&A, has declined in the third quarter of
2009 versus prior year and management expects net investment spread will remain pressured in the
intermediate future due to the low level of short-term interest rates, increased allocation to
lower yielding U.S. Treasuries and short-term investments, and anticipated performance of limited
partnerships and other alternative investments.
Stable value products will experience negative net flows in 2009 as a result of contractual
maturities and the payments associated with certain contracts which allow an investor to accelerate
principal repayments (after a defined notice period of typically thirteen months). Approximately
$825 of account value will be paid out on stable value contracts during the remainder of 2009.
Institutional will fund these obligations from cash and short-term investments presently held in
its investment portfolios along with projected receipts of earned interest and principal maturities
from long-term invested assets. As of September 30, 2009, Institutional has no remaining contracts
that contain an unexercised investor option feature that allows for contract surrender at book
value. The Company has the option to accelerate the repayment of principal for certain other
stable value products and will evaluate calling these contracts on a contract by contract basis
based upon the financial impact to the Company.
Performance Measures
DAC amortization ratio, return on assets (ROA) or after-tax margin, excluding realized gains
(losses) or DAC Unlock are non-GAAP financial measures that the Company uses to evaluate, and
believes are important measures of, segment operating performance. DAC amortization ratio, ROA or
after-tax margin is the most directly comparable GAAP measure. The Hartford believes that the
measures of DAC amortization ratio, ROA or after-tax margin, excluding realized gains (losses) and
DAC Unlock provide investors with a valuable measure of the performance of the Companys on-going
businesses because it reveals trends in our businesses that may be obscured by the effect of
realized gains (losses) or periodic DAC Unlocks. Some realized capital gains and losses are
primarily driven by investment decisions and external economic developments, the nature and timing
of which are unrelated to insurance aspects of our businesses. Accordingly, these non-GAAP
measures exclude the effect of all realized gains and losses that tend to be highly variable from
period to period based on capital market conditions. The Company believes, however, that some
realized capital gains and losses are integrally related to our insurance operations, so DAC
amortization ratio, ROA and after-tax margin, excluding the realized
gains (losses) and DAC Unlock but should include net realized gains and losses on net periodic settlements on the Japan fixed annuity
cross-currency swap. These net realized gains and losses are directly related to an offsetting
item included in the statement of operations such as net investment income. DAC Unlocks occur when
the Company determines based on actual experience or other evidence, that estimates of future gross
profits should be revised. As the DAC Unlock is a reflection of the Companys new best estimates
of future gross profits, the result and its impact on DAC amortization ratio, ROA and after-tax
margin is meaningful; however, it does distort the trend of DAC amortization ratio, ROA and
after-tax margin. DAC amortization ratio, ROA or after-tax margin, excluding realized gains
(losses) and DAC Unlock should not be considered as a substitute for DAC amortization ratio, ROA or
after-tax margin and does not reflect the overall profitability of our businesses. Therefore, the
Company believes it is important for investors to evaluate both DAC amortization ratio, ROA and
after-tax margin, excluding realized gains (losses) and DAC Unlock and DAC amortization ratio, ROA
and after-tax margin when reviewing the Companys performance.
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Table of Contents
Fee Income
Fee income is largely driven from amounts collected as a result of contractually defined
percentages of assets under management. These fees are generally collected on a daily basis. For
individual life insurance products, fees are contractually defined as percentages based on levels
of insurance, age, premiums and deposits collected and contract holder value. Life insurance fees
are generally collected on a monthly basis. Therefore, the growth in assets under management either
through positive net flows or net sales, or favorable equity market performance will have a
favorable impact on fee income. Conversely, either negative net flows or net sales, or unfavorable
equity market performance will reduce fee income.
As of and For the | As of and For the | |||||||||||||||
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
Product/Key Indicator Information | 2009 | 2008 | 2009 | 2008 | ||||||||||||
Individual Variable Annuities |
||||||||||||||||
Account value, beginning of period |
75,613 | 105,345 | 74,578 | 119,071 | ||||||||||||
Net flows |
(1,683 | ) | (1,540 | ) | (5,243 | ) | (4,357 | ) | ||||||||
Change in market value and other |
9,385 | (11,555 | ) | 13,980 | (22,464 | ) | ||||||||||
Account value, end of period |
83,315 | 92,250 | 83,315 | 92,250 | ||||||||||||
Retail Mutual Funds |
||||||||||||||||
Assets under management, beginning of period |
34,708 | 47,239 | 31,032 | 48,383 | ||||||||||||
Net sales |
779 | 816 | 1,406 | 3,838 | ||||||||||||
Change in market value and other |
4,640 | (7,152 | ) | 7,689 | (11,318 | ) | ||||||||||
Assets under management, end of period |
40,127 | 40,903 | 40,127 | 40,903 | ||||||||||||
Retirement Plans Group Annuities |
||||||||||||||||
Account value, beginning of period |
23,490 | 27,029 | 22,198 | 27,094 | ||||||||||||
Net flows |
259 | 587 | 305 | 2,098 | ||||||||||||
Change in market value and other |
2,350 | (2,448 | ) | 3,596 | (4,024 | ) | ||||||||||
Account value, end of period |
26,099 | 25,168 | 26,099 | 25,168 | ||||||||||||
Retirement Plans Mutual Funds |
||||||||||||||||
Assets under management, beginning of period |
15,342 | 19,854 | 14,838 | 1,454 | ||||||||||||
Net sales |
(748 | ) | 39 | (1,388 | ) | (69 | ) | |||||||||
Acquisitions |
| | | 18,725 | ||||||||||||
Change in market value and other |
2,054 | (1,767 | ) | 3,198 | (1,984 | ) | ||||||||||
Assets under management, end of period |
16,648 | 18,126 | 16,648 | 18,126 | ||||||||||||
Individual Life |
||||||||||||||||
Variable universal life account value, end of period |
5,552 | 5,848 | 5,552 | 5,848 | ||||||||||||
Variable universal life insurance in-force |
75,667 | 78,809 | 75,667 | 78,809 | ||||||||||||
S&P 500 Index |
||||||||||||||||
Period end closing value |
1,057 | 1,165 | 1,057 | 1,165 | ||||||||||||
Daily average value |
996 | 1,252 | 900 | 1,324 | ||||||||||||
Assets under management, across all businesses, shown above, have had substantial reductions in
values from prior year primarily due to declines in equity markets during 2008 and first quarter of
2009. The changes in line of business assets under management have also been affected by:
| Retail U.S. individual variable annuity recorded lower deposits for the three and nine months ended September 30, 2009 as a result of market disruptions, recent pricing actions and managements review of product offerings. |
| Retail Mutual funds have seen a decline in net sales for the three and nine months ended September 30, 2009 as a result of lower deposits driven by equity market declines and volatility. |
| Retirement Plans has seen declines in net flows in group annuities and net sales in mutual funds due largely to a few large case surrenders. |
| Individual Life experienced decreases in variable universal life account values as a result of the declines in equity markets, while variable universal life in-force declined as a result of lower sales in 2009 and aging of the variable universal life insurance block of business resulting in increasing mortality and surrender experience. |
57
Table of Contents
Net Investment Spread
Management evaluates performance of certain products based on net investment spread. These products
include those that have insignificant mortality risk, such as fixed annuities, certain general
account universal life contracts and certain institutional contracts. Net investment spread is
determined by taking the difference between the earned rate, (excluding the effects of capital
gains and losses, including those related to the Companys GMWB product and related reinsurance and
hedging programs), and the related crediting rates on average general account assets under
management. The net investment spreads shown below are for the total portfolio of relevant
contracts in each segment and reflect business written at different times. When pricing products,
the Company considers current investment yields and not the portfolio average. The determination of
credited rates is based upon consideration of current market rates for similar products, portfolio
yields and contractually guaranteed minimum credited rates. Net investment spread can be volatile
period over period, which can have a significant positive or negative effect on the operating
results of each segment. Investment earnings can also be influenced by factors such as the actions
of the Federal Reserve and a decision to hold higher levels of short-term investments. The volatile
nature of net investment spread is driven primarily by prepayment premiums on securities and
earnings on limited partnership and other alternative investments.
Net investment spread is calculated as a percentage of general account assets and expressed in
basis points (bps):
Three Months Ended September 30, | Nine Months Ended September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Retail- Individual Annuity |
64.0 | bps | 70.3 | bps | 21.4 | bps | 111.5 | bps | ||||||||
Retirement Plans |
93.8 | bps | 106.4 | bps | 65.2 | bps | 127.1 | bps | ||||||||
Institutional (GICs,
Funding Agreements,
Funding Agreement Backed
Notes and Consumer Notes) |
(33.2 | ) bps | 20.5 | bps | (47.6 | ) bps | 63.0 | bps | ||||||||
Individual Life |
109.9 | bps | 83.5 | bps | 89.0 | bps | 115.6 | bps | ||||||||
The primary reasons for the drop in net investment spread during the three and nine months ended
September 30, 2009 compared to the comparable 2008 periods were negative limited partnership
income, lower earnings on fixed maturities offset by certain reductions in credited rates. The
Company expects these conditions to persist throughout 2009.
| For Retail Individual Annuity for the three months ended September 30, 2009 the drop in net investment spread is primarily related to higher crediting rates of 11 bps and lower earnings on fixed maturities of 10 bps, partially offset by improved partnership returns of 15 bps. For the nine months ended September 30, 2009 the drop in net investment spread is primarily related to lower partnership returns of 35 bps, lower earnings on fixed maturities of 31 bps and higher crediting rates of 18 bps. The decline in fixed maturity returns was primarily related to a higher percentage of fixed maturities being held in short-term investments. |
| In Individual Life, the increase in net investment spread for the three months ended September 30, 2009 is attributable to increased partnership returns of 26 bps and a reduction in the credited rate of 30 bps partially offset by lower fixed maturity income returns. The drop in net investment spread for the nine months ended September 30, 2009 is attributable to lower partnership returns of 30 bps and lower maturity income returns partially offset by a reduction in the credited rate of 20 bps. |
| In Retirement Plans, for the three months ended September 30, 2009, lower net investment spread was a result of lower fixed income returns of 46 bps, partially offset by higher limited partnership returns of 19 bps and lower crediting rates of 15 bps. For the nine months ended September 30, 2009, lower net investment spread was a result of lower limited partnership returns of 32 bps and lower fixed income returns of 43 bps, partially offset by lower crediting rates of 13 bps. |
| In Institutional Stable Value, for the three months ended September 30,2009,net investment spreads were negatively impacted in the amount of 79 bps due to lower yields on variable rate securities and managements desire to maintain additional liquidity in the Institutional portfolios, partially offset by 30 bps of higher limited partnership returns. For the nine months ended September 30, 2009, net investment spreads were negatively impacted by 100 bps due to lower yields on variable rate securities and maintaining additional liquidity in the Institutional portfolios in the form of short term and Treasury securities, and 33 bps attributable to negative limited partnership returns. |
Expenses
There are three major categories for expenses. The first major category of expenses is benefits and
losses. These include the costs of mortality in the individual life business, as well as other
contractholder benefits to policyholders. The second major category is insurance operating costs
and expenses, which is commonly expressed in a ratio of a revenue measure depending on the type of
business. The third major category is the amortization of deferred policy acquisition costs and the
present value of future profits (DAC amortization ratio), which is typically expressed as a
percentage of pre-tax income before the cost of this amortization (an approximation of actual gross
profits) and excludes the effects of unrealized gains (losses). Retail Individual Annuity
business accounts for the majority of the amortization of deferred policy acquisition costs and
present value of future profits for the Company.
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Table of Contents
Three Months ended September 30, | Nine months ended September 30, | ||||||||||||||||
2009 | 2008 | 2009 | 2008 | ||||||||||||||
Retail |
|||||||||||||||||
General insurance expense ratio (individual annuity) |
19.7 | bps | 20.9 | bps | 21.0 | bps | 19.5 | bps | |||||||||
DAC
amortization ratio (individual annuity) [1] |
33.3 | % | 632.4 | % | 437.1 | % | 168.8 | % | |||||||||
DAC amortization ratio (individual annuity)
excluding DAC Unlock [1], [2] |
56.2 | % | 44.3 | % | 63.5 | % | 46.2 | % | |||||||||
Individual Life |
|||||||||||||||||
Death benefits |
$ | 79 | $ | 78 | $ | 233 | $ | 238 | |||||||||
Institutional |
|||||||||||||||||
General insurance expense ratio |
12.0 | bps | 13.7 | bps | 11.8 | bps | 14.5 | bps | |||||||||
[1] | Excludes the effects of realized gains and losses. | |
[2] | See Unlock and Sensitivity Analysis in the Critical Accounting Estimates section of the MD&A. |
| The Retail general insurance expense ratio decreased for the three months ended September, 30 2009 as a result of managements efforts to reduce expenses. For the nine months ended September 30, 2009 the Retail general expense ratio increased primarily due to the impact of a sharply declining asset base on lower expenses. |
| The Retail DAC amortization ratio (Individual Annuity) excluding realized gains (losses) and the effect of the DAC Unlock increased as a result of lower actual gross profits primarily as a result of lower fees earned on declining assets and for the nine months ended September 30, 2009, lower net investment income due to a greater percentage of fixed maturities being held in short-term and lower returns on limited partnerships and other alternative investments. |
| Individual Life death benefits decreased for the nine months ended September 30, 2009 due to favorable mortality volatility partially offset by an increase in net amount at risk for variable universal life policies caused by equity market declines. |
| Institutional general expense ratio decreased due to active expense management efforts and reduced information technology expenses. |
Profitability
Management evaluates the rates of return various businesses can provide as an input in determining
where additional capital should be invested to increase net income and shareholder returns. The
Company uses the return on assets for the Individual Annuity, Retirement Plans and Institutional
businesses for evaluating profitability. In Individual Life, after-tax margin is a key indicator of
overall profitability.
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Table of Contents
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
Retail |
||||||||||||||||
Individual annuity return on assets (ROA) |
(80.0 | ) bps | (305.9 | ) bps | (109.2 | ) bps | (88.4 | ) bps | ||||||||
Effect of net realized gains (losses), net of tax and DAC on ROA [1] |
(149.4 | ) bps | (99.9 | ) bps | (43.5 | ) bps | (65.4 | ) bps | ||||||||
Effect of DAC Unlock on ROA [2] |
30.2 | bps | (267.5 | ) | (97.6 | ) bps | (83.9 | ) bps | ||||||||
ROA excluding realized gains (losses) and effects of DAC Unlock |
39.2 | bps | 61.5 | bps | 31.9 | bps | 60.9 | bps | ||||||||
Retirement Plans |
||||||||||||||||
Retirement Plans ROA |
(33.3 | ) bps | (141.9 | ) bps | (54.1 | ) bps | (49.7 | ) bps | ||||||||
Effect of net realized gains (losses), net of tax and DAC on ROA [1] |
(41.6 | ) bps | (109.1 | ) bps | (40.9 | ) bps | (55.1 | ) bps | ||||||||
Effect of DAC Unlock on ROA [2] |
| bps | (43.4 | ) bps | (18.7 | ) bps | (18.1 | ) bps | ||||||||
ROA excluding realized gains (losses) and effects of DAC Unlock |
8.3 | bps | 10.6 | bps | 5.5 | bps | 23.5 | bps | ||||||||
Institutional |
||||||||||||||||
Institutional ROA |
(69.1 | ) bps | (255.4 | ) bps | (78.2 | ) bps | (119.1 | ) bps | ||||||||
Effect of net realized gains (losses), net of tax and DAC on ROA [1] |
(63.5 | ) bps | (255.1 | ) bps | (69.8 | ) bps | (129.3 | ) bps | ||||||||
ROA excluding realized gains (losses) and effects of DAC Unlock |
(5.6 | ) bps | (0.3 | ) bps | (8.4 | ) bps | 10.2 | bps | ||||||||
Individual Life |
||||||||||||||||
After-tax margin |
(0.4 | %) | (101.9 | %) | (1.0 | %) | (9.4 | %) | ||||||||
Effect of net realized gains (losses), net of tax and DAC on after-tax
margin [1] |
(5.4 | %) | (75.4 | %) | (7.2 | %) | (14.8 | %) | ||||||||
Effect of DAC Unlock on after-tax margin [2] |
(9.7 | %) | (39.5 | %) | (6.6 | %) | (8.0 | %) | ||||||||
After-tax margin excluding realized gains (losses) and effects of DAC Unlock |
14.7 | % | 13.0 | % | 12.8 | % | 13.3 | % | ||||||||
[1] | See Realized Capital Gains and Losses by Segment table within this section of the MD&A | |
[2] | See Unlock and Sensitivity Analysis within the Critical Accounting Estimates section of the MD&A. |
| The decrease in Individual Annuitys ROA, excluding realized gains (losses) and the effect of the DAC Unlock, reflects higher DAC rates due to lower actual gross profits over the past year; lower tax benefits, primarily related to DRD; and for the nine months ended September 30, 2009 significant losses on limited partnership and other alternative investments. | |
| The decrease in Retirement Plans ROA, excluding realized gains (losses) and the effect of the DAC Unlock for the three months ended September 30, 2009, was primarily driven by lower fees from equity market declines. For the nine months ended September 30, 2009, the decrease in ROA, excluding realized gains (losses) and the effect of the DAC Unlock was driven by lower returns on limited partnership and other alternative investments and lower fees from equity market declines. | |
| The decrease in Institutionals ROA, excluding realized gains (losses), is primarily due to lower yields on investments and a decline in income from limited partnership and other alternative investments | |
| The increase in Individual Lifes after-tax margin, excluding realized gains (losses) and the effect of the DAC Unlock, for the three months ended September 30, 2009 was primarily due to the recognition of tax benefits associated with the dividends received deduction. For the nine months ended September 30, 2009 the after-tax margin decreased primarily due to reserve increases on secondary guaranteed universal life insurance products, lower fees from equity market declines and lower net investment income from limited partnership and other alternative investments, partially offset by increased cost of insurance charges, favorable mortality volatility and life insurance in-force growth. |
60
Table of Contents
Investment Results
The primary investment objective of the Companys general account is to maximize economic value
consistent with acceptable risk parameters, including the management of credit risk and interest
rate sensitivity of investment assets, while generating sufficient after-tax income to support
policyholder and corporate obligations.
The following table presents the Companys invested assets by type.
Composition of Invested Assets
September 30, 2009 | December 31, 2008 | |||||||||||||||
Amount | Percent | Amount | Percent | |||||||||||||
Fixed maturities, AFS, at fair value |
$ | 39,436 | 72.2 | % | $ | 39,560 | 71.9 | % | ||||||||
Equity securities, AFS, at fair value |
409 | 0.7 | % | 434 | 0.8 | % | ||||||||||
Mortgage loans |
4,630 | 8.5 | % | 4,896 | 8.9 | % | ||||||||||
Policy loans, at outstanding balance |
2,156 | 3.9 | % | 2,154 | 3.9 | % | ||||||||||
Limited partnerships and other alternative investments |
776 | 1.4 | % | 1,033 | 1.9 | % | ||||||||||
Other investments [1] |
1,370 | 2.5 | % | 1,237 | 2.2 | % | ||||||||||
Short-term investments |
5,901 | 10.8 | % | 5,742 | 10.4 | % | ||||||||||
Total investments excl. equity securities, trading |
54,678 | 100.0 | % | 55,056 | 100.0 | % | ||||||||||
Equity securities, trading, at fair value [2] |
2,465 | 1,634 | ||||||||||||||
Total investments |
$ | 57,143 | $ | 56,690 | ||||||||||||
[1] | Primarily relates to derivative instruments. | |
[2] | These assets primarily support the European variable annuity business. Changes in these balances are also reflected in the respective liabilities. |
Total investments increased primarily due to equity securities, trading, partially offset by
declines in mortgage loans and limited partnerships and other alternative investments. Equity
securities, trading, increased primarily as a result of positive cash flows generated from sales
and deposits of U.K. unit-linked and pension product, as well as foreign currency gains due to the
appreciation of the British pound in comparison to the U.S. dollar and positive market performance
for the underlying investment funds. The decline in mortgage loans resulted from valuation
allowances and maturities, and the decline in limited partnerships and other alternative
investments was due to hedge fund redemptions and negative re-valuations of the underlying
investments associated with the real estate and private equity markets.
The following table summarizes the Companys net investment income (loss).
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||||||||||
September 30, | September 30, | |||||||||||||||||||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||||||||||||||||||
Amount | Yield [1] | Amount | Yield [1] | Amount | Yield [1] | Amount | Yield [1] | |||||||||||||||||||||||||
Fixed maturities [2] |
$ | 513 | 4.5 | % | $ | 614 | 5.3 | % | $ | 1,620 | 4.5 | % | $ | 1,893 | 5.4 | % | ||||||||||||||||
Equity securities, AFS |
12 | 9.6 | % | 12 | 6.6 | % | 35 | 8.7 | % | 48 | 8.4 | % | ||||||||||||||||||||
Mortgage loans |
58 | 5.0 | % | 62 | 5.4 | % | 177 | 4.9 | % | 184 | 5.6 | % | ||||||||||||||||||||
Policy loans |
35 | 6.5 | % | 33 | 6.3 | % | 106 | 6.6 | % | 98 | 6.3 | % | ||||||||||||||||||||
Limited partnerships and
other alternative
investments |
(16 | ) | (7.2 | %) | (57 | ) | (17.5 | %) | (165 | ) | (23.1 | %) | (56 | ) | (6.1 | %) | ||||||||||||||||
Other [3] |
65 | | (4 | ) | | 163 | | (41 | ) | | ||||||||||||||||||||||
Investment expense |
(23 | ) | | (17 | ) | | (55 | ) | | (48 | ) | | ||||||||||||||||||||
Total net investment
income excl. equity
securities, trading |
644 | 4.3 | % | 643 | 4.7 | % | 1,881 | 4.1 | % | 2,078 | 5.1 | % | ||||||||||||||||||||
Equity securities, trading |
299 | | (118 | ) | | 308 | | (240 | ) | | ||||||||||||||||||||||
Total net investment
income (loss) |
$ | 943 | | $ | 525 | | $ | 2,189 | | $ | 1,838 | | ||||||||||||||||||||
[1] | Yields calculated using annualized net investment income before investment expenses divided by the monthly average invested assets at cost, amortized cost, or adjusted carrying value, as applicable, excluding collateral received associated with the securities lending program and consolidated variable interest entity non-controlling interests. Included in the fixed maturity yield is other, which primarily relates to fixed maturities (see footnote [3] below). Included in the total net investment income yield is investment expense. | |
[2] | Includes net investment income on short-term bonds. | |
[3] | Includes income from derivatives that qualify for hedge accounting and hedge fixed maturities. Also includes fees associated with securities lending activities of $0 and $4, for the three and nine months ended September 30, 2009, respectively, and $9 and $42 for the three and nine months ended September 30, 2008, respectively. The income from securities lending activities is included within fixed maturities. |
61
Table of Contents
Nine months ended September 30, 2009 compared to the nine months ended September 30, 2008
Net investment income, excluding equity securities, trading, decreased primarily due to lower
income on fixed maturities and limited partnerships and other alternative investments, partially
offset by other income. The decline in fixed maturity income was primarily due to increased
allocation to short-term investments and lower yields on variable rate securities due to declines
in short-term interest rates. The decline in limited partnerships and other alternative investment
income was largely due to negative re-valuations of the underlying investments associated primarily
with the real estate and private equity markets. These losses were partially offset by income from
interest rate swaps reported above as other income.
The increase in net investment income on equity securities, trading, for the three and nine months
ended September 30, 2009 compared to the prior year periods was primarily attributed to the market
performance of the underlying investment funds supporting the U.K. unit-linked and pension product.
62
Table of Contents
Realized Capital Gains and Losses by Segment
The Company includes net realized capital gains and losses in each reporting segment. Following is
a summary of the types of realized gains and losses by segment:
Net realized capital gains (losses) for three months ended September 30, 2009
Individual | |||||||||||||||||||||||||
Retail | Life | Retirement | Institutional | Other | Total | ||||||||||||||||||||
Gross gains on sales |
$ | 28 | $ | 9 | $ | 10 | $ | 37 | $ | 19 | $ | 103 | |||||||||||||
Gross losses on sales |
(24 | ) | (10 | ) | (2 | ) | (8 | ) | (13 | ) | (57 | ) | |||||||||||||
Net OTTI losses
recognized in earnings |
(111 | ) | (28 | ) | (83 | ) | (168 | ) | (25 | ) | (415 | ) | |||||||||||||
Japanese fixed annuity
contract hedges, net |
| | | | (7 | ) | (7 | ) | |||||||||||||||||
Periodic net coupon
settlements on credit
derivatives/Japan |
(4 | ) | (1 | ) | (2 | ) | (2 | ) | 7 | (2 | ) | ||||||||||||||
Results of variable
annuity hedge program |
|||||||||||||||||||||||||
GMWB derivatives, net |
(198 | ) | | | | 7 | (191 | ) | |||||||||||||||||
Macro hedge |
(282 | ) | | | | (46 | ) | (328 | ) | ||||||||||||||||
Total results of
variable annuity hedge
program |
(480 | ) | | | | (39 | ) | (519 | ) | ||||||||||||||||
GMIB/GMAB/GMWB
reinsurance |
| | | | (420 | ) | (420 | ) | |||||||||||||||||
Other, net |
(26 | ) | (7 | ) | (12 | ) | (5 | ) | (145 | ) | (195 | ) | |||||||||||||
Total net realized
capital gains/(losses) |
(617 | ) | (37 | ) | (89 | ) | (146 | ) | (623 | ) | (1,512 | ) | |||||||||||||
Income tax
expense/(benefit) and
DAC |
(118 | ) | (13 | ) | (39 | ) | (52 | ) | (215 | ) | (437 | ) | |||||||||||||
Total net
realized losses, net of tax and
DAC |
$ | (499 | ) | $ | (24 | ) | $ | (50 | ) | $ | (94 | ) | $ | (408 | ) | $ | (1,075 | ) | |||||||
Net realized capital gains (losses) for three months ended September 30, 2008
Individual | |||||||||||||||||||||||||
Retail | Life | Retirement | Institutional | Other | Total | ||||||||||||||||||||
Gross gains on sales |
$ | 6 | $ | 7 | $ | 1 | $ | 16 | $ | 4 | $ | 34 | |||||||||||||
Gross losses on sales |
(22 | ) | (12 | ) | (12 | ) | (25 | ) | (14 | ) | (85 | ) | |||||||||||||
Net OTTI losses
recognized in earnings |
(329 | ) | (165 | ) | (174 | ) | (494 | ) | (148 | ) | (1,310 | ) | |||||||||||||
Japanese fixed annuity
contract hedges, net |
| | | | 36 | 36 | |||||||||||||||||||
Periodic net coupon
settlements on credit
derivatives/Japan |
(1 | ) | | (1 | ) | | (7 | ) | (9 | ) | |||||||||||||||
Fair value measurement
transition impact |
| | | | | | |||||||||||||||||||
Results of variable
annuity hedge program |
|||||||||||||||||||||||||
GMWB derivatives, net |
(115 | ) | | | | (18 | ) | (133 | ) | ||||||||||||||||
Macro hedge |
19 | | | | 5 | 24 | |||||||||||||||||||
Total results of
variable annuity hedge
program |
(96 | ) | | | | (13 | ) | (109 | ) | ||||||||||||||||
GMIB/GMAB/GMWB
reinsurance |
| | | | (403 | ) | (403 | ) | |||||||||||||||||
Other, net |
(40 | ) | 4 | 5 | (98 | ) | 15 | (114 | ) | ||||||||||||||||
Total net realized
capital gains/(losses) |
(482 | ) | (166 | ) | (181 | ) | (601 | ) | (530 | ) | (1,960 | ) | |||||||||||||
Income tax
expense/(benefit) and
DAC |
(201 | ) | (61 | ) | (58 | ) | (210 | ) | (174 | ) | (704 | ) | |||||||||||||
Total net
realized losses,
net of tax and DAC |
$ | (281 | ) | $ | (105 | ) | $ | (123 | ) | $ | (391 | ) | $ | (356 | ) | $ | (1,256 | ) | |||||||
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Table of Contents
Net realized capital gains (losses) for nine months ended September 30, 2009
Individual | |||||||||||||||||||||||||
Retail | Life | Retirement | Institutional | Other | Total | ||||||||||||||||||||
Gross gains on sales |
$ | 80 | $ | 19 | $ | 28 | $ | 65 | $ | 110 | $ | 302 | |||||||||||||
Gross losses on sales |
(314 | ) | (32 | ) | (39 | ) | (119 | ) | (84 | ) | (588 | ) | |||||||||||||
Net OTTI losses
recognized in earnings |
(196 | ) | (41 | ) | (130 | ) | (406 | ) | (75 | ) | (848 | ) | |||||||||||||
Japanese fixed annuity
contract hedges, net |
| | | | 28 | 28 | |||||||||||||||||||
Periodic net coupon
settlements on credit
derivatives/Japan |
(12 | ) | (3 | ) | (6 | ) | (6 | ) | 2 | (25 | ) | ||||||||||||||
Results of variable
annuity hedge program |
|||||||||||||||||||||||||
GMWB derivatives, net |
1,017 | | | | 36 | 1,053 | |||||||||||||||||||
Macro hedge |
(596 | ) | | | | (96 | ) | (692 | ) | ||||||||||||||||
Total results of
variable annuity hedge
program |
421 | | | | (60 | ) | 361 | ||||||||||||||||||
GMIB/GMAB/GMWB
reinsurance |
| | | | 1,012 | 1,012 | |||||||||||||||||||
Other, net |
(134 | ) | (60 | ) | (81 | ) | (14 | ) | 29 | (260 | ) | ||||||||||||||
Total net realized
capital gains/(losses) |
(155 | ) | (117 | ) | (228 | ) | (480 | ) | 962 | (18 | ) | ||||||||||||||
Income tax
expense/(benefit) and
DAC |
288 | (46 | ) | (95 | ) | (168 | ) | 345 | 324 | ||||||||||||||||
Total net
realized gains/(losses), net of tax and DAC |
$ | (443 | ) | $ | (71 | ) | $ | (133 | ) | $ | (312 | ) | $ | 617 | $ | (342 | ) | ||||||||
Net realized capital gains (losses) for nine months ended September 30, 2008
Individual | |||||||||||||||||||||||||
Retail | Life | Retirement | Institutional | Other | Total | ||||||||||||||||||||
Gross gains on sales |
$ | 26 | $ | 9 | $ | 8 | $ | 27 | $ | 32 | $ | 102 | |||||||||||||
Gross losses on sales |
(50 | ) | (24 | ) | (33 | ) | (72 | ) | (81 | ) | (260 | ) | |||||||||||||
Net OTTI losses
recognized in earnings |
(393 | ) | (197 | ) | (210 | ) | (643 | ) | (181 | ) | (1,624 | ) | |||||||||||||
Japanese fixed annuity
contract hedges, net |
| | | | 13 | 13 | |||||||||||||||||||
Periodic net coupon
settlements on credit
derivatives/Japan |
(3 | ) | (1 | ) | (2 | ) | 1 | (21 | ) | (26 | ) | ||||||||||||||
Fair value measurement
transition impact |
(616 | ) | | | | (182 | ) | (798 | ) | ||||||||||||||||
Results of variable
annuity hedge program |
|||||||||||||||||||||||||
GMWB derivatives, net |
(241 | ) | | | | (16 | ) | (257 | ) | ||||||||||||||||
Macro hedge |
24 | | | | 5 | 29 | |||||||||||||||||||
Total
results of variable annuity hedge program |
(217 | ) | | | | (11 | ) | (228 | ) | ||||||||||||||||
GMIB/GMAB/GMWB reinsurance |
| | | | (549 | ) | (549 | ) | |||||||||||||||||
Other, net |
(57 | ) | (6 | ) | 1 | (220 | ) | (18 | ) | (300 | ) | ||||||||||||||
Total net
realized capital gains/(losses) |
(1,310 | ) | (219 | ) | (236 | ) | (907 | ) | (998 | ) | (3,670 | ) | |||||||||||||
Income tax benefit and DAC |
(736 | ) | (81 | ) | (87 | ) | (318 | ) | (338 | ) | (1,560 | ) | |||||||||||||
Total net realized
losses, net of tax and
DAC |
$ | (574 | ) | $ | (138 | ) | $ | (149 | ) | $ | (589 | ) | $ | (660 | ) | $ | (2,110 | ) | |||||||
64
Table of Contents
For the three and nine months ended September 30, 2009 and 2008, the circumstances giving rise to
the Companys net realized capital losses are as follows:
Gross gains and losses on sales
|
Gross gains and losses on
sales for the three and nine months
ended September 30, 2009 were
predominantly within corporate
securities resulting primarily from
efforts to reduce portfolio risk and
within U.S. Treasuries in order to
reallocate the portfolio to
securities with more favorable
return profiles. |
|
Gross gains and losses on
sales for the three and nine months
ended September 30, 2008 were
predominantly within fixed
maturities and were primarily
comprised of corporate securities.
Gross gains and losses on sales
primarily resulted from the decision
to reallocate the portfolio to
securities with more favorable
risk/return profiles. |
||
Net OTTI losses
|
For further information,
see Other-Than-Temporary Impairments
within the Investment Credit Risk
Section of the MD&A. |
|
Variable annuity hedge program
|
For the three months
ended September 30, 2009, the
Company recorded a loss of $191 on
GMWB derivatives, net, comprised of
a loss of $103 related to the
Companys GMWB reinsurance
recoverable and a loss of $478
related to the Companys GMWB
dynamic hedging program partially
offset by a gain of $390 related to
the decrease in the liability for
GMWB. Increasing equity markets
resulted in a loss of $328 related
to the Companys macro hedge
program. |
|
For the nine months ended
September 30, 2009, the Company
recorded a gain of $1.1 billion on
GMWB derivatives, net, comprised of
a gain of $3.7 billion related to
the decrease in the liability for
GMWB, significantly offset by a loss
of $788 related to the Companys
GMWB reinsurance recoverable and a
loss of $1.9 billion related to the
Companys GMWB dynamic hedging
program. Increasing equity markets
resulted in a loss of $692 related
to the Companys macro hedge
program. For further information,
see Investments and Derivative
Instruments in Note 4 of the Notes
to Condensed Consolidated Financial
Statements. In addition, see the
Companys variable annuity hedging
program sensitivity disclosures
within Capital Markets Risk
Management section of the MD&A.
|
||
GMIB/GMAB/GMWB reinsurance |
The net loss on
derivatives associated with
GMIB/GMAB/GMWB product reinsurance
contracts, which are reinsured to a
related party, for the three months
ended September 30, 2009, was
primarily due to changes in the
credit market and liability model
assumption updates for lapses and
mortality, while the gain for the
nine months ended was primarily due
to liability model assumption
updates for credit standing, an
increase in the Japan equity
markets, an increase in interest
rates, and a decline in Japan equity
market volatility. For more
information on the liability model
assumption updates for credit
standing, refer to Note 3 of the
Notes to the Condensed Consolidated
Financial Statements. |
The net loss for the
three and nine months ended
September 30, 2008, related to
GMIB/GMAB/GMWB product reinsurance
contract derivatives, which are
reinsured to a related party, was
primarily due to a decline in the
Japan equity markets. |
||
Other, net
|
Other, net losses for the
three months ended September 30,
2009 primarily resulted from
transactional foreign currency
losses of $99, predominately on the
internal reinsurance of the Japan
variable annuity business, which is
offset in AOCI. Also included were
net additions to valuation
allowances on impaired mortgage
loans of $43. |
|
Other, net losses for the
nine months ended September 30, 2009
primarily resulted from net losses
of $212 on credit derivatives driven
by credit spread tightening and net
additions to valuation allowances on
impaired mortgage loans of $135.
These losses were partially offset
by transactional foreign currency
gains of $85, predominately on the
internal reinsurance of the Japan
variable annuity business. |
||
Other, net losses for the
three and nine months ended
September 30, 2008 were primarily
related to net losses on credit
derivatives of $93 and $271,
respectively, due to significant
credit spread widening on credit
derivatives that assume credit
exposure. Also included were
derivative related losses of $39 due
to counterparty default related to
the bankruptcy of Lehman Brothers
Holdings Inc. |
65
Table of Contents
CONSOLIDATED RESULTS OF OPERATIONS
Operating Summary
Three Months Ended | Nine Months Ended | ||||||||||||||||||
September 30, | September 30, | ||||||||||||||||||
2009 | 2008 | 2009 | 2008 | ||||||||||||||||
Fee income and other |
$ | 910 | $ | 1,082 | $ | 2,697 | $ | 3,295 | |||||||||||
Earned premiums |
51 | 277 | 387 | 733 | |||||||||||||||
Net investment income |
|||||||||||||||||||
Securities available-for-sale and other |
644 | 643 | 1,881 | 2,078 | |||||||||||||||
Equity securities, trading [3] |
299 | (118 | ) | 308 | (240 | ) | |||||||||||||
Total net investment income |
943 | 525 | 2,189 | 1,838 | |||||||||||||||
Net realized capital gains (losses): |
|||||||||||||||||||
Total other-than-temporary impairment (OTTI) losses |
(588 | ) | (1,310 | ) | (1,178 | ) | (1,624 | ) | |||||||||||
OTTI losses recognized to other comprehensive income |
173 | | 330 | | |||||||||||||||
Net OTTI losses recognized in earnings |
(415 | ) | (1,310 | ) | (848 | ) | (1,624 | ) | |||||||||||
Net realized capital gains (losses), excluding net OTTI
losses recognized in earnings |
(1,097 | ) | (650 | ) | 830 | (2,046 | ) | ||||||||||||
Total net realized capital losses |
(1,512 | ) | (1,960 | ) | (18 | ) | (3,670 | ) | |||||||||||
Total revenues [1] |
392 | (76 | ) | 5,255 | 2,196 | ||||||||||||||
Benefits, losses and loss adjustment expenses |
674 | 1,136 | 2,999 | 3,009 | |||||||||||||||
Benefits, loss and loss adjustment expenses returns
credited on International unit-linked bonds and pension
products [3] |
299 | (118 | ) | 308 | (240 | ) | |||||||||||||
Insurance operating costs and other expenses |
483 | 498 | 1,382 | 1,473 | |||||||||||||||
Amortization of deferred policy acquisition costs and
present value of future profits |
93 | 1,289 | 1,792 | 1,380 | |||||||||||||||
Total benefits, losses and expenses |
1,549 | 2,805 | 6,481 | 5,622 | |||||||||||||||
Income (loss) before income taxes |
(1,157 | ) | (2,881 | ) | (1,226 | ) | (3,426 | ) | |||||||||||
Income tax expense (benefit) |
(447 | ) | (1,049 | ) | (525 | ) | (1,346 | ) | |||||||||||
Net income (loss) [2] |
$ | (710 | ) | $ | (1,832 | ) | $ | (701 | ) | $ | (2,080 | ) | |||||||
Net (income) loss attributable to the noncontrolling interest |
(3 | ) | 10 | (9 | ) | (52 | ) | ||||||||||||
Net income (loss) attributable to shareholder |
$ | (713 | ) | $ | (1,822 | ) | $ | (710 | ) | $ | (2,028 | ) | |||||||
[1] | The transition impact related to the adoption of fair value accounting guidance was a reduction in revenues of $798 for the nine months ended September 30, 2008. | |
[2] | The transition impact related to the adoption of fair value accounting guidance was a reduction in net income of $311 for the nine months ended September 30, 2008. | |
[3] | Includes investment income and mark-to-market effects of equity securities, trading supporting the European variable annuity business, which are classified in net investment income with corresponding amounts credited to policyholders within benefits, losses and loss adjustment expenses. |
Three months ended September 30, 2009 compared to the three months ended September 30, 2008
The decrease in Lifes net loss was due to the following:
| Favorable DAC Unlock in the Retail segment compared to prior year period. See Critical Accounting Estimates of the MD&A for a further discussion on the DAC Unlock. Lower realized losses resulting from greater impaired assets in the comparable prior year period. For further discussion, please refer to the Realized Capital Gains and Losses by Segment table under the Operating Section of the MD&A. |
Nine months ended September 30, 2009 compared to the nine months ended September 30, 2008
The decrease in Lifes net loss was due to the following:
| Net realized losses decreased in the current period as compared to the prior year period primarily due to gains on the GMWB derivative and lower net OTTI losses. For further discussion, please refer to the Realized Capital Gains and Losses by Segment table under the Operating Section of the MD&A. |
Partially offsetting these results was:
| A DAC Unlock charge of $849, after-tax, during the nine months ended September 30, 2009. See Critical Accounting Estimates of the MD&A for a further discussion on the DAC Unlock. | ||
| Continued declines in assets under management in Retail effecting fee income. | ||
| Net investment income on securities, available-for-sale, and other declined primarily due to declines in limited partnership and other alternative investment and fixed maturities income. See investment results. |
66
Table of Contents
Income Taxes
The effective tax rate for the three months ended September 30, 2009 and 2008 was 39% and 37%,
respectively. The effective tax rate for the nine months ended September 30, 2009 and 2008 was 43%
and 40%, respectively. The principal cause of the difference between the effective rate and the
U.S. statutory rate of 35% was the separate account dividends received deduction (DRD). The DRD
caused an increase from the statutory rate as a result of a tax benefit on pretax losses.
The separate account DRD is estimated for the current year using information from the prior
year-end, adjusted for current year equity market performance and other appropriate factors,
including estimated levels of corporate dividend payments. The actual current year DRD can vary
from estimates based on, but not limited to, changes in eligible dividends received by the mutual
funds, amounts of distributions from these mutual funds, amounts of short-term capital gains at the
mutual fund level and the Companys taxable income before the DRD. Given recent financial markets
volatility, the Company is reviewing its DRD computations on a quarterly basis. The Company
recorded benefits related to the separate account DRD of $33 and $50 in the three months ended
September 30, 2009 and 2008, and $108 and $158 in the nine months ended September 30, 2009 and
2008, respectively. The benefit recorded in the three months ended September 30, 2009 included
prior period adjustments of $(6) related to the 2008 tax return and $1 related to the three months
ended June 30, 2009.
The Companys federal income tax returns are routinely audited by the IRS as part of the Hartfords
consolidated tax return. During the first quarter of 2009, the Company received notification of
the approval by the Joint Committee on Taxation of the results of the 2002 through 2003
examination. As a result, the Company recorded a tax benefit of $4. The 2004 through 2006
examination began during the second quarter of 2008, and is expected to close in early 2010. In
addition, the Company is working with the IRS on a possible settlement of a DRD issue related to
prior periods which, if settled, may result in the booking of tax benefits. Such benefits are not
expected to be material to the statement of operations.
The Company has determined a deferred tax asset valuation allowance that is adequate to reduce the
total deferred tax asset to an amount that will more likely than not be realized. In assessing the
need for a valuation allowance, management considered future reversals of existing taxable
temporary differences, future taxable income exclusive of reversing temporary differences and
carryforwards, and taxable income in prior carry back years, as well as tax planning strategies
that include holding debt securities with market value losses until maturity, selling appreciated
securities to offset capital losses, and sales of certain corporate assets. Such tax planning
strategies are viewed by management as prudent and feasible and will be implemented if necessary to
realize the deferred tax asset. However, future realized losses on investment securities could
result in the recognition of additional valuation allowance if additional tax planning strategies
are not available. At September 30, 2009 if the Company were to follow a separate entity
approach, it would have recorded a valuation allowance of $280 related to realized capital losses.
In addition, the current tax benefit related to any of the Companys tax attributes realized by
virtue of its inclusion in The Hartfords consolidated tax return would have recorded directly to
surplus rather than income. These benefits were $153 and $231 for the nine months ended September
30, 2009 and 2008, respectively.
67
Table of Contents
RETAIL
Operating Summary
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
September 30, | September 30, | |||||||||||||||||||||||
2009 | 2008 | Change | 2009 | 2008 | Change | |||||||||||||||||||
Fee income and other |
$ | 506 | $ | 704 | 28 | % | $ | 1,476 | $ | 2,171 | (32 | %) | ||||||||||||
Earned premiums |
2 | 11 | (82 | %) | | (2 | ) | 100 | % | |||||||||||||||
Net investment income |
199 | 187 | 6 | % | 560 | 573 | (2 | %) | ||||||||||||||||
Net realized capital losses |
(617 | ) | (482 | ) | (28 | %) | (155 | ) | (1,310 | ) | 88 | % | ||||||||||||
Total revenues [1] |
90 | 420 | (79 | %) | 1,881 | 1,432 | 31 | % | ||||||||||||||||
Benefits, losses and loss adjustment expenses |
132 | 350 | (62 | %) | 1,078 | 740 | 46 | % | ||||||||||||||||
Insurance operating costs and other expenses |
247 | 281 | (12 | %) | 690 | 887 | (22 | %) | ||||||||||||||||
Amortization of deferred policy acquisition
costs and present value of future profits |
20 | 1,121 | (98 | %) | 1,373 | 1,133 | 21 | % | ||||||||||||||||
Total benefits, losses and expenses |
399 | 1,752 | (77 | %) | 3,141 | 2,760 | 14 | % | ||||||||||||||||
Income (loss) before income taxes |
(309 | ) | (1,332 | ) | 77 | % | (1,260 | ) | (1,328 | ) | 5 | % | ||||||||||||
Income tax expense (benefit) |
(137 | ) | (507 | ) | 73 | % | (535 | ) | (596 | ) | 10 | % | ||||||||||||
Net income (loss) [2] |
$ | (172 | ) | $ | (825 | ) | 79 | % | $ | (725 | ) | $ | (732 | ) | 1 | % | ||||||||
2009 | 2008 | Change | ||||||||||||||||||||||
Assets Under Management |
||||||||||||||||||||||||
Individual variable annuity account values |
$ | 83,315 | $ | 92,250 | (10 | %) | ||||||||||||||||||
Individual fixed annuity and other account values [3] |
12,084 | 10,687 | 13 | % | ||||||||||||||||||||
Other retail products account values |
| 500 | (100 | %) | ||||||||||||||||||||
Total account values [4] |
$ | 95,399 | $ | 103,437 | (8 | %) | ||||||||||||||||||
Retail mutual fund assets under management |
40,127 | 40,903 | (2 | %) | ||||||||||||||||||||
Other mutual fund assets under management |
1,123 | 2,084 | (46 | %) | ||||||||||||||||||||
Total mutual fund assets under management |
41,250 | 42,987 | (4 | %) | ||||||||||||||||||||
Total assets under management |
136,649 | 146,424 | (7 | %) | ||||||||||||||||||||
[1] | During the nine months ended September 30, 2008, the transition impact related to the adoption of fair value accounting guidance was a reduction in revenues of $616. | |
[2] | During the nine months ended September 30, 2008, the transition impact related to the adoption of fair value accounting guidance was a reduction in net income of $209. | |
[3] | Includes policyholders balances for investment contracts and reserves for future policy benefits for insurance contracts. | |
[4] | Specialty products/ Other transferred to Other, effective January 1, 2009 on a prospective basis. |
Three and nine months ended September 30, 2009 compared to the three and nine months ended
September 30, 2008
Net loss improved for the three months ended September 30, 2009 primarily related to the third
quarter 2009 DAC Unlock benefit of $69 compared with the third quarter 2008 DAC Unlock charge of
$732, partially offset by higher realized capital losses and lower variable annuity and mutual fund
fee income. The DAC Unlock benefit was driven primarily by improvements in equity markets
throughout the second and third quarters of 2009. Net loss increased for the nine months ended
September 30, 2009 primarily due to the impacts of equity market declines on variable annuity and
mutual fund fee income and a higher 2009 individual annuity DAC amortization rate due to assumption
changes from the DAC Unlocks and lower gross profits; offset by lower net realized capital losses
due primarily to gains on GMWB derivatives and the transition impact related to the adoption of
fair value accounting guidance, which resulted in the recognition of $616 of net realized capital
losses in the nine months ended September 30, 2008.
Net realized capital losses worsened for the three months ended September 30, 2009, primarily due
to the U.S. variable annuity hedge program, partially offset by lower impairment levels. Net
realized capital losses improved for the nine months ended September 30, 2009 primarily due to
gains in the variable annuity hedge program of $421 in 2009 compared with losses of $217 in 2008;
as well as the recognition of $616 of losses associated with the transition impact related to the
adoption of fair value accounting guidance.
68
Table of Contents
For further discussion of realized capital losses, see the Realized Capital Gains and Losses by
Segment table under Lifes Operating Section of the MD&A. For further discussion of the 2009 and
2008 DAC Unlocks, see the Critical Accounting Estimates section of the MD&A. The following other
factors contributed to the changes in net loss:
Fee income and other
|
For the three and nine
months ended September 30, 2009, fee
income and other decreased primarily
as a result of lower variable
annuity and mutual fund fee income
due to a decline in average account
values. The decrease in average
variable annuity account values can
be attributed to market depreciation
of $1.8 billion and net outflows of
$7.1 billion during the last 12
months. Net outflows were driven by
decreased sales, and continued
surrender activity resulting from
the aging of the variable annuity
in-force block of business. The
decline in mutual fund assets under
management is primarily driven by
market depreciation of $1.1 billion,
partially offset by $408 of net
flows during the last 12
months. |
|
Net investment income
|
For the three months
ended September 30, 2009 net
investment income increased
primarily due to lower losses from
limited partnerships and other
alternative investments. |
|
For the nine months ended
September 30, 2009 net investment
income decreased primarily due to a
decline in income from limited
partnerships and other alternative
investments, combined with lower
yields on fixed maturities primarily
due to interest rate declines and
maintaining a greater percentage of
short-term investments in the asset
portfolio, partially offset by an
increase in general account assets.
|
||
Benefits, losses and loss adjustment
expenses
|
For the three months
ended September 30, 2009 benefits,
losses and loss adjustment expenses
decreased primarily as a result of
the impacts of the third quarter
2009 and 2008 Unlocks. The 2009
Unlock reduced death benefit
expense, while the 2008 Unlock
increased death benefit expense.
|
|
For the nine months ended
September 30, 2009, benefits, losses
and loss adjustment expenses
increased primarily as a result of
the net impact of the Unlocks over
the last twelve months, which
increased the benefit ratio used in
the calculation of GMDB reserves.
|
||
Insurance operating costs and other
expenses
|
For the three and nine
months ended September 30, 2009,
insurance operating costs and other
expenses decreased primarily as a
result of lower asset based trail
commissions due to equity market
declines as well as ongoing efforts
to actively reduce operating
expenses. |
|
Amortization of deferred policy
acquisition costs and present value
of future profits (DAC)
|
For the three months
ended September 30, 2009,
amortization of DAC decreased
primarily due to the impact of the
third quarter 2009 Unlock benefit as
compared to the third quarter of
2008 Unlock charge. |
|
For the nine months ended
September 30, 2009, amortization of
DAC increased primarily due to the
higher individual annuity DAC
amortization rate in 2009 as
compared to 2008 due primarily to
Unlock assumption changes made over
the last twelve months and lower
gross profits in 2009.
Additionally, the adoption of fair
value accounting guidance at the
beginning of the first quarter of
2008 resulted in a DAC benefit.
|
||
Income tax benefit
|
For the three and nine
months ended September 30, 2009, the
income tax benefit is primarily due
to the pre-tax losses driven by the
factors discussed previously. For
the three months ended September 30,
2009, the decline in tax benefits is
relatively consistent with the
improvement in pre-tax losses. For
the nine months ended September 30,
2009, tax benefits declined
primarily due to lower DRD benefit.
The difference from a 35% tax rate
is primarily due to the recognition
of tax benefits associated with the
DRD and foreign tax credits. |
69
Table of Contents
INDIVIDUAL LIFE
Operating Summary
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
September 30, | September 30, | |||||||||||||||||||||||
2009 | 2008 | Change | 2009 | 2008 | Change | |||||||||||||||||||
Fee income and other |
$ | 238 | $ | 208 | 14 | % | $ | 748 | $ | 641 | 17 | % | ||||||||||||
Earned premiums |
(22 | ) | (15 | ) | (47 | %) | (60 | ) | (49 | ) | (22 | %) | ||||||||||||
Net investment income |
79 | 76 | 4 | % | 227 | 241 | (6 | %) | ||||||||||||||||
Net realized capital losses |
(37 | ) | (166 | ) | 78 | % | (117 | ) | (219 | ) | 47 | % | ||||||||||||
Total revenues |
258 | 103 | 150 | % | 798 | 614 | 30 | % | ||||||||||||||||
Benefits, losses and loss adjustment expenses |
154 | 145 | 6 | % | 437 | 424 | 3 | % | ||||||||||||||||
Insurance operating costs and other expenses |
45 | 51 | (12 | %) | 139 | 150 | (7 | %) | ||||||||||||||||
Amortization of deferred policy acquisition
costs and present value of future profits |
78 | 73 | 7 | % | 257 | 140 | 84 | % | ||||||||||||||||
Total benefits, losses and expenses |
277 | 269 | 3 | % | 833 | 714 | 17 | % | ||||||||||||||||
Income (loss) before income taxes |
(19 | ) | (166 | ) | 89 | % | (35 | ) | (100 | ) | 65 | % | ||||||||||||
Income tax expense (benefit) |
(18 | ) | (61 | ) | 70 | % | (27 | ) | (42 | ) | 36 | % | ||||||||||||
Net income (loss) |
$ | (1 | ) | $ | (105 | ) | 99 | % | $ | (8 | ) | $ | (58 | ) | 86 | % | ||||||||
2009 | 2008 | Change | ||||||||||
Account Values |
||||||||||||
Variable universal life insurance |
5,552 | 5,848 | (5 | %) | ||||||||
Total account values |
$ | 10,710 | $ | 10,709 | | |||||||
70
Table of Contents
Three
and nine months ended September 30, 2009 compared to the three and nine months ended September 30, 2008:
Net income increased for the three and nine months ended September 30, 2009, driven primarily by
lower net realized capital losses and the impacts of the Unlocks. For further discussion of net
realized capital losses, see Realized Capital Gains and Losses by Segment section of the MD&A. For
further discussion on the Unlock, see the Critical Accounting Estimates section of the MD&A. The
following other factors contributed to the changes in net income:
Fee income and other
|
| Fee income and other increased for the three and nine months ended September 30, 2009 primarily due to an increase in cost of insurance charges of $9 and $33, respectively, as a result of growth in guaranteed universal life insurance in-force. Also contributing to these increases were the 2009 impact of the Unlocks, partially offset by lower variable life fees as a result of equity market declines. | ||
Earned premiums
|
| Earned premiums, which include premiums for ceded reinsurance, decreased for the three and nine months ended primarily due to increased ceded reinsurance premiums due to aging and growth in life insurance in-force. | ||
Net investment income
|
| Net investment income was higher for the three months ended September 30, 2009 primarily due to lower losses from limited partnership and other alternative investments. Net investment income was lower for the nine months ended September 30, 2009 primarily due to higher losses from limited partnership and other alternative investments, combined with lower yields on fixed maturity investments, partially offset by growth in general account values. | ||
Benefits, losses and loss adjustment
expenses
|
| Benefits, losses and loss adjustment expenses for the three and nine months ended September 30, 2009 increased slightly over the prior year periods primarily due to reserve increases on secondary guaranteed universal life products. Partially offsetting the nine month increase was lower death benefits related to favorable mortality experience. | ||
Insurance operating costs and other
expenses
|
| For the three and nine months ended September 30, 2009, insurance operating costs and other expenses decreased as a result of continued active expense management efforts. | ||
Amortization of DAC
|
| For the three and nine months ended September 30, 2009, the increase in DAC amortization was primarily attributed to additional Unlock charges in 2009 compared to 2008. DAC amortization had a partial offset in amortization of deferred revenues, included in fee income. | ||
Income tax benefit
|
| For the three and nine months ended September 30, 2009, income tax benefit decreased as a result of improved earnings before income taxes primarily due to lower net realized capital losses and the effects of the 2009 Unlocks. The effective tax rate differs from the statutory rate of 35% for the three and nine months ended September 30, 2009 and 2008 primarily due to the recognition of the dividends received deduction. |
71
Table of Contents
RETIREMENT PLANS
Operating Summary
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
September 30, | September 30, | |||||||||||||||||||||||
2009 | 2008 | Change | 2009 | 2008 | Change | |||||||||||||||||||
Fee income and other |
$ | 83 | $ | 94 | (12 | %) | $ | 234 | $ | 259 | (10 | %) | ||||||||||||
Earned premiums |
1 | 1 | | 3 | 3 | | ||||||||||||||||||
Net investment income |
80 | 87 | (8 | %) | 237 | 267 | (11 | %) | ||||||||||||||||
Net realized capital losses |
(89 | ) | (181 | ) | 51 | % | (228 | ) | (236 | ) | 3 | % | ||||||||||||
Total revenues |
75 | 1 | NM | 246 | 293 | (16 | %) | |||||||||||||||||
Benefits, losses and loss adjustment expenses |
62 | 69 | (10 | %) | 204 | 200 | 2 | % | ||||||||||||||||
Insurance operating costs and other expenses |
81 | 95 | (15 | %) | 241 | 248 | (3 | %) | ||||||||||||||||
Amortization of deferred policy acquisition
costs and present value of future profits |
(15 | ) | 94 | NM | 63 | 93 | (32 | %) | ||||||||||||||||
Total benefits, losses and expenses |
128 | 258 | (50 | %) | 508 | 541 | (6 | %) | ||||||||||||||||
Loss before income taxes |
(53 | ) | (257 | ) | 79 | % | (262 | ) | (248 | ) | (6 | %) | ||||||||||||
Income tax benefit |
(19 | ) | (97 | ) | 80 | % | (100 | ) | (114 | ) | 12 | % | ||||||||||||
Net loss |
$ | (34 | ) | $ | (160 | ) | 79 | % | $ | (162 | ) | $ | (134 | ) | (21 | %) | ||||||||
Assets Under Management |
||||||||||||||||||||||||
403(b)/457 account values |
$ | 10,760 | $ | 11,432 | (6 | %) | ||||||||||||||||||
401(k) account values |
15,339 | 13,736 | 12 | % | ||||||||||||||||||||
Total account values [1] |
26,099 | 25,168 | 4 | % | ||||||||||||||||||||
403(b)/457 mutual fund assets under management |
207 | 104 | 99 | % | ||||||||||||||||||||
401(k) mutual fund assets under management |
16,441 | 18,022 | (9 | %) | ||||||||||||||||||||
Total mutual fund assets under management |
16,648 | 18,126 | (8 | %) | ||||||||||||||||||||
Total assets under management |
$ | 42,747 | $ | 43,294 | (1 | %) | ||||||||||||||||||
Total assets under administration 401(k) |
$ | 5,867 | $ | 5,853 | | |||||||||||||||||||
[1] | Includes policyholder balances for investment contracts and reserves for future policy benefits for insurance contracts. |
Three and nine months ended September 30, 2009 compared to the three and nine months ended September 30, 2008
Net loss for the three months ended September 30, 2009 decreased primarily due to lower net
realized capital losses, along with the third quarter 2009 DAC Unlock of $0 compared to the third
quarter 2008 DAC Unlock charge of $49. Net loss in Retirement Plans increased for the nine months
ended September 30, 2009 due to lower net investment income and fee income. For further discussion
of net realized capital losses, see Realized Capital Gains and Losses by Segment table under Lifes
Operating section of the MD&A. For further discussion of the DAC Unlock, see the Critical
Accounting Estimates section of the MD&A. The following other factors contributed to the changes
in net loss:
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Table of Contents
Fee income and other
|
| For the three and nine months ended September 30, 2009, fee income and other decreased primarily due to lower average account values. | ||
Net investment income
|
| For the three months ended September 30, 2009, net investment income decreased primarily as a result of lower yields on fixed maturity investments. For the nine months ended September 30, 2009, net investment income decreased primarily as a result of lower yields on fixed maturity investments and lower limited partnership and other alternative investment returns. | ||
Insurance operating costs and other
expenses
|
| Insurance operating costs and other expenses decreased for the three and nine months ended September 30, 2009 due to expense management initiatives and higher expenses incurred in the prior year period associated with the acquired businesses. Partially offsetting this favorability for the nine months ended September 30, 2009 is that 2009 includes a full nine months of operating expenses associated with the businesses acquired in the latter part of the first quarter of 2008. | ||
Amortization of DAC
|
| Amortization of deferred policy acquisition costs and present value of future profits decreased for the three months ended September 30, 2009 as a result of a higher DAC Unlock change in the third quarter of 2008 as compared to an Unlock of $0 in the third quarter of 2009. | ||
Income tax benefit
|
| For the three months ended September 30, 2009 the income tax benefit is lower than the prior year periods income tax benefit due to a lower loss before income taxes primarily due to decreased realized capital losses and the DAC Unlock change in the third quarter of 2008. The effective tax rate differs from the statutory rate of 35% for the three and nine months ended September 30, 2009 and September 30, 2008 primarily due to the recognition of the DRD. |
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INSTITUTIONAL
Operating Summary
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
September 30, | September 30, | |||||||||||||||||||||||
2009 | 2008 | Change | 2009 | 2008 | Change | |||||||||||||||||||
Fee income and other |
$ | 29 | $ | 40 | (28 | %) | $ | 107 | $ | 120 | (11 | %) | ||||||||||||
Earned premiums |
31 | 244 | (87 | %) | 316 | 674 | (53 | %) | ||||||||||||||||
Net investment income |
212 | 236 | (10 | %) | 618 | 801 | (23 | %) | ||||||||||||||||
Net realized capital losses |
(146 | ) | (601 | ) | | (480 | ) | (907 | ) | 47 | % | |||||||||||||
Total revenues |
126 | (81 | ) | NM | 561 | 688 | (18 | %) | ||||||||||||||||
Benefits, losses and loss adjustment expenses [2] |
259 | 484 | (46 | %) | 1,028 | 1,423 | (28 | %) | ||||||||||||||||
Insurance operating costs and other expenses |
21 | 34 | (38 | %) | 68 | 93 | (27 | %) | ||||||||||||||||
Amortization
of deferred policy acquisition costs and present value of future profits |
6 | 5 | 20 | % | 13 | 16 | (19 | %) | ||||||||||||||||
Total benefits, losses and expenses |
286 | 523 | (45 | %) | 1,109 | 1,532 | (28 | %) | ||||||||||||||||
Loss before income taxes |
(160 | ) | (604 | ) | 74 | % | (548 | ) | (844 | ) | 35 | % | ||||||||||||
Income tax benefit |
(56 | ) | (213 | ) | 74 | % | (198 | ) | (301 | ) | 34 | % | ||||||||||||
Net loss |
$ | (104 | ) | $ | (391 | ) | 73 | % | $ | (350 | ) | $ | (543 | ) | 36 | % | ||||||||
2009 | 2008 | Change | ||||||||||
Assets Under Management |
||||||||||||
Institutional Investment Product account values [1] |
$ | 22,862 | $ | 24,496 | (6 | %) | ||||||
Private Placement Life Insurance account values [1] |
33,197 | 32,866 | 1 | % | ||||||||
Mutual fund assets under management |
4,453 | 3,325 | 34 | % | ||||||||
Total Assets Under Management |
$ | 60,512 | $ | 60,687 | | |||||||
[1] | Includes policyholder balances for investment contracts and reserves for future policy benefits for insurance contracts. | |
[2] | Included in Benefits, losses and loss adjustment expenses is $19 and $49 of interest credited on an intercompany funding agreement that is eliminated in consolidation for the three and nine months ended September 30, 2009, respectively. |
Three and nine months ended September 30, 2009 compared to the three and nine months ended
September 30, 2008
Net loss in Institutional decreased for the three and nine months ended September 30, 2009 as lower
net realized capital losses were partially offset by a decline in net investment spread. For
further discussion of net realized capital losses, see Realized Capital Gains and Losses by Segment
table under Lifes Operating Section of the MD&A. The following other factors contributed to
changes in net loss:
Earned premiums
|
| Earned premiums decreased for the three and nine months ended September 30, 2009 as ratings downgrades reduced payout annuity sales. The decrease in earned premiums was offset by a corresponding decrease in benefits, losses, and loss adjustment expenses. | ||
Net investment income
|
| Net investment income declined for the three and nine months ended September 30, 2009. The decline is a result of lower yields on variable rate securities due to declines in short-term interest rates, an increased allocation to lower yielding U.S. Treasuries and short-term investments, and for the nine months ended September 30, 2009, decreased returns on limited partnership and other alternative investments. The lower yield on variable rate securities was partially offset by a corresponding decrease in interest credited on liabilities reported in benefits, losses, and loss adjustment expenses. | ||
Insurance operating costs and other
expenses
|
| Insurance operating costs and other expenses decreased for the three and nine months ended September 30, 2009 due to active expense management efforts and reduced information technology expenses. |
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OTHER
Operating Summary
Three Months Ended | Nine Months Ended | |||||||||||||||||||||||
September 30, | September 30, | |||||||||||||||||||||||
2009 | 2008 | Change | 2009 | 2008 | Change | |||||||||||||||||||
Fee income and other |
$ | 54 | $ | 36 | 54 | % | $ | 132 | $ | 104 | 28 | % | ||||||||||||
Earned premiums |
39 | 36 | 8 | % | 128 | 107 | 20 | % | ||||||||||||||||
Net investment income |
||||||||||||||||||||||||
Securities available-for-sale and other |
74 | 57 | 30 | % | 239 | 196 | 22 | % | ||||||||||||||||
Equity securities, trading [3] |
299 | (118 | ) | NM | 308 | (240 | ) | NM | ||||||||||||||||
Total net investment income |
373 | (61 | ) | NM | 547 | (44 | ) | NM | ||||||||||||||||
Net realized capital gains (losses) |
(623 | ) | (530 | ) | (18 | %) | 962 | (998 | ) | NM | ||||||||||||||
Total revenues [1] |
(157 | ) | (519 | ) | 70 | % | 1,769 | (831 | ) | NM | ||||||||||||||
Benefits, losses and loss adjustment expenses |
67 | 88 | (24 | %) | 252 | 222 | 14 | % | ||||||||||||||||
Benefits, loss and loss adjustment expenses returns credited
on International unit-linked bonds and pension products [3] |
299 | (118 | ) | NM | 308 | (240 | ) | NM | ||||||||||||||||
Insurance operating costs and other expenses |
91 | 37 | 146 146 | % % |
244 | 95 | 157 | % | ||||||||||||||||
Amortization of deferred policy acquisition costs and present
value of future profits |
4 | (4 | ) | NM | 86 | (2 | ) | NM | ||||||||||||||||
Total benefits, losses and expenses |
461 | 3 | NM | 890 | 75 | NM | ||||||||||||||||||
Income (loss) before income taxes |
(618 | ) | (522 | ) | (19 | %) | 879 | (906 | ) | NM | ||||||||||||||
Income tax expense (benefit) |
(219 | ) | (171 | ) | (29 | %) | 335 | (293 | ) | NM | ||||||||||||||
Net income (loss) [2] |
(399 | ) | (351 | ) | (14 | %) | 544 | (613 | ) | NM | ||||||||||||||
Net income (loss) attributable to the noncontrolling interest |
(3 | ) | 10 | NM | (9 | ) | 52 | NM | ||||||||||||||||
Net income (loss) attributable to Hartford Life Insurance Company |
$ | (402 | ) | $ | (341 | ) | (18 | %) | $ | 535 | $ | (561 | ) | NM | ||||||||||
[1] | The transition impact related to the adoption of fair value accounting was a reduction in revenues of $172 for the nine months ended September 30, 2008. | |
[2] | The transition impact related to the adoption of fair value accounting was a reduction in net income of $102 for the nine months ended September 30, 2008. | |
[3] | Includes investment income and mark-to-market effects of equity securities, trading, supporting the European variable annuity business, which are classified in net investment income with corresponding amounts credited to policyholders within benefits, losses and loss adjustment expenses. |
The Company includes in an Other category its leveraged PPLI product line of business;
corporate items not directly allocated to any of its reporting segments; intersegment eliminations;
European insurance operations; several broker dealer entities and investment advisory and service
entities; GMIB, GMDB, GMWB and GMAB reinsurance assumed from Hartford Life Insurance KK (HLIKK),
a related party and subsidiary of Hartford Life, as well as certain group benefit products,
including group life and group disability insurance that is directly written by the Company and for
which nearly half is ceded to its parent, HLA.
Three and nine months ended September 30, 2009 compared to the three and nine months ended September 30, 2008
Realized capital gains (losses)
|
| See Realized Capital Gains and Losses by Segment table under Lifes Operating section of the MD&A. | ||
Benefits, losses and loss adjustment
expenses
|
| Benefits, losses and loss adjustment expenses increased for the three months ended September 30, 2009 due to intersegment eliminations of $19. Benefits, losses and loss adjustment expenses increased for the nine months ended September 30, 2009 as a result of the impact of the net 2009 Unlocks and was partially offset by the intersegment eliminations of $49. | ||
Insurance operating costs and
other expenses
|
| Insurance operating costs and other expenses increased for the three and nine months ended September 30, 2009 due to restructuring costs that are severance benefits and other costs associated with the suspension of sales in the Companys European operations as well as interest expense for the structured financing transaction with HLIKK that was initiated in the fourth quarter of 2008. Additionally, litigation reserves increased in the third quarter of 2009. See Note 13 for further details on the Companys restructuring, severance and other costs and restructurings within other Life segments and Note 11 for further details on the structured financing transaction with HLIKK. |
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INVESTMENT CREDIT RISK
The Company has established investment credit policies that focus on the credit quality of obligors
and counterparties, limit credit concentrations, encourage diversification and require frequent
creditworthiness reviews. Investment activity, including setting of policy and defining acceptable
risk levels, is subject to regular review and approval by senior management.
The Company invests primarily in securities which are rated investment grade and has established
exposure limits, diversification standards and review procedures for all credit risks including
borrower, issuer and counterparty. Creditworthiness of specific obligors is determined by
consideration of external determinants of creditworthiness, typically ratings assigned by
nationally recognized ratings agencies and is supplemented by an internal credit evaluation.
Obligor, asset sector and industry concentrations are subject to established Company limits and are
monitored on a regular basis.
The Company is not exposed to any credit concentration risk of a single issuer greater than 10% of
the Companys stockholders equity other than U.S. government and government agencies backed by the
full faith and credit of the U.S. government. For further discussion of concentration of credit
risk, see the Concentration of Credit Risk Section in Note 4 of Notes to the Condensed Consolidated
Financial Statements in the Companys Form 10-K Annual Report and the Current Report on Form 8-K
filed on April 30, 2009.
Derivative Instruments
In the normal course of business, the Company uses various derivative counterparties in executing
its derivative transactions. The use of counterparties creates credit risk that the counterparty
may not perform in accordance with the terms of the derivative transaction. The Company has
developed a derivative counterparty exposure policy which limits the Companys exposure to credit
risk.
The derivative counterparty exposure policy establishes market-based credit limits, favors
long-term financial stability and creditworthiness of the counterparty and typically requires
credit enhancement/credit risk reducing agreements.
The Company minimizes the credit risk of derivative instruments by entering into transactions with
high quality counterparties rated A2/A or better, which are monitored by the Companys internal
compliance unit and reviewed frequently by senior management. In addition, the internal compliance
unit monitors counterparty credit exposure on a monthly basis to ensure compliance with Company
policies and statutory limitations. The Company also maintains a policy of requiring that
derivative contracts, other than exchange traded contracts, certain currency forward contracts, and
certain embedded derivatives, be governed by an International Swaps and Derivatives Association
Master Agreement, which is structured by legal entity and by counterparty and permits right of
offset.
The Company has developed credit exposure thresholds which are based upon counterparty ratings.
Credit exposures are measured using the market value of the derivatives, resulting in amounts owed
to the Company by its counterparties or potential payment obligations from the Company to its
counterparties. Credit exposures are generally quantified daily based on the prior business days
market value and collateral is pledged to and held by, or on behalf of, the Company to the extent
the current value of derivatives exceeds the contractual thresholds. In accordance with industry
standards and the contractual agreements, collateral is typically settled on the next business day.
The Company has exposure to credit risk for amounts below the exposure thresholds which are
uncollateralized as well as for market fluctuations that may occur between contractual settlement
periods of collateral movements.
The maximum uncollateralized threshold for a derivative counterparty for a single legal entity is
$10. The Company currently transacts derivatives in two legal entities and therefore the maximum
combined threshold for a single counterparty over all legal entities that use derivatives is $20.
In addition, the Company may have exposure to multiple counterparties in a single corporate family
due to a common credit support provider. As of September 30, 2009, the maximum combined threshold
for all counterparties under a single credit support provider over all legal entities that use
derivatives is $40. Based on the contractual terms of the collateral agreements, these thresholds
may be immediately reduced due to a downgrade in a counterpartys credit rating. For further
discussion, see the Derivative Commitments Section of Note 9 of the Condensed Consolidated
Financial Statements.
For the three and nine months ended September 30, 2009, the Company has incurred no losses on
derivative instruments due to counterparty default.
In addition to counterparty credit risk, the Company enters into credit default swaps to manage
credit exposure.
Credit default swaps involve a transfer of credit risk of one or many referenced entities from one
party to another in exchange for periodic payments. The party that purchases credit protection
will make periodic payments based on an agreed upon rate and notional amount, and for certain
transactions there will also be an upfront premium payment. The second party, who sells credit
protection, will typically only make a payment if there is a credit event and such payment will be
equal to the notional value of the swap contract less the value of the referenced security issuers
debt obligation. A credit event is generally defined as default on contractually obligated
interest or principal payments or bankruptcy of the referenced entity.
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Table of Contents
The Company uses credit derivatives to purchase credit protection and, to a lesser extent, assume
credit risk with respect to a single entity, referenced index, or asset pool. The Company
purchases credit protection through credit default swaps to economically hedge and manage credit
risk of certain fixed maturity investments across multiple sectors of the investment portfolio.
The Company has also entered into credit default swaps that assume credit risk as part of
replication transactions. Replication transactions are used as an economical means to
synthetically replicate the characteristics and performance of assets that would otherwise be
permissible investments under the Companys investment policies. These swaps reference investment
grade single corporate issuers and baskets, which include trades ranging from baskets of up to five
corporate issuers to standard and customized diversified portfolios of corporate issuers. The
baskets of diversified portfolios are established within sector concentration limits and are
typically divided into tranches which possess different credit ratings ranging from AAA through the
CCC rated first loss position.
Available-for-Sale Securities
The following table presents the Companys fixed maturities by credit quality. The ratings
referenced below are based on the ratings of a nationally recognized rating organization or, if not
rated, assigned based on the Companys internal analysis of such securities.
Fixed Maturities by Credit Quality | ||||||||||||||||||||||||
September 30, 2009 | December 31, 2008 | |||||||||||||||||||||||
Percent of | Percent of | |||||||||||||||||||||||
Amortized | Total Fair | Amortized | Total Fair | |||||||||||||||||||||
Cost | Fair Value | Value | Cost | Fair Value | Value | |||||||||||||||||||
U.S. government/government agencies |
$ | 4,200 | $ | 4,159 | 10.5 | % | $ | 7,200 | $ | 7,289 | 18.4 | % | ||||||||||||
AAA |
6,766 | 5,980 | 15.2 | % | 10,316 | 7,368 | 18.6 | % | ||||||||||||||||
AA |
6,391 | 5,447 | 13.8 | % | 7,304 | 5,704 | 14.4 | % | ||||||||||||||||
A |
12,026 | 11,187 | 28.4 | % | 11,590 | 9,626 | 24.4 | % | ||||||||||||||||
BBB |
11,300 | 10,417 | 26.4 | % | 10,292 | 8,288 | 21.0 | % | ||||||||||||||||
BB & below |
3,514 | 2,246 | 5.7 | % | 1,742 | 1,285 | 3.2 | % | ||||||||||||||||
Total fixed maturities |
$ | 44,197 | $ | 39,436 | 100.0 | % | $ | 48,444 | $ | 39,560 | 100.0 | % | ||||||||||||
The movement within the Companys investment ratings was primarily attributable to rating agency
downgrades across multiple sectors and sales of U.S. Treasuries being re-deployed into corporate
securities. The ratings associated with the Companys commercial mortgage backed-securities
(CMBS) and commercial real estate (CRE) collateralized debt obligations (CDOs) may be
negatively impacted as rating agencies contemplate changes to their methodologies and/or continue
to monitor security performance in the upcoming months.
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The following table presents the Companys AFS securities by type.
Available-for-Sale Securities by Type | ||||||||||||||||||||||||||||||||||||||||
September 30, 2009 | December 31, 2008 | |||||||||||||||||||||||||||||||||||||||
Percent | Percent | |||||||||||||||||||||||||||||||||||||||
Cost or | Gross | Gross | of Total | Cost or | Gross | Gross | of Total | |||||||||||||||||||||||||||||||||
Amortized | Unrealized | Unrealized | Fair | Fair | Amortized | Unrealized | Unrealized | Fair | Fair | |||||||||||||||||||||||||||||||
Cost | Gains | Losses | Value | Value | Cost | Gains | Losses | Value | Value | |||||||||||||||||||||||||||||||
Asset-backed
securities (ABS) |
||||||||||||||||||||||||||||||||||||||||
Consumer loans |
$ | 1,652 | $ | 14 | $ | (297 | ) | $ | 1,369 | 3.5 | % | $ | 1,880 | $ | | $ | (512 | ) | $ | 1,368 | 3.4 | % | ||||||||||||||||||
Small business |
429 | 1 | (186 | ) | 244 | 0.6 | % | 428 | | (197 | ) | 231 | 0.6 | % | ||||||||||||||||||||||||||
Other |
407 | 28 | (60 | ) | 375 | 0.9 | % | 482 | 5 | (110 | ) | 377 | 1.0 | % | ||||||||||||||||||||||||||
CDOs |
||||||||||||||||||||||||||||||||||||||||
CLOs [1] |
2,033 | | (298 | ) | 1,735 | 4.4 | % | 2,107 | | (537 | ) | 1,570 | 4.0 | % | ||||||||||||||||||||||||||
CRE |
1,340 | 22 | (987 | ) | 375 | 0.9 | % | 1,566 | 2 | (1,170 | ) | 398 | 1.0 | % | ||||||||||||||||||||||||||
Other |
4 | 1 | (1 | ) | 4 | | 19 | | (6 | ) | 13 | | ||||||||||||||||||||||||||||
CMBS |
||||||||||||||||||||||||||||||||||||||||
Agency backed [2] |
183 | 10 | | 193 | 0.5 | % | 243 | 8 | | 251 | 0.6 | % | ||||||||||||||||||||||||||||
Bonds |
6,597 | 45 | (1,876 | ) | 4,766 | 12.1 | % | 7,160 | 1 | (2,719 | ) | 4,442 | 11.2 | % | ||||||||||||||||||||||||||
Interest only (IOs) |
716 | 44 | (46 | ) | 714 | 1.8 | % | 840 | 12 | (196 | ) | 656 | 1.7 | % | ||||||||||||||||||||||||||
Corporate |
||||||||||||||||||||||||||||||||||||||||
Basic industry |
1,725 | 77 | (68 | ) | 1,734 | 4.4 | % | 1,459 | 5 | (233 | ) | 1,231 | 3.1 | % | ||||||||||||||||||||||||||
Capital goods |
1,972 | 116 | (48 | ) | 2,040 | 5.2 | % | 1,656 | 26 | (201 | ) | 1,481 | 3.7 | % | ||||||||||||||||||||||||||
Consumer cyclical |
1,401 | 55 | (47 | ) | 1,409 | 3.6 | % | 1,588 | 29 | (244 | ) | 1,373 | 3.5 | % | ||||||||||||||||||||||||||
Consumer non-cyclical |
3,152 | 233 | (21 | ) | 3,364 | 8.5 | % | 2,455 | 46 | (172 | ) | 2,329 | 5.9 | % | ||||||||||||||||||||||||||
Energy |
2,072 | 144 | (14 | ) | 2,202 | 5.6 | % | 1,320 | 19 | (118 | ) | 1,221 | 3.1 | % | ||||||||||||||||||||||||||
Financial services |
5,051 | 89 | (725 | ) | 4,415 | 11.2 | % | 5,563 | 163 | (994 | ) | 4,732 | 12.0 | % | ||||||||||||||||||||||||||
Tech./comm. |
2,524 | 161 | (43 | ) | 2,642 | 6.7 | % | 2,597 | 69 | (248 | ) | 2,418 | 6.1 | % | ||||||||||||||||||||||||||
Transportation |
515 | 19 | (30 | ) | 504 | 1.3 | % | 410 | 8 | (67 | ) | 351 | 0.9 | % | ||||||||||||||||||||||||||
Utilities |
3,794 | 256 | (73 | ) | 3,977 | 10.1 | % | 3,189 | 76 | (376 | ) | 2,889 | 7.3 | % | ||||||||||||||||||||||||||
Other [3] |
1,021 | 17 | (133 | ) | 905 | 2.3 | % | 1,015 | | (305 | ) | 710 | 1.8 | % | ||||||||||||||||||||||||||
Foreign govt./govt.
agencies |
492 | 40 | (7 | ) | 525 | 1.3 | % | 2,094 | 86 | (33 | ) | 2,147 | 5.4 | % | ||||||||||||||||||||||||||
Municipal |
961 | 10 | (171 | ) | 800 | 2.0 | % | 917 | 8 | (220 | ) | 705 | 1.8 | % | ||||||||||||||||||||||||||
RMBS |
||||||||||||||||||||||||||||||||||||||||
Agency |
2,061 | 71 | (1 | ) | 2,131 | 5.4 | % | 1,924 | 53 | (8 | ) | 1,969 | 5.0 | % | ||||||||||||||||||||||||||
Non-agency |
133 | | (25 | ) | 108 | 0.3 | % | 159 | | (43 | ) | 116 | 0.3 | % | ||||||||||||||||||||||||||
Alt-A |
213 | | (73 | ) | 140 | 0.4 | % | 256 | | (90 | ) | 166 | 0.4 | % | ||||||||||||||||||||||||||
Sub-prime |
1,793 | 3 | (866 | ) | 930 | 2.4 | % | 2,084 | 4 | (741 | ) | 1,347 | 3.4 | % | ||||||||||||||||||||||||||
U.S. Treasuries |
1,956 | 23 | (144 | ) | 1,835 | 4.6 | % | 5,033 | 75 | (39 | ) | 5,069 | 12.8 | % | ||||||||||||||||||||||||||
Total fixed maturities |
44,197 | 1,479 | (6,240 | ) | 39,436 | 100.0 | % | 48,444 | 695 | (9,579 | ) | 39,560 | 100.0 | % | ||||||||||||||||||||||||||
Equity securities |
||||||||||||||||||||||||||||||||||||||||
Financial Services |
300 | 6 | (72 | ) | 234 | 334 | | (107 | ) | 227 | ||||||||||||||||||||||||||||||
Other |
164 | 22 | (11 | ) | 175 | 280 | 4 | (77 | ) | 207 | ||||||||||||||||||||||||||||||
Total equity securities |
464 | 28 | (83 | ) | 409 | 614 | 4 | (184 | ) | 434 | ||||||||||||||||||||||||||||||
Total AFS securities |
$ | 44,661 | $ | 1,507 | $ | (6,323 | ) | $ | 39,845 | $ | 49,058 | $ | 699 | $ | (9,763 | ) | $ | 39,994 | ||||||||||||||||||||||
[1] | As of September 30, 2009, 86% of these senior secured bank loan collateralized loan obligations (CLOs) were rated AA and above with an average subordination of 27%. | |
[2] | Represents securities with pools of loans by the Small Business Administration whose issued loans are backed by the full faith and credit of the U.S. government. | |
[3] | Includes structured investments with an amortized cost and fair value of $333 and $252, respectively, as of September 30, 2009 and $326 and $222, respectively, as of December 31, 2008. The underlying securities supporting these investments are primarily diversified pools of investment grade corporate issuers which can withstand a 15% cumulative default rate, assuming a 35% recovery. |
The Company continued to reallocate its AFS investment portfolio to securities with more
favorable return profiles, in particular
corporate securities within consumer non-cyclical and
other recession resistant sectors while reducing U.S. Treasuries. The Companys AFS net unrealized
loss position decreased as a result of improved security valuations due to credit spread
tightening, partially offset by $738 due to a before-tax cumulative effect of accounting change
related to impairments. For further discussion on the accounting change, see Note 1 of the Notes
to the Condensed Consolidated Financial Statements. The following sections highlight the Companys
significant investment sectors.
Financial Services
Several positive developments occurred in the financial services sectors during the three months
ended September 30, 2009. Earnings for large domestic banks surpassed expectations, and losses for
banks that underwent the Supervisory Capital Assessment Program (SCAP), or stress test, were less
than the Federal Reserves projections. In addition, unrealized losses on banks investment
portfolios decreased as credit spreads tightened and banks improved their capitalization through
common equity capital raises, exchanges and
78
Table of Contents
tenders. Banks and insurance firms were also able to access re-opened debt capital markets,
reducing their dependence on government guarantee programs and enhancing their liquidity positions.
Despite these positive developments, financial services companies continue to face a difficult
macroeconomic environment and remain vulnerable to deteriorating asset performance and quality, as
well as weak earnings prospects.
The Company has exposure to the financial services sector predominantly through banking and
insurance firms. Since December 31, 2008, the Company has reduced its exposure to this sector. A
comparison of fair value to amortized cost is not indicative of the pricing of individual
securities as impairments have occurred. The following table presents the Companys exposure to
the financial services sector included in the AFS Securities by Type table above.
Financial Services by Credit Quality [1] | ||||||||||||||||||||||||
September 30, 2009 | December 31, 2008 | |||||||||||||||||||||||
Percent of | Percent of | |||||||||||||||||||||||
Amortized | Total Fair | Amortized | Total Fair | |||||||||||||||||||||
Cost | Fair Value | Value | Cost | Fair Value | Value | |||||||||||||||||||
AAA |
$ | 162 | $ | 165 | 3.6 | % | $ | 463 | $ | 394 | 8.0 | % | ||||||||||||
AA |
1,306 | 1,245 | 26.8 | % | 1,422 | 1,240 | 25.0 | % | ||||||||||||||||
A |
2,614 | 2,238 | 48.1 | % | 3,386 | 2,834 | 57.1 | % | ||||||||||||||||
BBB |
779 | 633 | 13.6 | % | 537 | 411 | 8.3 | % | ||||||||||||||||
BB & below |
490 | 368 | 7.9 | % | 89 | 80 | 1.6 | % | ||||||||||||||||
Total |
$ | 5,351 | $ | 4,649 | 100.0 | % | $ | 5,897 | $ | 4,959 | 100.0 | % | ||||||||||||
[1] | The credit qualities above include downgrades that have shifted the portfolio from higher rated assets to lower rated assets since December 31, 2008. |
Sub-Prime Residential Mortgage Loans
The following table presents the Companys exposure to residential mortgage-backed securities
(RMBS) supported by sub-prime mortgage loans by current credit quality and vintage year included
in the AFS Securities by Type table above. These securities have been affected by deterioration in
collateral performance caused by declining home prices and continued macroeconomic pressures. A
comparison of fair value to amortized cost is not indicative of the pricing of individual
securities as impairments have occurred. Credit protection represents the current weighted average
percentage, excluding wrapped securities, of the outstanding capital structure subordinated to the
Companys investment holding that is available to absorb losses before the security incurs the
first dollar loss of principal.
Sub-Prime Residential Mortgage Loans [1] [2] [3] [4] [5]
September 30, 2009 | ||||||||||||||||||||||||||||||||||||||||||||||||
AAA | AA | A | BBB | BB and Below | Total | |||||||||||||||||||||||||||||||||||||||||||
Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | |||||||||||||||||||||||||||||||||||||
Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | |||||||||||||||||||||||||||||||||||||
2003 & Prior |
$ | 20 | $ | 14 | $ | 59 | $ | 45 | $ | 74 | $ | 48 | $ | 10 | $ | 6 | $ | 58 | $ | 33 | $ | 221 | $ | 146 | ||||||||||||||||||||||||
2004 |
82 | 66 | 246 | 160 | 63 | 39 | 4 | 2 | 3 | 2 | 398 | 269 | ||||||||||||||||||||||||||||||||||||
2005 |
58 | 24 | 270 | 173 | 135 | 75 | 83 | 23 | 165 | 35 | 711 | 330 | ||||||||||||||||||||||||||||||||||||
2006 |
8 | 7 | 11 | 8 | 11 | 7 | 27 | 8 | 224 | 76 | 281 | 106 | ||||||||||||||||||||||||||||||||||||
2007 |
| | | | | | 7 | 1 | 175 | 78 | 182 | 79 | ||||||||||||||||||||||||||||||||||||
Total |
$ | 168 | $ | 111 | $ | 586 | $ | 386 | $ | 283 | $ | 169 | $ | 131 | $ | 40 | $ | 625 | $ | 224 | $ | 1,793 | $ | 930 | ||||||||||||||||||||||||
Credit protection |
43.7% | 53.1% | 40.6% | 36.9% | 25.8% | 40.7% | ||||||||||||||||||||||||||||||||||||||||||
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December 31, 2008 | ||||||||||||||||||||||||||||||||||||||||||||||||
AAA | AA | A | BBB | BB and Below | Total | |||||||||||||||||||||||||||||||||||||||||||
Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | |||||||||||||||||||||||||||||||||||||
Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | |||||||||||||||||||||||||||||||||||||
2003 & Prior |
$ | 26 | $ | 22 | $ | 129 | $ | 109 | $ | 48 | $ | 35 | $ | 17 | $ | 13 | $ | 34 | $ | 19 | $ | 254 | $ | 198 | ||||||||||||||||||||||||
2004 |
108 | 79 | 303 | 240 | | | 8 | 7 | | | 419 | 326 | ||||||||||||||||||||||||||||||||||||
2005 |
73 | 56 | 525 | 353 | 138 | 70 | 24 | 16 | 22 | 18 | 782 | 513 | ||||||||||||||||||||||||||||||||||||
2006 |
45 | 41 | 109 | 50 | 10 | 5 | 87 | 35 | 96 | 36 | 347 | 167 | ||||||||||||||||||||||||||||||||||||
2007 |
42 | 27 | 40 | 9 | 33 | 15 | 35 | 19 | 132 | 73 | 282 | 143 | ||||||||||||||||||||||||||||||||||||
Total |
$ | 294 | $ | 225 | $ | 1,106 | $ | 761 | $ | 229 | $ | 125 | $ | 171 | $ | 90 | $ | 284 | $ | 146 | $ | 2,084 | $ | 1,347 | ||||||||||||||||||||||||
Credit protection |
39.3% | 48.3% | 32.1% | 23.5% | 20.1% | 41.4% | ||||||||||||||||||||||||||||||||||||||||||
[1] | The vintage year represents the year the underlying loans in the pool were originated. | |
[2] | Includes second lien residential mortgages with an amortized cost and fair value of $75 and $34, respectively, as of September 30, 2009 and $120 and $60, respectively, as of December 31, 2008, which are composed primarily of loans to prime and Alt-A borrowers. | |
[3] | As of September 30, 2009, the weighted average life of the sub-prime residential mortgage portfolio was 4.8 years. | |
[4] | Approximately 91% of the portfolio is backed by adjustable rate mortgages. | |
[5] | The credit qualities above include downgrades that have shifted the portfolio from higher rated assets to lower rated assets since December 31, 2008. |
Commercial Mortgage Loans
The Company has observed and expects continued pressure on commercial real estate market
fundamentals including increased vacancies, rising delinquencies, lower rent growth and declining
property values. The following tables present the Companys exposure to CMBS bonds, CRE CDOs and
CMBS IOs by current credit quality and vintage year, included in the AFS Securities by Type table
above. A comparison of fair value to amortized cost is not indicative of the pricing of individual
securities as impairments have occurred. Credit protection represents the current weighted average
percentage of the outstanding capital structure subordinated to the Companys investment holding
that is available to absorb losses before the security incurs the first dollar loss of principal.
This credit protection does not include any equity interest or property value in excess of
outstanding debt. The ratings associated with the Companys CMBS and CRE CDOs may be negatively
impacted as rating agencies contemplate changes to their methodologies and/or continue to monitor
security performance in the upcoming months.
CMBS Bonds [1] [2]
September 30, 2009 | ||||||||||||||||||||||||||||||||||||||||||||||||
AAA | AA | A | BBB | BB and Below | Total | |||||||||||||||||||||||||||||||||||||||||||
Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | |||||||||||||||||||||||||||||||||||||
Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | |||||||||||||||||||||||||||||||||||||
2003 & Prior |
$ | 1,196 | $ | 1,199 | $ | 251 | $ | 202 | $ | 69 | $ | 50 | $ | 10 | $ | 9 | $ | 23 | $ | 17 | $ | 1,549 | $ | 1,477 | ||||||||||||||||||||||||
2004 |
347 | 343 | 49 | 32 | 40 | 23 | 30 | 14 | | | 466 | 412 | ||||||||||||||||||||||||||||||||||||
2005 |
569 | 519 | 197 | 117 | 108 | 53 | 86 | 49 | 109 | 59 | 1,069 | 797 | ||||||||||||||||||||||||||||||||||||
2006 |
1,213 | 991 | 152 | 81 | 346 | 159 | 537 | 273 | 313 | 107 | 2,561 | 1,611 | ||||||||||||||||||||||||||||||||||||
2007 |
376 | 264 | 30 | 10 | 40 | 14 | 284 | 117 | 222 | 64 | 952 | 469 | ||||||||||||||||||||||||||||||||||||
Total |
$ | 3,701 | $ | 3,316 | $ | 679 | $ | 442 | $ | 603 | $ | 299 | $ | 947 | $ | 462 | $ | 667 | $ | 247 | $ | 6,597 | $ | 4,766 | ||||||||||||||||||||||||
Credit protection |
26.9% | 22.3% | 15.4% | 14.9% | 6.9% | 21.5% | ||||||||||||||||||||||||||||||||||||||||||
December 31, 2008 | ||||||||||||||||||||||||||||||||||||||||||||||||
AAA | AA | A | BBB | BB and Below | Total | |||||||||||||||||||||||||||||||||||||||||||
Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | |||||||||||||||||||||||||||||||||||||
Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | |||||||||||||||||||||||||||||||||||||
2003 & Prior |
$ | 1,492 | $ | 1,365 | $ | 259 | $ | 179 | $ | 71 | $ | 40 | $ | 11 | $ | 8 | $ | 23 | $ | 16 | $ | 1,856 | $ | 1,608 | ||||||||||||||||||||||||
2004 |
365 | 317 | 53 | 22 | 41 | 15 | 20 | 8 | | | 479 | 362 | ||||||||||||||||||||||||||||||||||||
2005 |
561 | 428 | 243 | 93 | 235 | 109 | 48 | 23 | | | 1,087 | 653 | ||||||||||||||||||||||||||||||||||||
2006 |
1,732 | 1,025 | 228 | 76 | 353 | 140 | 354 | 129 | 39 | 12 | 2,706 | 1,382 | ||||||||||||||||||||||||||||||||||||
2007 |
528 | 256 | 263 | 90 | 102 | 31 | 134 | 59 | 5 | 1 | 1,032 | 437 | ||||||||||||||||||||||||||||||||||||
Total |
$ | 4,678 | $ | 3,391 | $ | 1,046 | $ | 460 | $ | 802 | $ | 335 | $ | 567 | $ | 227 | $ | 67 | $ | 29 | $ | 7,160 | $ | 4,442 | ||||||||||||||||||||||||
Credit protection |
24.7% | 18.6% | 12.6% | 4.9% | 4.3% | 20.6% | ||||||||||||||||||||||||||||||||||||||||||
[1] | The vintage year represents the year the pool of loans was originated. | |
[2] | The credit qualities above include downgrades that have shifted the portfolio from higher rated assets to lower rated assets since December 31, 2008. |
80
Table of Contents
CMBS CRE CDOs [1] [2] [3] [4]
September 30, 2009 | ||||||||||||||||||||||||||||||||||||||||||||||||
AAA | AA | A | BBB | BB and Below | Total | |||||||||||||||||||||||||||||||||||||||||||
Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | |||||||||||||||||||||||||||||||||||||
Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | |||||||||||||||||||||||||||||||||||||
2003 & Prior |
$ | 38 | $ | 11 | $ | 31 | $ | 12 | $ | 69 | $ | 11 | $ | 152 | $ | 38 | $ | 59 | $ | 34 | $ | 349 | $ | 106 | ||||||||||||||||||||||||
2004 |
18 | 12 | 70 | 4 | 38 | 4 | 28 | 8 | 25 | 19 | 179 | 47 | ||||||||||||||||||||||||||||||||||||
2005 |
17 | 3 | 73 | 2 | 30 | 7 | 47 | 7 | 16 | 17 | 183 | 36 | ||||||||||||||||||||||||||||||||||||
2006 |
49 | 12 | 127 | 5 | 65 | 21 | 55 | 12 | 16 | 43 | 312 | 93 | ||||||||||||||||||||||||||||||||||||
2007 |
55 | 7 | 28 | 7 | 64 | 24 | 36 | 11 | 41 | 18 | 224 | 67 | ||||||||||||||||||||||||||||||||||||
2008 |
17 | 2 | 6 | | 18 | 5 | 6 | 3 | 17 | 9 | 64 | 19 | ||||||||||||||||||||||||||||||||||||
2009 |
9 | 2 | 2 | | 7 | 3 | 2 | 1 | 9 | 1 | 29 | 7 | ||||||||||||||||||||||||||||||||||||
Total |
$ | 203 | $ | 49 | $ | 337 | $ | 30 | $ | 291 | $ | 75 | $ | 326 | $ | 80 | $ | 183 | $ | 141 | $ | 1,340 | $ | 375 | ||||||||||||||||||||||||
Credit protection |
34.9% | 10.7% | 23.6% | 31.3% | 29.4% | 24.7% | ||||||||||||||||||||||||||||||||||||||||||
December 31, 2008 | ||||||||||||||||||||||||||||||||||||||||||||||||
AAA | AA | A | BBB | BB and Below | Total | |||||||||||||||||||||||||||||||||||||||||||
Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | |||||||||||||||||||||||||||||||||||||
Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | |||||||||||||||||||||||||||||||||||||
2003 & Prior |
$ | 127 | $ | 43 | $ | 90 | $ | 28 | $ | 59 | $ | 14 | $ | 48 | $ | 6 | $ | 30 | $ | 5 | $ | 354 | $ | 96 | ||||||||||||||||||||||||
2004 |
118 | 35 | 16 | 5 | 31 | 9 | 12 | 2 | 13 | 2 | 190 | 53 | ||||||||||||||||||||||||||||||||||||
2005 |
71 | 29 | 58 | 12 | 56 | 10 | 10 | 2 | 1 | | 196 | 53 | ||||||||||||||||||||||||||||||||||||
2006 |
222 | 68 | 83 | 18 | 74 | 19 | 15 | 2 | | | 394 | 107 | ||||||||||||||||||||||||||||||||||||
2007 |
126 | 40 | 106 | 19 | 101 | 10 | 11 | 1 | | | 344 | 70 | ||||||||||||||||||||||||||||||||||||
2008 |
39 | 11 | 22 | 5 | 24 | 3 | 3 | | | | 88 | 19 | ||||||||||||||||||||||||||||||||||||
Total |
$ | 703 | $ | 226 | $ | 375 | $ | 87 | $ | 345 | $ | 65 | $ | 99 | $ | 13 | $ | 44 | $ | 7 | $ | 1,566 | $ | 398 | ||||||||||||||||||||||||
Credit protection |
27.1% | 21.3% | 17.9% | 17.0% | 57.5% | 23.9% | ||||||||||||||||||||||||||||||||||||||||||
[1] | The vintage year represents the year that the underlying collateral in the pool was originated. Individual CDO market value is allocated by the proportion of collateral within each vintage year. | |
[2] | As of September 30, 2009, approximately 32% of the underlying CRE CDOs collateral are seasoned, below investment grade securities. | |
[3] | For certain CRE CDOs, the collateral manager has the ability to reinvest proceeds that become available, primarily from collateral maturities. The increase in the 2008 and 2009 vintage years represents reinvestment under these CRE CDOs. | |
[4] | The credit qualities above include downgrades that have shifted the portfolio from higher rated assets to lower rated assets since December 31, 2008. |
CMBS IOs [1] [2]
September 30, 2009 | December 31, 2008 | |||||||||||||||||||||||||||||||||||||||
AAA | A | BBB | Total | AAA | ||||||||||||||||||||||||||||||||||||
Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | |||||||||||||||||||||||||||||||
Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | |||||||||||||||||||||||||||||||
2003 & Prior |
$ | 243 | $ | 264 | $ | | $ | | $ | | $ | | $ | 243 | $ | 264 | $ | 295 | $ | 287 | ||||||||||||||||||||
2004 |
132 | 138 | | | | | 132 | 138 | 158 | 119 | ||||||||||||||||||||||||||||||
2005 |
169 | 164 | | | 1 | 1 | 170 | 165 | 200 | 136 | ||||||||||||||||||||||||||||||
2006 |
83 | 65 | 2 | 3 | | | 85 | 68 | 93 | 54 | ||||||||||||||||||||||||||||||
2007 |
86 | 79 | | | | | 86 | 79 | 94 | 60 | ||||||||||||||||||||||||||||||
Total |
$ | 713 | $ | 710 | $ | 2 | $ | 3 | $ | 1 | $ | 1 | $ | 716 | $ | 714 | $ | 840 | $ | 656 | ||||||||||||||||||||
[1] | The vintage year represents the year the pool of loans was originated | |
[2] | The credit qualities above include downgrades that have shifted the portfolio from higher rated assets to lower rated assets since December 31, 2008. |
In addition to commercial mortgage-backed securities, the Company has commercial mortgage
loans with a carrying value of $4.2 billion and $4.5 billion as of September 30, 2009 and December
31, 2008, respectively. These loans are collateralized by a variety of commercial properties and
are diversified both geographically throughout the United States and by property type. These loans
may be either in the form of a whole loan, where the Company is the sole lender, or a loan
participation. Loan participations are loans where the Company has purchased or retained a portion
of an outstanding loan or package of loans and participates on a pro-rata basis in collecting
interest and principal pursuant to the terms of the participation agreement. In general, A-Note
participations have senior payment priority, followed by B-Note participations and then mezzanine
loan participations. As of September 30, 2009, loans within the Companys mortgage loan portfolio
have had minimal extension or restructurings.
81
Table of Contents
The following table presents the Companys amortized cost and valuation allowances for commercial
mortgage loans by type and loan structure.
Commercial Mortgage Loans | ||||||||||||||||||||||||
September 30, 2009 | December 31, 2008 | |||||||||||||||||||||||
Amortized | Valuation | Carrying | Amortized | Valuation | Carrying | |||||||||||||||||||
Cost [1] | Allowance | Value | Cost [1] | Allowance | Value | |||||||||||||||||||
Whole loans |
$ | 2,611 | $ | (20 | ) | $ | 2,591 | $ | 2,707 | $ | (2 | ) | $ | 2,705 | ||||||||||
A-Note participations |
326 | | 326 | 335 | | 335 | ||||||||||||||||||
B-Note participations |
525 | (37 | ) | 488 | 562 | | 562 | |||||||||||||||||
Mezzanine loans |
857 | (58 | ) | 799 | 859 | | 859 | |||||||||||||||||
Total [2] |
$ | 4,319 | $ | (115 | ) | $ | 4,204 | $ | 4,463 | $ | (2 | ) | $ | 4,461 | ||||||||||
[1] | Amortized cost represents carrying value prior to valuation allowances, if any. | |
[2] | Excludes agricultural mortgage loans. For further information on the total mortgage loan portfolio, see Note 4 of Notes to the Condensed Consolidated Financial Statements. |
At origination, the weighted average loan-to-value (LTV) rate of the Companys commercial
mortgage loan portfolio was approximately 55%. As of September 30, 2009, the current weighted
average LTV was approximately 70%. LTV rates compare the loan amount to the value of the
underlying property collateralizing the loan. The loan values are updated periodically through
property level reviews of the mortgage loan portfolio. Factors considered in the property
valuation include, but are not limited to, actual and expected property cash flows, geographic
market data and capitalization rates.
ABS Consumer Loans
The following table presents the Companys exposure to ABS consumer loans by credit quality,
included in the AFS Securities by Type table above. Currently, the Company expects its ABS
consumer loan holdings will continue to pay contractual principal and interest payments due to the
ultimate expected borrower repayment performance and structural credit enhancements, which remain
sufficient to absorb a significantly higher level of defaults than are currently anticipated.
ABS Consumer Loans
September 30, 2009 | ||||||||||||||||||||||||||||||||||||||||||||||||
AAA | AA | A | BBB | BB and Below | Total | |||||||||||||||||||||||||||||||||||||||||||
Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | |||||||||||||||||||||||||||||||||||||
Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | |||||||||||||||||||||||||||||||||||||
Auto [1] |
$ | 46 | $ | 46 | $ | 89 | $ | 86 | $ | 106 | $ | 104 | $ | 100 | $ | 95 | $ | 11 | $ | 8 | $ | 352 | $ | 339 | ||||||||||||||||||||||||
Credit card |
319 | 331 | | | 36 | 35 | 195 | 181 | 58 | 52 | 608 | 599 | ||||||||||||||||||||||||||||||||||||
Student loan [2] |
271 | 164 | 302 | 210 | 119 | 57 | | | | | 692 | 431 | ||||||||||||||||||||||||||||||||||||
Total [3] |
$ | 636 | $ | 541 | $ | 391 | $ | 296 | $ | 261 | $ | 196 | $ | 295 | $ | 276 | $ | 69 | $ | 60 | $ | 1,652 | $ | 1,369 | ||||||||||||||||||||||||
December 31, 2008 | ||||||||||||||||||||||||||||||||||||||||||||||||
AAA | AA | A | BBB | BB and Below | Total | |||||||||||||||||||||||||||||||||||||||||||
Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | |||||||||||||||||||||||||||||||||||||
Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | |||||||||||||||||||||||||||||||||||||
Auto |
$ | 108 | $ | 84 | $ | 7 | $ | 6 | $ | 142 | $ | 103 | $ | 160 | $ | 123 | $ | 15 | $ | 10 | $ | 432 | $ | 326 | ||||||||||||||||||||||||
Credit card |
313 | 273 | 6 | 4 | 97 | 86 | 278 | 197 | 57 | 39 | 751 | 599 | ||||||||||||||||||||||||||||||||||||
Student loan |
272 | 143 | 306 | 229 | 119 | 71 | | | | | 697 | 443 | ||||||||||||||||||||||||||||||||||||
Total |
$ | 693 | $ | 500 | $ | 319 | $ | 239 | $ | 358 | $ | 260 | $ | 438 | $ | 320 | $ | 72 | $ | 49 | $ | 1,880 | $ | 1,368 | ||||||||||||||||||||||||
[1] | As of September 30, 2009, approximately 9% of the auto consumer loan-backed securities were issued by lenders whose primary business is to sub-prime borrowers. | |
[2] | As of September 30, 2009, approximately half of the student loan-backed exposure is guaranteed by the Federal Family Education Loan Program, with the remainder comprised of loans to prime borrowers. | |
[3] | The credit qualities above include downgrades that have shifted the portfolio from higher rated assets to lower rated assets since December 31, 2008. |
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Table of Contents
Limited Partnerships and Other Alternative Investments
The Company has investments in limited partnerships and other alternative investments which include
hedge funds, mortgage and real estate funds, mezzanine debt funds, and private equity and other
funds. Hedge funds include investments in funds of funds and direct funds. Mortgage and real
estate funds consist of investments in funds whose assets consist of mortgage loans, mortgage loan
participations, mezzanine loans or other notes which may be below investment grade quality, as well
as equity real estate and real estate joint ventures. Mezzanine debt funds include investments in
funds whose assets consist of subordinated debt that often incorporates equity-based options such
as warrants and a limited amount of direct equity investments. Private equity and other funds
primarily consist of investments in funds whose assets typically consist of a diversified pool of
investments in small non-public businesses with high growth potential.
The following table summarizes the Companys limited partnerships and other alternative investments
by type.
Limited Partnerships and Other Alternative Investments | ||||||||||||||||
September 30, 2009 | December 31, 2008 | |||||||||||||||
Amount | Percent | Amount | Percent | |||||||||||||
Hedge funds |
$ | 116 | 15.0 | % | $ | 263 | 25.5 | % | ||||||||
Mortgage and real estate funds |
142 | 18.3 | % | 228 | 22.1 | % | ||||||||||
Mezzanine debt funds |
66 | 8.5 | % | 78 | 7.5 | % | ||||||||||
Private equity and other funds |
452 | 58.2 | % | 464 | 44.9 | % | ||||||||||
Total |
$ | 776 | 100.0 | % | $ | 1,033 | 100.0 | % | ||||||||
Limited partnerships and other alternative investments decreased primarily due to hedge fund
redemptions and negative re-valuations of the underlying investments associated primarily with the
real estate and private equity markets. The Company expects further hedge fund redemptions and
does not expect significant additions to limited partnerships and other alternative investments in
2009 except for the funding of existing commitments.
Other-Than-Temporary Impairments
The following table presents the Companys impairments recognized in earnings.
Three Months Ended | Nine Months Ended | |||||||||||||||
September 30, | September 30, | |||||||||||||||
2009 | 2008 | 2009 | 2008 | |||||||||||||
ABS |
$ | 41 | $ | 11 | $ | 47 | $ | 11 | ||||||||
CDOs |
||||||||||||||||
CREs |
153 | 95 | 242 | 209 | ||||||||||||
Other |
21 | | 23 | | ||||||||||||
CMBS |
||||||||||||||||
Bonds |
69 | 26 | 118 | 33 | ||||||||||||
IOs |
| 34 | 17 | 34 | ||||||||||||
Corporate |
||||||||||||||||
Financial services |
23 | 714 | 113 | 766 | ||||||||||||
Other |
20 | 177 | 35 | 215 | ||||||||||||
Equities |
||||||||||||||||
Financial services |
23 | 120 | 53 | 128 | ||||||||||||
Other |
1 | 1 | 47 | 15 | ||||||||||||
Foreign govt./govt. agencies |
| 1 | | 3 | ||||||||||||
Municipal |
| | | 1 | ||||||||||||
RMBS |
||||||||||||||||
Non-agency |
2 | 13 | 3 | 13 | ||||||||||||
Alt-A |
28 | 16 | 29 | 16 | ||||||||||||
Sub-prime |
34 | 102 | 119 | 180 | ||||||||||||
U. S. Treasuries |
| | 2 | | ||||||||||||
Impairments recognized in earnings |
$ | 415 | $ | 1,310 | $ | 848 | $ | 1,624 | ||||||||
Three months ended September 30, 2009
Impairments recognized in earnings were comprised of credit impairments of $378, impairments on
debt securities for which the Company intends to sell of $13 and impairments on equity securities
of $24.
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Credit impairments were primarily concentrated on structured securities, mainly CRE CDOs, CMBS
bonds and below-prime RMBS. These securities were impaired primarily due to increased severity in
macroeconomic assumptions and continued deterioration of the underlying collateral. The Company
determined these impairments using discounted cash flow models that considered losses under current
and expected future economic conditions. Assumptions used over the current recessionary period
included macroeconomic factors, such as a continued increase in the unemployment rate and continued
gross domestic product contraction, as well as sector specific factors including, but not limited
to:
| Commercial property value declines that averaged 40% to 45% from the valuation peak but differed by property type and location. | |
| Average cumulative CMBS collateral loss rates that varied by vintage year but reached approximately 11% for the 2006 and 2007 vintage years. | |
| Residential property value declines that averaged approximately 40% from the valuation peak but differed by location. | |
| Average cumulative RMBS collateral loss rates that varied by vintage year but reached approximately 40% for the 2007 vintage year. |
Impairments on securities for which the Company had the intent to sell were primarily on corporate
financial services securities where the Company has an active plan to dispose of the securities.
Impairments on equity securities were primarily on below investment grade hybrid securities.
Nine months ended September 30, 2009
Impairments recognized in earnings were comprised of credit impairments of $657, including $73 of
impairments taken prior to the accounting change related to impairments, impairments on securities
for which the Company intends to sell of $91 primarily related to corporate financial services
securities and impairments on equity securities of $100 primarily related to common stock and below
investment grade hybrid securities.
Future impairments may develop as the result of changes in intent to sell or if actual results
underperform current modeling assumptions, which may be the result of, but are not limited to,
macroeconomic factors, changes in assumptions used, property value declines beyond current average
assumptions or security loss rates exceeding average assumptions.
Three and nine months ended September 30, 2008
Impairments were primarily concentrated in subordinated fixed maturities and preferred equities
within the financial services sector, as well as on structured securities. The remaining
impairments were comprised of securities in various sectors that experienced significant credit
spread widening and for which the Company was uncertain of its intent to retain the investments for
a period of time sufficient to allow for recovery.
Security Unrealized Loss Aging
As part of the Companys ongoing security monitoring process, the Company has reviewed its AFS
securities in an unrealized loss position and concluded that there were no additional impairments
as of September 30, 2009 and December 31, 2008. During this analysis, the Company determined that
it neither has an intention to sell nor does it expect to be required to sell the securities
outlined below. For further discussion, see the Recognition and Presentation of
Other-Than-Temporary Impairments Section in Note 1 of the Notes to the Condensed Consolidated
Financial Statements.
The following table presents the Companys unrealized loss aging for AFS securities by length of
time the security was in a continuous unrealized loss position.
Consolidated Securities | ||||||||||||||||||||||||||||||||
September 30, 2009 | December 31, 2008 | |||||||||||||||||||||||||||||||
Cost or | Cost or | |||||||||||||||||||||||||||||||
Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | |||||||||||||||||||||||||||
Items | Cost | Value | Loss | Items | Cost | Value | Loss | |||||||||||||||||||||||||
Three months or less |
222 | $ | 740 | $ | 708 | $ | (32 | ) | 1,039 | $ | 11,458 | $ | 10,538 | $ | (920 | ) | ||||||||||||||||
Greater than three to six months |
245 | 1,483 | 1,256 | (227 | ) | 596 | 3,599 | 2,817 | (782 | ) | ||||||||||||||||||||||
Greater than six to nine months |
81 | 1,960 | 1,496 | (464 | ) | 535 | 4,554 | 3,735 | (819 | ) | ||||||||||||||||||||||
Greater than nine to twelve months |
145 | 1,996 | 1,604 | (392 | ) | 360 | 3,107 | 2,183 | (924 | ) | ||||||||||||||||||||||
Greater than twelve months |
1,633 | 16,714 | 11,506 | (5,208 | ) | 1,626 | 16,303 | 9,985 | (6,318 | ) | ||||||||||||||||||||||
Total |
2,326 | $ | 22,893 | $ | 16,570 | $ | (6,323 | ) | 4,156 | $ | 39,021 | $ | 29,258 | $ | (9,763 | ) | ||||||||||||||||
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The following tables present the Companys unrealized loss aging for AFS securities by length of
time the security was in a continuous greater than 20% unrealized loss position.
Securitized Assets Depressed over 20% | ||||||||||||||||||||||||||||||||
September 30, 2009 | December 31, 2008 | |||||||||||||||||||||||||||||||
Cost or | Cost or | |||||||||||||||||||||||||||||||
Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | |||||||||||||||||||||||||||
Consecutive Months | Items | Cost | Value | Loss | Items | Cost | Value | Loss | ||||||||||||||||||||||||
Three months or less |
17 | $ | 62 | $ | 41 | $ | (21 | ) | 652 | $ | 7,786 | $ | 4,561 | $ | (3,225 | ) | ||||||||||||||||
Greater than three to six months |
97 | 399 | 255 | (144 | ) | 119 | 1,122 | 444 | (678 | ) | ||||||||||||||||||||||
Greater than six to nine months |
61 | 1,409 | 925 | (484 | ) | 89 | 1,145 | 458 | (687 | ) | ||||||||||||||||||||||
Greater than nine to twelve months |
189 | 1,804 | 1,045 | (759 | ) | 143 | 1,363 | 391 | (972 | ) | ||||||||||||||||||||||
Greater than twelve months |
402 | 4,413 | 1,633 | (2,780 | ) | 31 | 311 | 57 | (254 | ) | ||||||||||||||||||||||
Total |
766 | $ | 8,087 | $ | 3,899 | $ | (4,188 | ) | 1,034 | $ | 11,727 | $ | 5,911 | $ | (5,816 | ) | ||||||||||||||||
All Other Securities Depressed over 20% | ||||||||||||||||||||||||||||||||
September 30, 2009 | December 31, 2008 | |||||||||||||||||||||||||||||||
Cost or | Cost or | |||||||||||||||||||||||||||||||
Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | |||||||||||||||||||||||||||
Consecutive Months | Items | Cost | Value | Loss | Items | Cost | Value | Loss | ||||||||||||||||||||||||
Three months or less |
16 | $ | 201 | $ | 151 | $ | (50 | ) | 564 | $ | 6,359 | $ | 4,188 | $ | (2,171 | ) | ||||||||||||||||
Greater than three to six months |
53 | 1,198 | 870 | (328 | ) | 28 | 238 | 124 | (114 | ) | ||||||||||||||||||||||
Greater than six to nine months |
24 | 350 | 219 | (131 | ) | 14 | 173 | 102 | (71 | ) | ||||||||||||||||||||||
Greater than nine to twelve months |
78 | 1,048 | 723 | (325 | ) | 11 | 199 | 112 | (87 | ) | ||||||||||||||||||||||
Greater than twelve months |
60 | 1,025 | 680 | (345 | ) | | | | | |||||||||||||||||||||||
Total |
231 | $ | 3,822 | $ | 2,643 | $ | (1,179 | ) | 617 | $ | 6,969 | $ | 4,526 | $ | (2,443 | ) | ||||||||||||||||
Consolidated Securities Depressed over 20% | ||||||||||||||||||||||||||||||||
September 30, 2009 | December 31, 2008 | |||||||||||||||||||||||||||||||
Cost or | Cost or | |||||||||||||||||||||||||||||||
Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | |||||||||||||||||||||||||||
Consecutive Months | Items | Cost | Value | Loss | Items | Cost | Value | Loss | ||||||||||||||||||||||||
Three months or less |
33 | $ | 263 | $ | 192 | $ | (71 | ) | 1,216 | $ | 14,145 | $ | 8,749 | $ | (5,396 | ) | ||||||||||||||||
Greater than three to six months |
150 | 1,597 | 1,125 | (472 | ) | 147 | 1,360 | 568 | (792 | ) | ||||||||||||||||||||||
Greater than six to nine months |
85 | 1,759 | 1,144 | (615 | ) | 103 | 1,318 | 560 | (758 | ) | ||||||||||||||||||||||
Greater than nine to twelve months |
267 | 2,852 | 1,768 | (1,084 | ) | 154 | 1,562 | 503 | (1,059 | ) | ||||||||||||||||||||||
Greater than twelve months |
462 | 5,438 | 2,313 | (3,125 | ) | 31 | 311 | 57 | (254 | ) | ||||||||||||||||||||||
Total |
997 | $ | 11,909 | $ | 6,542 | $ | (5,367 | ) | 1,651 | $ | 18,696 | $ | 10,437 | $ | (8,259 | ) | ||||||||||||||||
The following tables present the Companys unrealized loss aging for AFS securities (included in
the tables above) by length of time the security was in a continuous greater than 50% unrealized
loss position.
Securitized Assets Depressed over 50% | ||||||||||||||||||||||||||||||||
September 30, 2009 | December 31, 2008 | |||||||||||||||||||||||||||||||
Cost or | Cost or | |||||||||||||||||||||||||||||||
Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | |||||||||||||||||||||||||||
Consecutive Months | Items | Cost | Value | Loss | Items | Cost | Value | Loss | ||||||||||||||||||||||||
Three months or less |
16 | $ | 61 | $ | 27 | $ | (34 | ) | 430 | $ | 5,072 | $ | 1,716 | $ | (3,356 | ) | ||||||||||||||||
Greater than three to six months |
71 | 221 | 81 | (140 | ) | 37 | 299 | 50 | (249 | ) | ||||||||||||||||||||||
Greater than six to nine months |
69 | 643 | 202 | (441 | ) | 24 | 194 | 32 | (162 | ) | ||||||||||||||||||||||
Greater than nine to twelve months |
194 | 2,069 | 624 | (1,445 | ) | 2 | 7 | 1 | (6 | ) | ||||||||||||||||||||||
Greater than twelve months |
74 | 843 | 143 | (700 | ) | | | | | |||||||||||||||||||||||
Total |
424 | $ | 3,837 | $ | 1,077 | $ | (2,760 | ) | 493 | $ | 5,572 | $ | 1,799 | $ | (3,773 | ) | ||||||||||||||||
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All Other Securities Depressed over 50% | ||||||||||||||||||||||||||||||||
September 30, 2009 | December 31, 2008 | |||||||||||||||||||||||||||||||
Cost or | Cost or | |||||||||||||||||||||||||||||||
Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | |||||||||||||||||||||||||||
Consecutive Months | Items | Cost | Value | Loss | Items | Cost | Value | Loss | ||||||||||||||||||||||||
Three months or less |
| $ | | $ | | $ | | 74 | $ | 832 | $ | 352 | $ | (480 | ) | |||||||||||||||||
Greater than three to six months |
3 | 42 | 16 | (26 | ) | | | | | |||||||||||||||||||||||
Greater than six to nine months |
9 | 79 | 31 | (48 | ) | | | | | |||||||||||||||||||||||
Greater than nine to twelve months |
7 | 44 | 18 | (26 | ) | | | | | |||||||||||||||||||||||
Greater than twelve months |
| | | | | | | | ||||||||||||||||||||||||
Total |
19 | $ | 165 | $ | 65 | $ | (100 | ) | 74 | $ | 832 | $ | 352 | $ | (480 | ) | ||||||||||||||||
Consolidated Securities Depressed over 50% | ||||||||||||||||||||||||||||||||
September 30, 2009 | December 31, 2008 | |||||||||||||||||||||||||||||||
Cost or | Cost or | |||||||||||||||||||||||||||||||
Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | |||||||||||||||||||||||||||
Consecutive Months | Items | Cost | Value | Loss | Items | Cost | Value | Loss | ||||||||||||||||||||||||
Three months or less |
16 | $ | 61 | $ | 27 | $ | (34 | ) | 504 | $ | 5,904 | $ | 2,068 | $ | (3,836 | ) | ||||||||||||||||
Greater than three to six months |
74 | 263 | 97 | (166 | ) | 37 | 299 | 50 | (249 | ) | ||||||||||||||||||||||
Greater than six to nine months |
78 | 722 | 233 | (489 | ) | 24 | 194 | 32 | (162 | ) | ||||||||||||||||||||||
Greater than nine to twelve months |
201 | 2,113 | 642 | (1,471 | ) | 2 | 7 | 1 | (6 | ) | ||||||||||||||||||||||
Greater than twelve months |
74 | 843 | 143 | (700 | ) | | | | | |||||||||||||||||||||||
Total |
443 | $ | 4,002 | $ | 1,142 | $ | (2,860 | ) | 567 | $ | 6,404 | $ | 2,151 | $ | (4,253 | ) | ||||||||||||||||
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CAPITAL MARKETS RISK MANAGEMENT
The Company has a disciplined approach to managing risks associated with its capital markets and
asset/liability management activities. Investment portfolio management is organized to focus
investment management expertise on the specific classes of investments, while asset/liability
management is the responsibility of a dedicated risk management unit supporting the Company.
Derivative instruments are utilized in compliance with established Company policy and regulatory
requirements and are monitored internally and reviewed by senior management.
Market Risk
The Company is exposed to market risk, primarily relating to the market price and/or cash flow
variability associated with changes in interest rates, credit spreads including issuer defaults,
equity prices or market indices, and foreign currency exchange rates. The Company is also exposed
to credit and counterparty repayment risk. The Company analyzes interest rate risk using various
models including parametric models that forecast cash flows of the liabilities and the supporting
investments, including derivative instruments, under various market scenarios. For further
discussion of market risk, see the Capital Markets Risk Management Section of the MD&A in the
Companys 2008 Form 10-K Annual Report and the Current Report on Form 8-K filed on April 30, 2009.
Interest Rate Risk
The Companys exposure to interest rate risk relates to the market price and/or cash flow
variability associated with the changes in market interest rates.
In addition, the Company manages net investment spread in certain
products.
The Company manages its exposure
to interest rate risk through asset allocation limits, asset/liability duration matching and
through the use of derivatives. For further discussion of interest rate risk, see the Interest
Rate Risk discussion within the Capital Markets Risk Management Section of the MD&A in the
Companys 2008 Form 10-K Annual Report and the Current Report on Form 8-K filed on April 30, 2009.
The Company is also exposed to interest rate risk based upon the discount rate assumption
associated with the Parents pension and other postretirement benefit obligations. The discount
rate assumption is based upon an interest rate yield curve comprised of bonds rated Aa or higher
with maturities primarily between zero and thirty years. For further discussion of interest rate
risk associated with the benefit obligations, see the Critical Accounting Estimates Section of the
MD&A under Pension and Other Postretirement Benefit Obligations and Note 14 of the Companys 2008
Form 10-K Annual Report and the Current Report on Form 8-K filed on April 30, 2009.
Credit Risk
For further information on credit risk derivatives, see the Investment Credit Risk Section of the
MD&A.
The Company is also exposed to credit spread risk related to security market price and cash flows
associated with changes in credit spreads. Credit spread widening will reduce the fair value of
the investment portfolio and will increase net investment income on new purchases. This will also
result in losses associated with credit based non-qualifying derivatives where the Company assumes
credit exposure. If issuer credit spreads increase significantly or for an extended period of
time, it may result in higher OTTI losses. Credit spread tightening will reduce net investment
income associated with new purchases of fixed maturities and increase the fair value of the
investment portfolio. Credit spread tightening results in a decrease in the Companys unrealized
losses. For further discussion of sectors most significantly impacted, see the Investment Credit
Risk Section of the MD&A. Also, for a discussion of the movements of credit spread impacts on the
Companys statutory financial results as it relates to the accounting and reporting for market
value fixed annuities, see the Capital Resources and Liquidity Section of the MD&A.
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Equity Product Risk
The Companys operations are significantly influenced by changes in the equity markets, primarily
in the U.S., Japanese and other global markets. Appreciation or depreciation in equity markets
impacts certain assets and liabilities related to the Companys variable products and the Companys
earnings derived from those products. The Companys variable products include variable annuities,
mutual funds, and variable life insurance sold to retail and institutional customers. These
variable products may include product guarantees such as GMWB, GMDB, and GMIB. The Company also
reinsures GMWB, GMDB and GMIB benefits issued by HLIKK, an affiliate of the Company.
Substantially all of the Companys variable annuity contracts contain GMDBs and a portion of those
contracts also contain GMWBs. The Companys maximum exposures disclosed below for death and living
benefits are calculated independently; however, these exposures are substantially overlapping.
Generally, declines in equity markets, such as those experienced in 2008 and in the first quarter
of 2009, will and did:
| reduce the value of assets under management and the amount of fee income generated from those assets; | |
| increase the liability for direct GMWB benefits, and reinsured GMWB and GMIB benefits, resulting in realized capital losses; | |
| increase the value of derivative assets used to hedge product guarantees resulting in realized capital gains; | |
| increase costs under the Companys hedging program; | |
| increase the Companys net amount at risk for GMDB benefits; | |
| decrease the Companys actual gross profits, resulting in increased DAC amortization; | |
| increase the amount of required statutory capital necessary to maintain targeted risk based capital (RBC) ratios; | |
| turn customer sentiment toward equity-linked products negative, causing a decline in sales; and | |
| cause a significant decrease in the Companys estimates of future gross profits. See Life Estimated Gross Profits Used in the Valuation and Amortization of Assets and Liabilities Associated with Variable Annuity and Other Universal Life-Type Contracts within Critical Accounting Estimates for further information on DAC and related equity market sensitivities. |
GMWB and Intercompany Reinsurance of GMWB and GMIB
The majority of the Companys U.S. and U.K. variable annuities include a GMWB living benefit rider,
which is accounted for as an embedded derivative reported at fair value with changes in fair value
recorded in realized capital gains (losses) in earnings. As of May 8, 2009, the Company suspended
all new product sales in the U.K. For the in-force block of U.S. and U.K. business, declines in
the equity market will increase the Companys exposure to benefits, under the GMWB contracts,
leading to an increase in the Companys existing liability for those benefits.
For example, a GMWB contract is in the money if the contract holders guaranteed remaining
benefit (GRB) becomes greater than the account value. As of September 30, 2009 and December 31,
2008, 53% and 88%, respectively, of all unreinsured U.S. GMWB in-force contracts were in the
money. For U.S. and U.K. GMWB contracts that were in the money the Companys exposure to the
GRB, after reinsurance, as of September 30, 2009 and December 31, 2008, was $3.3 billion and $7.4
billion, respectively.
However, the only ways the GMWB contract holder can monetize the excess of the GRB over the account
value of the contract is upon death or if their account value is reduced to a contractually
specified minimum level, through a combination of a series of withdrawals that do not exceed a
specific percentage of the premiums paid per year and market declines. If the account value is
reduced to the contractually specified minimum level, the contract holder will receive an annuity
equal to the remaining GRB and, for the Companys life-time GMWB products, the annuity can
continue beyond the GRB. As the amount of the excess of the GRB over the account value can
fluctuate with equity market returns on a daily basis, and the ultimate life-time GMWB payments can
exceed the GRB, the ultimate amount to be paid by the Company, if any, is uncertain and could be
significantly more or less than $3.3 billion. For additional information on the Companys GMWB
liability, see Note 3 of Notes to Condensed Consolidated Financial Statements.
The Company enters into various reinsurance agreements to reinsure GMWB and GMIB benefits issued by
HLIKK, a Japan affiliate of the Company. As of June 1, 2009, all new product sales in the Japan
affiliate were suspended. The reinsurance of GMWB and GMIB is accounted for as a freestanding
derivative with changes in fair value recorded in realized capital gains (losses) in earnings. For
further discussion of transactions with affiliates, see Note 11 of Notes to Condensed Consolidated
Financial Statements.
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Table of Contents
GMDB and Intercompany Reinsurance of GMDB
The Company sells variable annuity contracts that offer various GMDBs. Declines in the equity
market will increase the Companys liability for death benefits under these contracts. The Company
accounts for these GMDB liabilities as death benefit and other insurance benefit liabilities which
are not reported at fair value.
The Companys total gross exposure (i.e. before reinsurance) to U.S. GMDBs as of September 30, 2009
is $21.4 billion. The Company will incur these GMDB payments in the future only if the
policyholder has an in-the-money GMDB benefit at their time of death. The Company currently
reinsures 52% of these GMDB benefit guarantees. Under certain of these reinsurance agreements, the
reinsurers exposure is subject to an annual cap. For these products, the Companys net exposure
(i.e. after reinsurance), referred to as the retained net amount at risk, is $10.2 billion, as of
September 30, 2009. For additional information on the Companys GMDB liability, see Note 7 of
Notes to Condensed Consolidated Financial Statements.
The Company enters into various reinsurance agreements to reinsure GMDB benefits issued by HLIKK, a
Japan affiliate of the Company. As of June 1, 2009, all new product sales in the Japan affiliate
were suspended. The reinsurance of GMDB is accounted for as a death benefit and other insurance
benefit liability which is not reported at fair value. For further discussion of transactions with
affiliates, see Note 11.
Product Guarantee Accounting Models
The accounting for various living and death benefit guarantees is significantly different and
influences the form of risk management employed by the Company. GMWBs, and reinsurance of GMWBs and
GMIBs, meet the definition of an embedded derivative and are accounted for at fair value,
incorporating changes in equity indices and equity index volatility, with changes in fair value
recorded in earnings. For contracts where the contract holder can only obtain the value of the
guaranteed benefit upon the occurrence of an insurable event such as death (GMDB), the accounting
is not reported at fair value. As a result of these accounting differences under U.S. GAAP, the
liability valuation for GMWBs is significantly different than for GMDBs and GMIBs.
Equity Product Risk Management
The Company has made considerable investment in analyzing current and potential future market risk
exposures arising from a number of factors, including but not limited to, product guarantees (GMDB,
GMWB and reinsurance of GMIB, GMWB, and GMDB), equity market and interest rate risks (in the U.S.,
U.K. and Japan) and foreign currency exchange rates. The Company evaluates these risks individually
and, increasingly, in the aggregate to determine the risk profiles of all of its products and to
judge their potential impacts on financial metrics including U.S. GAAP earnings and statutory
surplus., The Company suspended all new product sales in the U.K., as of May 8, 2009, as did its
affiliate in Japan, as of June 1, 2009. The Company continues to manage the product risk of all
in-force blocks of business including the equity market, interest rate and foreign currency
exchange risks embedded in these product guarantees through a combination of product design,
reinsurance, customized derivatives, and dynamic hedging and macro hedging programs.
In consideration of current market conditions, the Companys risk management program for the U.S.
variable annuity market will include redesigned product features which serve to lessen the
financial risk of the product guarantees and increased rider fees charged for the product
guarantees on new sales and in-force, as contractually permitted. Depending upon competitors
reactions with respect to product suites and related rider charges, the Companys strategies of
reducing product risk and increasing fees may cause a further decline in market share.
Reinsurance
The Company uses reinsurance to manage the risk exposure for a portion of contracts issued with
GMWB riders prior to the third quarter of 2003 and, in addition, in 2008, the Company entered into
a reinsurance agreement to reinsure GMWB risks associated with a block of business sold between the
third quarter of 2003 and the second quarter of 2006. The Companys GMWB reinsurance is accounted
for as a freestanding derivative and is reported at fair value.
The Company also uses reinsurance to manage the risk exposure for a portion of the death benefit
riders issued in the U.S.
Derivative Hedging Programs
The Company maintains derivative hedging programs for its product guarantee risk to meet multiple,
and in some cases, competing risk management objectives, including providing protection against
tail scenario equity market events, providing resources to pay product guarantee claims, and
minimizing U.S. GAAP earnings volatility, statutory surplus volatility and other economic metrics.
For reinsurance and derivatives, the Company retains credit risk associated with the third parties.
Refer to the preceding Credit Risk section for the Companys discussion of credit risk.
The Company is continually exploring new ways and new markets to manage or layoff the capital
markets and policyholder behavior risks associated with its GMWB living benefits. During 2007 and
2008, the Company entered into customized derivative contracts to hedge certain capital market risk
components for the remaining term of specific blocks of non-reinsured GMWB riders. These customized
derivative contracts provide protection from capital markets risks based on policyholder behavior
assumptions specified by the Company at the inception of the derivative transactions. The Company
retains the risk for actual policyholder behavior that is different from assumptions within the
customized derivatives.
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The Companys dynamic hedging program uses derivative instruments to manage the U.S. GAAP earnings
volatility associated with variable annuity product guarantees including equity market declines,
equity implied volatility, declines in interest rates and foreign currency exchange risk. The
Company uses hedging instruments including interest rate futures and swaps, variance swaps, S&P
500, NASDAQ and EAFE index put options and futures contracts. The dynamic hedging program involves
a detailed monitoring of policyholder behavior and capital markets conditions on a daily basis and
rebalancing of the hedge position as needed depending upon the risk strategy employed. While the
Company actively manages this dynamic hedging program, increased GAAP earnings volatility may
result from factors including, but not limited to, policyholder behavior, capital markets
dislocation or discontinuity, divergence between the performance of the underlying funds and the
hedging indices, and the relative emphasis placed on various risk management objectives.
The Companys macro hedge program uses derivative instruments to partially hedge the statutory tail
scenario risk associated primarily with its U.S. living and death benefit statutory reserves,
providing an additional measure of protection, under tail scenarios, on statutory surplus and the
associated RBC ratios. A consequence of the macro hedge program will be additional cost and
volatility, under non-tail scenarios, as the macro hedge is intended to partially hedge certain
equity-market sensitive liabilities calculated under statutory accounting (see Capital Resources
and Liquidity) and changes in the value of the derivatives may not be closely aligned to changes in
liabilities determined in accordance with U.S. GAAP, causing volatility in U.S. GAAP earnings
including significant losses in periods of equity market growth.
Throughout 2009, the rebalancing of variable annuity hedging programs resulted in the sale of
certain derivative positions, a portion of which proceeds were used to purchase other derivatives
for the protection of statutory surplus and the associated target RBC ratios. The Company maintains
hedge positions on the S&P 500 index to economically hedge statutory reserves and to provide
protection of statutory surplus arising primarily from GMDB and GMWB obligations. Refer to Footnote
4 of Notes to Condensed Consolidated Financial Statements for additional information on hedging
derivatives.
The following table summarizes the Companys U.S. GMWB account value by type of risk management
strategy as of September 30, 2009:
GMWB | ||||||||||||
Account | % of GMWB | |||||||||||
Risk Management Strategy | Duration | Value | Account Value | |||||||||
Entire GMWB risk reinsured with a third party |
Life of the product | $ | 11,227 | 25 | % | |||||||
Capital markets risk transferred to a third
party behavior risk retained by the
Company |
Designed to cover the effective life of the product |
$ | 10,857 | 24 | % | |||||||
Dynamic hedging of capital markets risk
using various derivative instruments(1) |
Weighted average of 3 years | $ | 22,421 | 51 | % | |||||||
$ | 44,505 | 100 | % | |||||||||
(1) | Through the second quarter of 2009, the Company continued to maintain a reduced level of dynamic hedge protection on U.S. GAAP earnings while placing a greater relative emphasis on the protection of statutory surplus. This shift in emphasis includes the macro hedge program. |
Based on the construction of our derivative hedging program (both dynamic and macro hedge) as
of September 30, 2009, which can change based on capital market conditions, notional amounts and
other factors and has changed as we have disclosed elsewhere, an independent change in the
following capital market factors is likely to have the following impacts.
These sensitivities do not capture the impact of elapsed time on
liabilities or hedge assets.
Each of the sensitivities
set forth below is estimated individually, without consideration of any correlation among the key
assumptions. Therefore, it would be inappropriate to take each of the sensitivities below and add
them together in an attempt to estimate the volatility in our GMWB hedging program. In addition,
there are other factors, including policyholder behavior, which could materially impact the GMWB
liability. As a result, actual net changes in the value of the GMWB liability, the related
derivative hedging assets and the macro hedge program may vary materially from those calculated
using only the sensitivities disclosed below:
Net Impact on | ||||
Hedging | ||||
Program Pre- | ||||
Tax/DAC Gain | ||||
Capital Market Factor | (Loss) | |||
Equity markets decrease 1% |
$ | 11 | [1] | |
Volatility increases 1% |
$ | (47 | ) [2] | |
Interest rates decrease 1 basis point |
$ | (2 | ) [3] | |
[1] | Represents the aggregate net impact of a 1% decrease in each of the S&P 500, NASDAQ and EAFE indices. | |
[2] | Represents the aggregate net impact of a 1% increase in blended implied volatility that is generally skewed towards longer durations of each of the S&P 500, NASDAQ and EAFE indices. | |
[3] | Represents the aggregate net impact of a 1 basis point parallel shift on the LIBOR yield curve. |
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During the quarter ended September 30, 2009. U.S. GMWB liabilities, net of our dynamic and
macro hedging program, incurred a net realized pre-tax loss of $480. This net realized loss was
primarily driven by increases in U.S. equity markets of approximately 15%, increases in volatility
of approximately 40 basis points, interest rate decreases of approximately 30 basis points, a
tightening of the Companys own credit spread and liability model assumption changes, partially
offset by gains resulting from the relative outperformance of the underlying actively managed funds
as compared to their respective indices. See Note 3 for a description and impact of the Companys
own credit spread and liability model assumption changes. During the quarter ended September 30,
2009, the Company rebalanced its hedging position, which decreased the net impact on hedging
program amounts from $25 to $11 for the equity market factor and from $(38) to $(47) for the
volatility factor. During the nine months ended September 30, 2009. U.S. GMWB liabilities, net of
our dynamic and macro hedging program, incurred a net realized pre-tax gain of $421. This net
realized gain was primarily driven by decreases in volatility of approximately 7%, interest rate
increases of approximately 50 basis points, an increase in the Companys own credit risk, the
relative outperformance of the underlying actively managed funds as compared to their respective
indices and liability model assumption changes, partially offset by increases in U.S. equity
markets of approximately 20%. See Note 3 for a description and impact of the Companys own credit
spread and liability model assumption changes.
Equity Risk Impact on Statutory Capital and Risked Based Capital
See Capital Resources and Liquidity, Ratings for information on the equity risk impact on statutory
results.
Derivative Instruments
The Company utilizes a variety of derivative instruments, including swaps, caps, floors, forwards,
futures and options through one of four Company-approved objectives: to hedge risk arising from
interest rate, equity market, credit spread including issuer default, price or currency exchange
rate risk or volatility; to manage liquidity; to control transaction costs; or to enter into
replication transactions.
CAPITAL RESOURCES AND LIQUIDITY
Capital resources and liquidity represent the overall strength of Hartford Life Insurance Company
and its ability to generate strong cash flows from each of the business segments, borrow funds at
competitive rates and raise new capital to meet operating and growth needs over the next twelve
months.
Capital Purchase Program
On June 26, 2009, as part of the Capital Purchase Program (CPP) established by the U.S.
Department of the Treasury (Treasury) under the Emergency Economic Stabilization Act of 2008 (the
EESA), The Hartford entered into a Private Placement Purchase Agreement with the Treasury
pursuant to which The Hartford issued and sold to the Treasury 3,400,000 shares of its Fixed Rate
Cumulative Perpetual Preferred Stock, Series E, having a liquidation preference of $1,000 per
share, and a ten-year warrant to purchase up to 52,093,973 shares of The Hartfords common stock,
par value $.01 per share, at an initial exercise price of $9.79 per share, for an aggregate
purchase price of $3.4 billion. The Hartford has contributed $500 of the CPP funds to the Company.
Derivative Commitments
Certain of the Companys derivative agreements contain provisions that are tied to the financial
strength ratings of the individual legal entity that entered into the derivative agreement as set
by nationally recognized statistical rating agencies. If the insurance operating entitys
financial strength were to fall below certain ratings, the counterparties to the derivative
agreements could demand immediate and ongoing full collateralization and in certain instances
demand immediate settlement of all outstanding derivative positions traded under each impacted
bilateral agreement. The settlement amount is determined by netting the derivative positions
transacted under each agreement. If the termination rights were to be exercised by the
counterparties, it could impact the insurance operating entitys ability to conduct hedging
activities by increasing the associated costs and decreasing the willingness of counterparties to
transact with the insurance operating entity. The aggregate fair value of all derivative
instruments with credit-risk-related contingent features that are in a net liability position as of
September 30, 2009, is $578. Of this $578, the Company has posted collateral of $577 in the normal
course of business. Based on derivative market values as of September 30, 2009, a downgrade of one
level below our current financial strength ratings by either Moodys or S&P could require
approximately an additional $17 to be posted as collateral. These collateral amounts could change
as derivative market values change, as a result of change in our hedging activities or to the
extent changes in contractual terms are negotiated. The nature of the collateral that we may be
required to post is primarily in the form of U.S. Treasury bills and U.S. Treasury notes.
The table below presents the aggregate notional amount and fair value of derivative relationships
that could be subject to immediate termination in the event of further rating agency downgrades.
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As of September 30, 2009 | ||||||||
Ratings levels | Notional Amount | Fair Value | ||||||
Either BBB+ or Baa1 |
$ | 4,175 | $ | 200 | ||||
Both BBB+ and Baa1 [1] [2] |
$ | 12,174 | $ | 537 | ||||
[1] | The notional amount and fair value include both the scenario where only one rating agency takes action to this level as well as where both rating agencies take action to this level. | |
[2] | The notional and fair value amounts include a customized GMWB derivative with a notional amount of $5.4 billion and a fair value of $199, for which the Company has a contractual right to make a collateral payment in the amount of approximately $61 to prevent its termination. |
Securities Lending
The Company participates in securities lending programs to generate additional income. Through
these programs, certain domestic fixed income securities are loaned from the Companys portfolio to
qualifying third party borrowers in return for collateral in the form of cash or U.S. Treasuries.
Borrowers of these securities provide collateral of 102% of the market value of the loaned
securities at the time of the loan and can return the securities to the Company for cash at varying
maturity dates. The market value of the loaned securities is monitored and additional collateral
is obtained if the market value of the collateral falls below 100% of the market value of the
loaned securities. As of September 30, 2009 and December 31, 2008, under terms of securities
lending programs, the fair value of loaned securities was approximately $209 and $1.8 billion,
respectively. The Company held collateral of $213 as of September 30, 2009 which represents
collateral associated with the Companys open lending program. This collateral may be returned to
the borrowers in thirty days or less. The Company held collateral associated with the loaned
securities of $1.8 billion at December 31, 2008. The decrease in both the fair value of loan
securities and the associated collateral is attributable to the maturation of the loans in the term
lending program throughout 2009.
Insurance Operations
As of September 30, 2009, the Companys total assets under management were $291.1 billion. Of the
total assets under management, approximately $218.3 billion is held in separate accounts, within
mutual funds or were held in international statutory separate accounts. Mutual funds are not
recorded on the Companys balance sheet. The remaining $72.9 billion was held in the Companys
general account supported by the Companys general account invested assets of $54.7 billion
including a significant short-term investment position to meet liquidity needs. As of September
30, 2009 and December 31, 2008, the Company held total fixed maturity investments of $45.3 billion
and $45.3 billion, respectively, of which $5.9 billion and $5.7 billion were short-term
investments, respectively. As of September 30, 2009, the Companys cash and short-term investments
of $6.9 billion, included $1.0 billion of collateral received from, and held on behalf of,
derivative counterparties and $327 of collateral pledged to derivative counterparties. The Company
also held $1.8 billion of treasury securities, of which $577 had been pledged to derivative
counterparties.
In the event customers elect to surrender separate account assets, international statutory separate
accounts or retail mutual funds, the Company will use the proceeds from the sale of the assets to
fund the surrender and the Companys liquidity position will not be impacted. In many instances
the Company will receive a percentage of the surrender amount as compensation for early surrender
(surrender charge), increasing the Companys liquidity position. In addition, a surrender of
variable annuity separate account or general account assets (see below) will decrease the Companys
obligation for payments on guaranteed living and death benefits.
Capital resources available to fund liquidity, upon contract holder surrender, is a function of the
legal entity in which the liquidity requirement resides. Generally, obligations of Individual
Annuity and Individual Life will be generally funded by both Hartford Life Insurance Company and
Hartford Life and Annuity Insurance Company; obligations of Retirement and Institutional will be
generally funded by Hartford Life Insurance Company; and obligations of the Companys European
insurance operations will be generally funded by the legal entity in the country in which the
obligation was generated.
$11.0 billion relates to the Companys Retail Fixed MVA annuities that are held in a statutory
separate account, but under U.S. GAAP are recorded in the general account as Fixed MVA annuity
contract holders are subject to the Companys credit risk. In the statutory separate account, the
Company is required to maintain invested assets with a fair value equal to the market value
adjusted surrender value of the Fixed MVA contract. In the event assets decline in value at a
greater rate than the market value adjusted surrender value of the Fixed MVA contract, the Company
is required to contribute additional capital to the statutory separate account. The Company will
fund these required contributions with operating cash flows and short-term investments. In the
event that operating cash flows or short-term investments are not sufficient to fund required
contributions, the Company may have to sell other invested assets at a loss, potentially resulting
in a decrease to statutory surplus. As the fair value of invested assets in the statutory separate
account are generally equal to the market value adjusted surrender value of the Fixed MVA contract,
surrender of Fixed MVA annuities will have an insignificant impact on the liquidity requirements of
the Company.
Approximately $1.4 billion of GIC contracts are subject to discontinuance provisions which allow
the policyholders to terminate their contracts prior to scheduled maturity at the lesser of the
book value or market value. Generally, the market value adjustment is reflective of changes in
interest rates and credit spreads. As a result, the market value adjustment feature in the GIC
contract serves to protect the Company from interest rate risks and limit the Companys liquidity
requirements in the event of a surrender. Approximately $0.7 billion of funding agreements allow
the policyholders to terminate at book value without a market value adjustment after a defined
notice period typically of thirteen months. All policyholders with this provision have exercised
it, and the associated account value will be paid out by December 31, 2009 and will be funded by
cash flows from Institutional operations or existing short-term investments within the
Institutional investment portfolio.
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Surrenders of, or policy loans taken from, as applicable, the remaining $18.2 billion of general
account liabilities, which include the general account option for Retails individual variable
annuities and Individual Lifes variable life contracts, the general account option for Retirement
Plan annuities and universal life contracts sold by Individual Life may be funded through operating
cash flows of the Company, available short-term investments, or the Company may be required to sell
fixed maturity investments to fund the surrender payment. Sales of fixed maturity investments
could result in the recognition of significant realized losses and insufficient proceeds to fully
fund the surrender amount. In this circumstance, the Company may need to acquire additional
liquidity from the HFSG Holding Company or take other actions, including enforcing certain contract
provisions which could restrict surrenders and/or slow or defer payouts.
Surrenders of term life and group benefits contracts will have no current effect on the Companys
liquidity requirements.
Ratings
Ratings are an important factor in establishing the competitive position in the insurance and
financial services marketplace. There can be no assurance that the Companys ratings will continue
for any given period of time or that they will not be changed. In the event the Companys ratings
are downgraded, the level of revenues, or the persistency of the Companys business may be
adversely impacted.
The following table summarizes Hartford Life Insurance Companys significant member companies
financial ratings from the major independent rating organizations as of November 3, 2009:
Standard & | ||||||||||||||||
A.M. Best | Fitch | Poors | Moodys | |||||||||||||
Insurance Ratings |
||||||||||||||||
Hartford Life Insurance Company |
A | A- | A | A3 | ||||||||||||
Hartford Life and Annuity Insurance Company |
A | A- | A | A3 | ||||||||||||
Hartford Life Limited (Ireland) |
| | A | | ||||||||||||
Other Ratings |
||||||||||||||||
Hartford Life Insurance Company: |
||||||||||||||||
Short Term Rating |
| | A-1 | P-2 | ||||||||||||
Consumer Notes |
a | BBB+ | A | Baa1 |
These ratings are not a recommendation to buy or hold any of the Companys securities and they may
be revised or revoked at any time at the sole discretion of the rating organization.
The agencies consider many factors in determining the final rating of an insurance company. One
consideration is the relative level of statutory surplus necessary to support the business written.
Statutory surplus represents the capital of the insurance company reported in accordance with
accounting practices prescribed by the applicable state insurance department.
The Companys aggregate statutory capital and surplus, as prepared in accordance with the National
Association of Insurance Commissioners Accounting Practices and Procedures Manual (US STAT) was
$5.4 billion as of September 30, 2009 and $4.1 billion as of December 31, 2008, respectively. The
statutory surplus amount as of December 31, 2008 is based on actual statutory filings with the
applicable regulatory authorities. The $4.1 billion of statutory surplus at December 31, 2008 does
not reflect the impact of the contribution of certain subsidiaries to HLIC on March 31, 2009, which
increased statutory surplus by $1.3 billion. The statutory surplus amount as of September 30,
2009, is an estimate, as the 2009 statutory filings have not yet been made.
The Company has received approval from the Connecticut Insurance Department regarding the use of
two permitted practices in the statutory financial statements of its Connecticut-domiciled life
insurance subsidiaries. The first permitted practice relates to the statutory accounting for
deferred income taxes for both life and property and casualty insurers. The second permitted
practice relates to the statutory reserving requirements for variable annuities with guaranteed
living benefit riders. These permitted practices will expire in the fourth quarter of 2009.
As of September 30, 2009, the Company received a benefit to statutory surplus of $89 related to the
deferred income tax permitted practice and a statutory surplus benefit of $224 related to the
reserving permitted practice. When the reserving permitted practice expires in 2009, the Company
will be required to adopt VA CARVM, which will differ from the current reserving standards. While
it is difficult to predict what the ultimate impact of adopting VA CARVM will be at December 31,
2009, it is estimated that the adoption will likely result in
increased required reserves, if market conditions at September 30, 2009
persist.
The National Association of Insurance Commissioners (NAIC) is actively considering modifying its
statutory accounting practice for deferred tax assets to allow for greater admissibility of
deferred income taxes. The proposal under consideration is similar in many respects to the
permitted practice granted to the company by the State of Connecticut for year-end 2008, and the
first three quarters of 2009. The NAIC proposal would apply to 2009 and 2010 during which time the
NAIC would decide whether to make permanent changes in this area of statutory accounting. It is
expected that the NAIC will act at or before its national meeting in early December 2009.
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Equity Markets
For a discussion of the potential impact of the equity markets on capital and liquidity, see the
Capital Markets Risk Management section under Market Risk above.
Contingencies
Legal Proceedings For a discussion regarding contingencies related to the Companys legal
proceedings, please see Part II, Item 1, Legal Proceedings.
Legislative Developments
On May 11, 2009, the Obama Administration released the General Explanations of the
Administrations Revenue Proposals. Although the Administration has not released proposed
statutory language, the General Explanations of the Administrations Revenue Proposals includes
proposals which if enacted, would affect the taxation of life insurance companies and certain life
insurance products. In particular, the proposals would affect the treatment of corporate owned life
insurance policies or COLIs by limiting the availability of certain interest deductions for
companies that purchase those policies. The proposals would also change the method used to
determine the amount of dividend income received by a life insurance company on assets held in
separate accounts used to support products, including variable life insurance and variable annuity
contracts, that is eligible for the dividends-received deduction, or DRD. The DRD reduces the
amount of dividend income subject to tax and is a significant component of the difference between
the Companys actual tax expense and expected amount determined using the federal statutory tax
rate of 35%. If proposals of this type were enacted, the Companys sale of COLI, variable
annuities, and variable life products could be adversely affected and the Companys actual tax
expense could increase, reducing earnings.
ACCOUNTING STANDARDS
For a discussion of accounting standards, see Note 1 of Notes to the Condensed Consolidated
Financial Statements included in the Companys 2008 Form 10-K Annual Report and the Current Report
on Form 8-K filed on April 30, 2009 and Note 1 of Notes to the Condensed Consolidated Financial
Statements.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See Capital Markets Risk Management section of Managements Discussion and Analysis for a
discussion of the Companys market risk.
Item 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures
The Companys principal executive officer and its principal financial officer, based on their
evaluation of the Companys disclosure controls and procedures (as defined in Exchange Act Rule
13a-15(e)) have concluded that the Companys disclosure controls and procedures are effective for
the purposes set forth in the definition thereof in Exchange Act Rule 13a-15(e) as of September 30,
2009.
Changes in internal control over financial reporting
There was no change in the Companys internal control over financial reporting that occurred during
the Companys third fiscal quarter of 2009 that has materially affected, or is reasonably likely to
materially affect, the Companys internal control over financial reporting.
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Part II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
Litigation
The Company is involved in claims litigation arising in the ordinary course of business, both as a
liability insurer defending or providing indemnity for third-party claims brought against insureds
and as an insurer defending coverage claims brought against it. The Company accounts for such
activity through the establishment of unpaid loss and loss adjustment expense reserves. Management
expects that the ultimate liability, if any, with respect to such ordinary-course claims
litigation, after consideration of provisions made for potential losses and costs of defense, will
not be material to the consolidated financial condition, results of operations or cash flows of the
Company.
The Company is also involved in other kinds of legal actions, some of which assert claims for
substantial amounts. These actions include, among others, putative state and federal class actions
seeking certification of a state or national class. Such putative class actions have alleged, for
example, improper sales practices in connection with the sale of life insurance and other
investment products; and improper fee arrangements in connection with investment products and
structured settlements. The Company also is involved in individual actions in which punitive
damages are sought, such as claims alleging bad faith in the handling of insurance claims.
Management expects that the ultimate liability, if any, with respect to such lawsuits, after
consideration of provisions made for estimated losses, will not be material to the consolidated
financial condition of the Company. Nonetheless, given the large or indeterminate amounts sought in
certain of these actions, and the inherent unpredictability of litigation, an adverse outcome in
certain matters could, from time to time, have a material adverse effect on the Companys
consolidated results of operations or cash flows in particular quarterly or annual periods.
Broker Compensation Litigation -
Following the New York Attorney Generals filing of a civil complaint against Marsh & McLennan
Companies, Inc., and Marsh, Inc. (collectively, Marsh) in October 2004 alleging 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, private plaintiffs brought several lawsuits against the Company predicated
on the allegations in the Marsh complaint, to which the Company was not party. Among these is a
multidistrict litigation in the United States District Court for the District of New Jersey. There
are two consolidated amended complaints filed in the multidistrict litigation, one related to
conduct in connection with the sale of property-casualty insurance and the other related to alleged
conduct in connection with the sale of group benefits products. The Company and various of its
subsidiaries are named in both complaints. The complaints assert, on behalf of a putative class of
persons who purchased insurance through broker defendants, claims under the Sherman Act, the
Racketeer Influenced and Corrupt Organizations Act (RICO), state law, and in the case of the
group benefits complaint, claims under the Employee Retirement Income Security Act of 1974
(ERISA). The claims are predicated upon allegedly undisclosed or otherwise improper payments of
contingent commissions to the broker defendants to steer business to the insurance company
defendants. The district court has dismissed the Sherman Act and RICO claims in both complaints
for failure to state a claim and has granted the defendants motions for summary judgment on the
ERISA claims in the group-benefits products complaint. The district court further has declined to
exercise supplemental jurisdiction over the state law claims, has dismissed those state law claims
without prejudice, and has closed both cases. The plaintiffs have appealed the dismissal of the
claims in both consolidated amended complaints, except the ERISA claims.
Structured Settlement Class Action Litigation - In October 2005, a putative nationwide class action
was filed in the United States District Court for the District of Connecticut against the Company
and several of its subsidiaries on behalf of persons who had asserted claims against an insured of
a Hartford property & casualty insurance company that resulted in a settlement in which some or all
of the settlement amount was structured to afford a schedule of future payments of specified
amounts funded by an annuity from a Hartford life insurance company (Structured Settlements).
The operative complaint alleges that since 1997 the Company has systematically deprived the
settling claimants of the value of their damages recoveries by secretly deducting 15% of the
annuity premium of every Structured Settlement to cover brokers commissions, other fees and costs,
taxes, and a profit for the annuity provider, and asserts claims under the Racketeer Influenced and
Corrupt Organizations Act (RICO) and state law. The plaintiffs seek compensatory damages,
punitive damages, pre-judgment interest, attorneys fees and costs, and injunctive or other
equitable relief. The Company vigorously denies that any claimant was misled or otherwise
received less than the amount specified in the structured-settlement agreements. In March 2009,
the district court certified a class for the RICO and fraud claims composed of all persons, other
than those represented by a plaintiffs broker, who entered into a Structured Settlement since 1997
and received certain written representations about the cost or value of the settlement. The
district court declined to certify a class for the breach-of-contract and unjust-enrichment claims.
The Companys petition to the United States Court of Appeals for the Second Circuit for permission
to file an interlocutory appeal of the class-certification ruling was denied in October 2009.
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Item 1A. RISK FACTORS
Refer to Item 1A of Part I of the Companys Annual Report on Form 10-K for the year ended December
31, 2008 and in Item 1A of Part II of the Companys Quarterly Report on Form 10-Q for the quarters
ended March 31, 2009 and June 30, 2009 for an explanation of the Companys risk factors.
Item 6. EXHIBITS
See Exhibits Index on page 79.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
HARTFORD LIFE INSURANCE COMPANY
/s/ Ernest M. McNeill Jr.
|
||||
Senior Vice President and Chief Accounting Officer | ||||
November 3, 2009 |
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HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
FORM 10-Q
FOR THE THREE MONTHS ENDED September 30, 2009
EXHIBITS INDEX
Exhibit # | ||
12.01
|
Computation of Ratio of Earnings to Fixed Charges | |
15.01
|
Deloitte & Touche LLP Letter of Awareness | |
31.01
|
Certification of John C. Walters pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.02
|
Certification of Glenn D. Lammey pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.01
|
Certification of John C. Walters pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
32.02
|
Certification of Glenn D. Lammey pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
98