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EX-10.08 - EXHIBIT 10.08 - HARTFORD FINANCIAL SERVICES GROUP INC/DEc13002exv10w08.htm
EX-23.01 - EXHIBIT 23.01 - HARTFORD FINANCIAL SERVICES GROUP INC/DEc13002exv23w01.htm
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EX-24.01 - EXHIBIT 24.01 - HARTFORD FINANCIAL SERVICES GROUP INC/DEc13002exv24w01.htm
EX-32.02 - EXHIBIT 32.02 - HARTFORD FINANCIAL SERVICES GROUP INC/DEc13002exv32w02.htm
EX-10.09 - EXHIBIT 10.09 - HARTFORD FINANCIAL SERVICES GROUP INC/DEc13002exv10w09.htm
EX-99.01 - EXHIBIT 99.01 - HARTFORD FINANCIAL SERVICES GROUP INC/DEc13002exv99w01.htm
EX-12.01 - EXHIBIT 12.01 - HARTFORD FINANCIAL SERVICES GROUP INC/DEc13002exv12w01.htm
EX-21.01 - EXHIBIT 21.01 - HARTFORD FINANCIAL SERVICES GROUP INC/DEc13002exv21w01.htm
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
     
þ   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2010
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 001-13958
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
(Exact name of registrant as specified in its charter)
     
Delaware   13-3317783
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
One Hartford Plaza, Hartford, Connecticut 06155
(Address of principal executive offices) (Zip Code)
(860) 547-5000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: the following, all of which are listed on the New York Stock Exchange, Inc.
Common Stock, par value $0.01 per share
Depositary shares, representing interests in 7.25% Mandatory Convertible Preferred Stock, Series F, par value $0.01 per share
Warrants (expiring June 26, 2019)
6.10% Notes due October 1, 2041
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No þ
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
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
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large accelerated filer þ   Accelerated filer o  Non-accelerated filer o  Smaller Reporting Company o
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
The aggregate market value of the shares of Common Stock held by non-affiliates of the registrant as of June 30, 2010 was approximately $9.8 billion, based on the closing price of $22.13 per share of the Common Stock on the New York Stock Exchange on June 30, 2010.
As of February 18, 2011, there were outstanding 444,734,147 shares of Common Stock, $0.01 par value per share, of the registrant.
Documents Incorporated by Reference
Portions of the registrant’s definitive proxy statement for its 2011 annual meeting of shareholders are incorporated by reference in Part III of this Form 10-K.
 
 

 

 


 

THE HARTFORD FINANCIAL SERVICES GROUP, INC.
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2010
TABLE OF CONTENTS
             
Item   Description   Page  
   
 
       
           
   
 
       
1.       5  
   
 
       
1A.       13  
   
 
       
1B.       25  
   
 
       
2.       25  
   
 
       
3.       25  
   
 
       
4.       27  
   
 
       
           
   
 
       
5.       27  
   
 
       
6.       29  
   
 
       
7.       30  
   
 
       
7A.       121  
   
 
       
8.       121  
   
 
       
9.       121  
   
 
       
9A.       121  
   
 
       
9B.       123  
   
 
       
           
   
 
       
10.       124  
   
 
       
11.       126  
   
 
       
12.       126  
   
 
       
13.       128  
   
 
       
14.       128  
   
 
       
           
   
 
       
15.       128  
   
 
       
        II-1  
   
 
       
        II-2  
   
 
       
 Exhibit 10.07
 Exhibit 10.08
 Exhibit 10.09
 Exhibit 10.10
 Exhibit 10.11
 Exhibit 10.12
 Exhibit 10.27
 Exhibit 12.01
 Exhibit 21.01
 Exhibit 23.01
 Exhibit 24.01
 Exhibit 31.01
 Exhibit 31.02
 Exhibit 32.01
 Exhibit 32.02
 Exhibit 99.01
 Exhibit 99.02

 

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Forward-Looking Statements
Certain of the statements contained herein are forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements can be identified by words such as “anticipates,” “intends,” “plans,” “seeks,” “believes,” “estimates,” “expects,” “projects,” and similar references to future periods.
Forward-looking statements are based on our current expectations and assumptions regarding economic, competitive and legislative developments. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. They have been made based upon management’s expectations and beliefs concerning future developments and their potential effect upon The Hartford Financial Services Group, Inc. and its subsidiaries (collectively, the “Company”). Future developments may not be in line with management’s expectations or have unanticipated effects. Actual results could differ materially from expectations, depending on the evolution of various factors, including those set forth in Part I, Item 1A. Risk Factors. These important risks and uncertainties include:
 
uncertainties related to the Company’s current operating environment, which reflects constrained capital and credit markets and uncertainty about the timing and strength of an economic recovery, and whether management’s efforts to identify and address these risks will be timely and effective;
 
risks associated with our continued execution of steps to realign our business and reposition our investment portfolio, including the potential need to take other actions;
 
market risks associated with our business, including changes in interest rates, credit spreads, equity prices, foreign exchange rates, and implied volatility levels, as well as uncertainty in key sectors such as the global real estate market, that continued to pressure our results in 2010;
 
volatility in our earnings resulting from our adjustment of our risk management program to emphasize protection of statutory surplus;
 
the impact on our statutory capital of various factors, including many that are outside the Company’s control, which can in turn affect our credit and financial strength ratings, cost of capital, regulatory compliance and other aspects of our business and results;
 
risks to our business, financial position, prospects and results associated with negative rating actions or downgrades in the Company’s financial strength and credit ratings or negative rating actions or downgrades relating to our investments;
 
the potential for differing interpretations of the methodologies, estimations and assumptions that underlie the valuation of the Company’s financial instruments that could result in changes to investment valuations;
 
the subjective determinations that underlie the Company’s evaluation of other-than-temporary impairments on available-for-sale securities;
 
losses due to nonperformance or defaults by others;
 
the potential for further acceleration of deferred policy acquisition cost amortization;
 
the potential for further impairments of our goodwill or the potential for changes in valuation allowances against deferred tax assets;
 
the possible occurrence of terrorist attacks and the Company’s ability to contain its exposure, including the effect of the absence or insufficiency of applicable terrorism legislation on coverage;
 
the difficulty in predicting the Company’s potential exposure for asbestos and environmental claims;
 
the possibility of a pandemic, earthquake, or other natural or man-made disaster that may adversely affect our businesses and cost and availability of reinsurance;
 
weather and other natural physical events, including the severity and frequency of storms, hail, winter storms, hurricanes and tropical storms, as well as climate change and its potential impact on weather patterns;
 
the response of reinsurance companies under reinsurance contracts and the availability, pricing and adequacy of reinsurance to protect the Company against losses;
 
the possibility of unfavorable loss development;
 
actions by our competitors, many of which are larger or have greater financial resources than we do;

 

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the restrictions, oversight, costs and other consequences of being a savings and loan holding company, including from the supervision, regulation and examination by the Office of Thrift Supervision (the “OTS”), and in the future, as a result of the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), The Federal Reserve as the Company’s regulator and the Office of the Controller of the Currency as regulator of Federal Trust Bank;
 
the cost and other effects of increased regulation as a result of the enactment of the Dodd-Frank Act, which will, among other effects, vest a newly created Financial Services Oversight Council with the power to designate “systemically important” institutions, require central clearing of, and/or impose new margin and capital requirements on, derivatives transactions, and may affect our ability as a savings and loan holding company to manage our general account by limiting or eliminating investments in certain private equity and hedge funds;
 
the potential effect of domestic and foreign regulatory developments, including those that could adversely impact the demand for the Company’s products, operating costs and required capital levels, including changes to statutory reserves and/or risk-based capital requirements related to secondary guarantees under universal life and variable annuity products;
 
the Company’s ability to distribute its products through distribution channels, both current and future;
 
the uncertain effects of emerging claim and coverage issues;
 
the ability of the Company to declare and pay dividends is subject to limitations;
 
the Company’s ability to effectively price its property and casualty policies, including its ability to obtain regulatory consents to pricing actions or to non-renewal or withdrawal of certain product lines;
 
the Company’s ability to maintain the availability of its systems and safeguard the security of its data in the event of a disaster or other unanticipated events;
 
the risk that our framework for managing business risks may not be effective in mitigating risk and loss to us that could adversely affect our business;
 
the potential for difficulties arising from outsourcing relationships;
 
the impact of potential changes in federal or state tax laws, including changes affecting the availability of the separate account dividend received deduction;
 
the impact of potential changes in accounting principles and related financial reporting requirements;
 
the Company’s ability to protect its intellectual property and defend against claims of infringement;
 
unfavorable judicial or legislative developments; and
 
other factors described in such forward-looking statements.
Any forward-looking statement made by the Company in this document speaks only as of the date of the filing of this Form 10-K. Factors or events that could cause the Company’s actual results to differ may emerge from time to time, and it is not possible for the Company to predict all of them. The Company undertakes no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise.

 

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Table of Contents

PART I
Item 1. BUSINESS
(Dollar amounts in millions, except for per share data, unless otherwise stated)
General
The Hartford Financial Services Group, Inc. (together with its subsidiaries, “The Hartford” or the “Company”) is an insurance and financial services company. The Hartford, headquartered in Connecticut, is among the largest providers of investment products and life, property, and casualty insurance to both individual and business customers in the United States of America. Also, The Hartford continues to administer business previously sold in Japan and the United Kingdom. Hartford Fire Insurance Company, founded in 1810, is the oldest of The Hartford’s subsidiaries. At December 31, 2010, total assets and total stockholders’ equity of The Hartford were $318.3 billion and $20.3 billion, respectively.
Organization
The Hartford strives to maintain and enhance its position as a market leader within the financial services industry. The Company sells diverse and innovative products through multiple distribution channels to consumers and businesses. The Company is continuously seeking to develop and expand its distribution channels, achieving cost efficiencies through economies of scale and improved technology, and capitalizes on its brand name and The Hartford Stag Logo, one of the most recognized symbols in the financial services industry. In 2009, the Company announced it would focus on its U.S. businesses and suspended sales in Japan and the United Kingdom. In 2010, the Company announced a customer-oriented strategy and established three divisions Commercial Markets, Consumer Markets, and Wealth Management. In 2010, the Company announced the sale of two businesses that are not core to its focus and strategy: its Canadian mutual fund business, Hartford Investments Canada Corporation, and Specialty Risk Services, LLC, a third-party administrator for claims administration (scheduled to close in 2011). Going forward, the Company intends to continue evaluating its businesses and may make additional divestitures of businesses and assets that are outside its focus or not necessary to the implementation of its strategy.
As a holding company that is separate and distinct from its subsidiaries, The Hartford Financial Services Group, Inc. has no significant business operations of its own. Therefore, it relies on the dividends from its insurance companies and other subsidiaries as the principal source of cash flow to meet its obligations. Additional information regarding the cash flow and liquidity needs of The Hartford Financial Services Group, Inc. may be found in the Capital Resources and Liquidity section of Part II, Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”).
The Company maintains a retail mutual fund operation, whereby the Company, through wholly-owned subsidiaries, provides investment management and administrative services to The Hartford Mutual Funds, Inc. and The Hartford Mutual Funds II, Inc. (collectively, “mutual funds”), consisting of 52 mutual funds, as of December 31, 2010. The Company charges fees to these mutual funds, which are recorded as revenue by the Company. These mutual funds are registered with the Securities and Exchange Commission (“SEC”) under the Investment Company Act of 1940. The mutual funds are owned by the shareholders of those funds and not by the Company.
Reporting Segments
The Hartford made changes to its reporting segments in 2010 to reflect the manner in which the Company is currently organized for purposes of making operating decisions and assessing performance. Accordingly, segment data for prior reporting periods has been adjusted to reflect the new segment reporting. As a result, the Company created three customer-oriented divisions, Commercial Markets, Consumer Markets and Wealth Management, conducting business principally in seven reporting segments. The Hartford includes in Corporate and Other the Company’s debt financing and related interest expense, as well as other capital raising activities; banking operations; certain fee income and commission expenses associated with sales of non-proprietary products by broker-dealer subsidiaries; and certain purchase accounting adjustments and other charges not allocated to the reporting segments. Also included in Corporate and Other is the Company’s management of certain property and casualty operations that have discontinued writing new business and substantially all of the Company’s asbestos and environmental exposures, collectively referred to as Other Operations.
The following discussion describes the principal products and services, marketing and distribution, and competition of each of the three divisions of The Hartford. For further discussion on changes to reporting segments in 2010, as well as financial disclosures on revenues by product, net income (loss), and assets for each reporting segment, see Note 3 of the Notes to Consolidated Financial Statements.

 

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Table of Contents

Commercial Markets
The Commercial Markets division is organized into two reporting segments; Property & Casualty Commercial and Group Benefits.
Principal Products and Services
Property & Casualty Commercial provides workers’ compensation, property, automobile, liability and umbrella coverages under several different products, primarily throughout the U.S, within its standard commercial lines, which consists of The Hartford’s small commercial and middle market lines of business. Additionally, a variety of customized insurance products and risk management services including workers’ compensation, automobile, general liability, professional liability, fidelity, surety and specialty casualty coverages are offered to large companies through the segment’s specialty lines.
Standard commercial lines seeks to offer products with more coverage options and customized pricing based on the policyholder’s individualized risk characteristics. For small businesses, those businesses whose annual payroll is under $5 and whose revenue and property values are less than $15 each, coverages are bundled as part of a single multi-peril package policy marketed under the Spectrum name. Medium-sized businesses, companies whose payroll, revenue and property values exceed the small business definition, are served within middle market. The middle market line of business provides workers’ compensation, property, automobile, liability, umbrella, marine and livestock coverages. The sale of Spectrum business owners’ package policies and workers’ compensation policies accounts for the majority of the written premium in the standard commercial lines.
Within the specialty lines, a significant portion of the specialty casualty business, including workers’ compensation business, is written through large deductible programs where the insured typically provides collateral to support loss payments made within their deductible. The specialty casualty business also provides retrospectively-rated programs where the premiums are adjustable based on loss experience. Captive and Specialty Programs provide insurance products and services primarily to captive insurance companies, pools and self-insurance groups. In addition, specialty lines has provided third-party administrator services for claims administration, integrated benefits and loss control through Specialty Risk Services, LLC (“SRS”), an indirect wholly-owned subsidiary of the Company. The Company signed a definitive agreement on December 17, 2010 to sell SRS.
Group Benefits provides group life, accident and disability coverage, group retiree health and voluntary benefits to individual members of employer groups, associations, affinity groups and financial institutions. Group Benefits offers disability underwriting, administration, claims processing and reinsurance to other insurers and self-funded employer plans. Policies sold in this segment are generally term insurance, allowing Group Benefits to adjust the rates or terms of its policies in order to minimize the adverse effect of market trends, declining interest rates, and other factors. Policies are typically sold with one, two or three-year rate guarantees depending upon the product.
In addition to the products and services traditionally offered within each of its lines of business, in 2010 Commercial Markets launched The Hartford Productivity Advantage (“THPA”), a single-company solution for leave management, integrating the insurer’s short- and long-term group disability and workers’ compensation insurance with its leave management administration services.
Marketing and Distribution
Standard commercial lines provide insurance products and services through the Company’s home office located in Hartford, Connecticut, and multiple domestic regional office locations and insurance centers. The products are marketed nationwide utilizing brokers and independent agents. The current pace of consolidation within the independent agent and broker distribution channel will likely continue such that, in the future a larger proportion of written premium will likely be concentrated among fewer agents and brokers. Additionally the Company offers insurance products to customers of the payroll service providers through its relationships with major national payroll companies.
Specialty lines also provide insurance products and services through its home office located in Hartford, Connecticut and multiple domestic office locations. Specialty lines markets its products nationwide utilizing a variety of distribution networks including independent retail agents, brokers and wholesalers.
The Group Benefits distribution network includes an experienced group of Company employees, managed through a regional sales office system, to distribute its group insurance products and services through a variety of distribution outlets including brokers, consultants, third-party administrators and trade associations.
During 2010 the Company launched a nationwide joint sales management effort across standard commercial lines, specialty lines and Group Benefits, facilitating the marketing of both integrated and traditional products and services across commercial markets.

 

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Competition
In the small commercial marketplace, The Hartford competes against a number of large national carriers, as well as regional competitors in certain territories. Competitors include other stock companies, mutual companies and other underwriting organizations. The small commercial market has become increasingly competitive as favorable loss costs in the past few years have led carriers to differentiate themselves through product expansion, price reduction, enhanced service and cutting-edge technology. Larger carriers such as The Hartford have improved their pricing sophistication and ease of doing business with agents through the use of predictive modeling tools and automation which speeds up the process of evaluating a risk and quoting new business.
Written premium growth rates in the small commercial market have slowed and underwriting margins have deteriorated due to earned pricing decreases, economy-related exposure reductions and increases in loss cost severity. A number of companies have sought to grow their business by increasing their underwriting appetite, appointing new agents and expanding business with existing agents. Also, carriers serving middle market-sized accounts are more aggressively competing for small commercial accounts as small commercial business has generally been less price-sensitive.
Middle market business is characterized as “high touch” and involves case-by-case underwriting and pricing decisions. Compared to small commercial lines, the pricing of middle market accounts is prone to more significant variation or cyclicality over time, with more sensitivity to legislative and macro-economic forces. The economic downturn which began in 2008 has driven a reduction in average premium size as shrinking company payrolls, smaller auto fleets, and fewer business locations depress insurance exposures. Additionally, various state legislative reforms in recent years designed to control workers compensation indemnity costs have led to rate reductions in many states. These factors coupled with soft market conditions, characterized by highly competitive pricing on new business, have resulted in more new business opportunities in the marketplace as customers shop their policies for a better price. In the face of this competitive environment, The Hartford continues to maintain a disciplined underwriting approach. To gain a competitive advantage in this environment, carriers are improving automation with agents and brokers, increasing pricing sophistication, and enhancing their product offerings. These enhancements include industry specialization, with The Hartford and other national carriers tailoring products and services to specific industry verticals such as technology, health care and renewable energy.
Specialty lines is comprised of a diverse group of businesses that operate independently within their specific industries. These businesses, while somewhat interrelated, have different business models and operating cycles. Specialty lines competes on an account- by-account basis due to the complex nature of each transaction. Competition in this market includes other stock companies, mutual companies, alternative risk sharing groups and other underwriting organizations. The relatively large size and underwriting capacity of The Hartford provides opportunities not available to smaller companies. Disciplined underwriting and targeted returns are the objectives of specialty lines since premium writings may fluctuate based on the segment’s view of perceived market opportunity.
For specialty casualty businesses, written pricing competition continues to be significant, particularly for the larger individual accounts. Carriers are protecting their in-force casualty business by initiating the renewal process well in advance of the policy renewal date, effectively preventing other carriers from quoting on the business and resulting in fewer new business opportunities within the marketplace. Within the national account business, as the market continues to soften, more insureds may opt for guaranteed cost policies in lieu of loss-sensitive products.
Carriers writing professional liability business are increasingly focused on profitable private, middle market companies. This trend has continued as the downturn in the economy has led to a significant drop in the number of initial public offerings, and volatility for all public companies. Also, carriers’ new business opportunities in the marketplace for directors & officers and errors & omissions insurance have been significantly influenced by customer perceptions of financial strength, as investment portfolio losses have had a negative affect on the financial strength ratings of some insurers.
In the surety business, favorable underwriting results over the past couple of years has led to increased competition for market share, setting the stage for potential written price declines and less favorable terms and conditions. Driven by the upheaval in the credit markets, new private construction activity has declined dramatically, resulting in lower demand for contract surety business.
Group Benefits competes with numerous other insurance companies and other financial intermediaries marketing insurance products. This line of business focuses on both its risk management expertise and economies of scale to derive a competitive advantage. Competitive factors affecting Group Benefits include the variety and quality of products and services offered, the price quoted for coverage and services, the Company’s relationships with its third-party distributors, and the quality of customer service. In addition, active price competition continues in the marketplace resulting in longer rate guarantee periods being offered to customers. Top tier carriers in the marketplace also offer on-line and self service capabilities to agents and consumers. The relatively large size and underwriting capacity of the Group Benefits business provides opportunities not available to smaller companies.
In the commercial marketplace, generally soft market conditions and a weak economy has prompted carriers to offer differentiated products and services as a means of gaining a competitive advantage. In addition to the initiatives specific to each of The Hartford’s Commercial Markets’ lines of business noted above, the Company is leveraging its diverse product, service and distribution capabilities to deliver differentiated value in the market, while simultaneously increasing its ability to access to its own diverse customer base.

 

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Consumer Markets
The Consumer Markets division constitutes the reporting segment.
Principal Products and Services
Consumer Markets provides standard automobile, homeowners and home-based business coverages to individuals across the United States, including a special program designed exclusively for members of AARP (“AARP Program”). The Hartford’s auto and homeowners products provide coverage options and customized pricing tailored to a customer’s individual risk Although The Hartford has individual customer relationships with AARP Program policyholders, as a group these customers represent a significant portion of the total Consumer Markets business. Business sold direct to AARP members amounted to earned premiums of $2.9 billion, $2.8 billion and $2.8 billion in 2010, 2009 and 2008, respectively. Consumer Markets also operates a member contact center for health insurance products offered through the AARP Health program, which is in place through 2018.
Marketing and Distribution
Consumer Markets reaches diverse customers through multiple distribution channels including direct sales to the consumer, brokers and independent agents. In direct sales to the consumer, the Company markets its products through a mix of media, including direct marketing, the internet and advertising in publications. Most of Consumer Markets’ direct sales to the consumer are associated with its exclusive licensing arrangement with AARP to market automobile, homeowners and home-based business insurance products to AARP’s nearly 37 million members. The Hartford’s exclusive licensing arrangement with AARP continues until January 1, 2020 for automobile, homeowners and home-based business. This agreement provides Consumer Markets with an important competitive advantage given the number of “baby boomers” over age 50 many of whom become AARP members during this period.
The agency channel provides customized products and services to customers through a network of independent agents in the standard personal lines market. These independent agents are not employees of The Hartford. An important strategic objective of the Company is to develop common products and processes for all of its personal lines business regardless of the distribution channel. In 2010, the Company continued the rollout of its new Open Road Advantage Product and, as of December 31, 2010, this product was sold in 33 states across the Company’s distribution channels, including directly to AARP members, through independent agents to both AARP members and non-members and directly to non-members. In 2009, Consumer Markets piloted mass marketing direct to the consumer without the benefit of an affinity partnership. In 2010, Consumer Markets changed its strategy away from mass marketing to targeting specific customer groups, including individuals in the over 40 age group, and writing business through affinities other than AARP. The Company entered into an affinity agreement with American Kennel Club effective January 1, 2011 and expects to enter into additional affinity arrangements in 2011.
Competition
The personal lines automobile and homeowners businesses are highly competitive. Personal lines insurance is written by insurance companies of varying sizes that compete on the basis of price, product, service (including claims handling), stability of the insurer and brand recognition. Companies with recognized brands, direct sales capability and economies of scale will have a competitive advantage. In recent years, a number of carriers have increased their advertising in an effort to gain new business and retain profitable business. This has been particularly true of carriers that sell directly to the consumer. Industry sales of personal lines insurance direct to the consumer have been growing faster than sales through agents, particularly for auto insurance.
Carriers that distribute products mainly through agents have been competing by offering agents increased commissions and additional incentives to attract new business. To distinguish themselves in the marketplace, top tier carriers are offering on-line and self service capabilities to agents and consumers. More agents have been using “comparative rater” tools that allow the agent to compare premium quotes among several insurance companies. The use of comparative rater tools has further increased price competition. Carriers with more efficient cost structures will have an advantage in competing for new business through price. The use of data mining and predictive modeling is used by more and more carriers to target the most profitable business and, carriers have further segmented their pricing plans to expand market share in what they believe to be the most profitable segments. Some companies, including The Hartford, have written a greater percentage of their new business in preferred market segments which tend to have better loss experience but also lower average premiums.
Wealth Management
The Wealth Management division consists of the following reporting segments: Global Annuity, Life Insurance, Retirement Plans and Mutual Funds. Wealth Management provides investment products for over 7 million customers and life insurance for approximately 716,000 customers.
As part of the Company’s strategic decision to focus on its U.S. businesses, the Company suspended all new sales in its Japan and European operations in the second quarter of 2009 and divested its Brazil joint venture, Canadian mutual fund business and its offshore insurance business in 2010.

 

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Principal Products and Services
Global Annuity offers individual variable, fixed market value adjusted (“fixed MVA”) and single premium immediate annuities in the U.S., a range of products to institutional investors, including but not limited to, stable value contracts and institutional annuities, and administers investments, retirement savings and other insurance and savings products to individuals and groups outside the U.S., primarily in Japan and Europe.
Life Insurance sells a variety of life insurance products, including variable universal life, universal life, and term life, as well as variable private placement life insurance (“PPLI”) owned by corporations and high net worth individuals.
Retirement Plans provides products and services to corporations, municipalities, and not-for-profit organizations pursuant to Sections 401(k), 457 and 403(b) of the Internal Revenue Code of 1986, as amended (the “Code”), respectively.
Mutual Funds offers retail mutual funds, investment-only mutual funds and college savings plans under Section 529 of the Code (collectively referred to as non-proprietary) and proprietary mutual funds.
Marketing and Distribution
Global Annuity’s distribution network includes national and regional broker-dealer organizations, banks and other financial institutions and independent financial advisors. The Company periodically negotiates provisions and terms of its relationships with unaffiliated parties. The Company’s primary wholesaler of its individual annuities is Hartford Life Distributors, LLC, and its affiliate, PLANCO, LLC (collectively “HLD”) which are indirect wholly-owned subsidiaries of Hartford Life, Inc. HLD provides sales support to registered representatives, financial planners and broker-dealers at brokerage firms and banks across the United States.
Life Insurance’s distribution network includes national and regional broker-dealer organizations, banks, independent agents, independent life and property-casualty agents, and Woodbury Financial Services, an indirect, wholly-owned subsidiary retail broker-dealer. PPLI’s distribution network includes: specialized brokers with expertise in the large case market; financial advisors that work with individual investors; investment banking and wealth management specialists; benefits consulting firms; investment consulting firms employed by retirement plan sponsors; and The Hartford employees.
Retirement Plans distribution network includes Company employees with extensive retirement experience selling its products and services through national and regional broker-dealer firms, banks and other financial institutions.
Mutual Fund sales professionals are segmented into two teams; a retail team and an institutional team. The retail team distributes The Hartford’s open-end funds and 529 College Savings funds to national and regional broker-dealer organizations, banks and other financial institutions, independent financial advisors and registered investment advisors. The institutional team distributes The Hartford’s funds to professional buyers, such as broker-dealer wrap, consultants, record keepers, and bank trust groups.
Competition
Global Annuity competes with other life insurance companies, as well as certain banks, securities brokerage firms, independent financial advisors, asset managers, and other financial intermediaries marketing annuities, mutual funds and other retirement-oriented products. Product sales are affected by competitive factors such as investment performance ratings, product design, visibility in the marketplace, financial strength ratings, distribution capabilities, levels of charges and credited rates, reputation and customer service. Global Annuity’s U.S. annuity deposits continue to decline due to competitive activity and the Company’s product and risk decisions. Many competitors have responded to the equity market volatility by increasing the price of their living benefit products and changing the level of the guarantee offered. Management believes that the most significant industry de-risking changes have occurred. In 2010, the Company transitioned to a new variable annuity product designed to meet customers future income needs while abiding by the risk tolerances of the Company.
Life Insurance competes with other life insurance companies in the United States, as well as other financial intermediaries marketing insurance products. Product sales are affected primarily by the availability and price of reinsurance, volatility in the equity markets, breadth and quality of life insurance products being offered, pricing, relationships with third-party distributors, effectiveness of wholesaling support, and the quality of underwriting and customer service. The individual life industry continues to see a distribution shift away from the traditional life insurance sales agents to the consultative financial advisor as the place people go to buy their life insurance. Life Insurance’s regional sales office system is a differentiator in the market and allows it to compete effectively across multiple distribution outlets.
Retirement Plans compete with other insurance carriers, large investment brokerage companies and large mutual fund companies. The 401(k), 457, and 403(b) products offer mutual funds wrapped in variable annuities, variable funding agreements, or mutual fund retirement products. Plan sponsors seek a diversity of available funds and favorable fund performance. Consolidation among industry providers has continued as competitors increase scale advantages.
Mutual Funds compete with other mutual fund companies along with investment brokerage companies and differentiate themselves through product solutions, performance, and service. In this non-proprietary broker sold market, the Company and its competitors compete aggressively for net sales.

 

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Reserves
The Hartford establishes and carries as liabilities reserves for its insurance products to estimate for the following:
 
a liability for unpaid losses, including those that have been incurred but not yet reported, as well as estimates of all expenses associated with processing and settling these claims;
 
a liability equal to the balance that accrues to the benefit of the Wealth Management insurance policyholder as of the consolidated financial statement date, otherwise known as the account value;
 
a liability for future policy benefits, representing the present value of future benefits to be paid to or on behalf of policyholders less the present value of future net premiums;
 
fair value reserves for living benefits embedded derivative guarantees; and
 
death and living benefit reserves which are computed based on a percentage of revenues less actual claim costs.
Further discussion of The Hartford’s property and casualty insurance product reserves, including asbestos and environmental claims reserves, may be found in Part II, Item 7, MD&A — Critical Accounting Estimates — Property and Casualty Insurance Product Reserves, Net of Reinsurance. Additional discussion may be found in the Company’s accounting policies for insurance product reserves within Note 11 of the Notes to Consolidated Financial Statements.
Reinsurance
The Hartford cedes insurance risk to reinsurance companies for both its property and casualty and life insurance products. Ceded reinsurance does not relieve The Hartford of its primary liability and, as such, failure of reinsurers to honor their obligations could result in losses to The Hartford. For further discussion, see Note 6 of the Notes to Consolidated Financial Statements.
For property and casualty insurance products, reinsurance arrangements are intended to provide greater diversification of business and limit The Hartford’s maximum net loss arising from large risks or catastrophes. A major portion of The Hartford’s property and casualty insurance product reinsurance is effected under general reinsurance contracts known as treaties, or, in some instances, is negotiated on an individual risk basis, known as facultative reinsurance. The Hartford also has in-force excess of loss contracts with reinsurers that protect it against a specified part or all of a layer of losses over stipulated amounts. For further discussion on property and casualty insurance product reinsurance, see Part II, Item 7, MD&A — Insurance Risk — Reinsurance.
For life insurance products, The Hartford is involved in both the cession and assumption of insurance with other insurance and reinsurance companies. As of December 31, 2010 and 2009, the Company’s policy for the largest amount of life insurance retained on any one life by any one of its operations was $10. The Company also assumes reinsurance from other insurers. For the years ended December 31, 2010, 2009 and 2008, the Company did not make any significant changes in the terms under which reinsurance is ceded to other insurers. In addition, the Company has reinsured a portion of the risk associated with U.S. minimum death benefit guarantees, Japan’s guaranteed minimum death, as well as U.S. guaranteed minimum withdrawal benefits offered in connection with its variable annuity contracts. For further discussion on reinsurance, see Part II, Item 7, MD&A — Market Risk — Variable Product Equity Risk.
Investment Operations
The majority of the Company’s investment portfolios are managed by Hartford Investment Management Company (“HIMCO”). HIMCO manages the portfolios to maximize economic value, while attempting to generate the income necessary to support the Company’s various product obligations, within internally established objectives, guidelines and risk tolerances. The portfolio objectives and guidelines are developed based upon the asset/liability profile, including duration, convexity and other characteristics within specified risk tolerances. The risk tolerances considered include, for example, asset and credit issuer allocation limits, maximum portfolio below investment grade holdings and foreign currency exposure. The Company attempts to minimize adverse impacts to the portfolio and the Company’s results of operations from changes in economic conditions through asset allocation limits, asset/liability duration matching and through the use of derivatives. For further discussion of HIMCO’s portfolio management approach, see the Investment Credit Risk Section of the MD&A.
In addition to managing the general account assets of the Company, HIMCO is also a SEC registered investment adviser for third party institutional clients, a sub-advisor for certain mutual funds and serves as the sponsor and collateral manager for capital markets transactions. HIMCO specializes in investment management that incorporates proprietary research and active management within a disciplined risk framework that seeks to provide value added returns versus peers and benchmarks. As of December 31, 2010 and 2009, the fair value of HIMCO’s total assets under management was approximately $159.7 billion and $144.0 billion, respectively, of which $8.7 billion and $8.1 billion, respectively, were held in HIMCO managed third party accounts.

 

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Risk Management
The Company has an independent enterprise risk management function (“ERM”) whose responsibility it is to provide a comprehensive, in depth, and transparent view of the Company’s risk on an aggregated basis and to ensure the Company’s risks remain within tolerance. ERM is led by the Chief Risk Officer who reports to the Chief Executive Officer. ERM is staffed with risk professionals focused on insurance risk, investment risk, market risk, and operational risk. The mission of ERM is to support the Company in achieving its strategic priorities within an agreed upon risk profile by providing a comprehensive view of the risks facing the Company, including risk concentrations and correlations; helping management define the Company’s risk tolerances through the evaluation of the risk return profile of the business relative to the Company’s strategic intent and financial underpinnings; and monitoring and communicating the Company’s risk exposures relative to set tolerances and recommending/implementing appropriate mitigation where applicable.
The Company maintains an internal Enterprise Risk and Capital Committee (“ERCC”), which includes the Company’s Chief Executive Officer (“CEO”), Chief Risk Officer, Chief Financial Officer, Chief Investment Officer, the Presidents and Chief Operating Officers of Commercial Markets, Consumer Markets, and Wealth Management and the Company’s General Counsel. The ERCC, which is chaired by the CEO, meets regularly to manage the Company’s strategic risk profile and risk management activities across the organization; approve financial and investment strategies along with the methodology to attribute capital among business lines; determine the Company’s capital structure; and establish the Company’s risk management framework, limits, and standards.
The Board as a whole has ultimate responsibility for risk oversight. It exercises its oversight function through its standing committees, each of which has primary risk oversight responsibility with respect to all matters within the scope of its duties as contemplated by its charter. The Finance, Investment and Risk Management Committee (“FIRMCo”), which consists of all members of the Board, has responsibility for oversight of all risks that do not fall within the oversight responsibility of any other standing committee. Together, these committees oversee and assess general risk management activities, investment activities and financial management of the Company and its subsidiaries. They review the Company’s risk management framework and enterprise policies related to governance and provide a forum for discussion between management and the Board on risk and risk-related matters.
Regulation
Insurance companies are subject to comprehensive and detailed regulation and supervision throughout the United States. The extent of such regulation varies, but generally has its source in statutes which delegate regulatory, supervisory and administrative powers to state insurance departments. Such powers relate to, among other things, the standards of solvency that must be met and maintained; the licensing of insurers and their agents; the nature of and limitations on investments; establishing premium rates; claim handling and trade practices; restrictions on the size of risks which may be insured under a single policy; deposits of securities for the benefit of policyholders; approval of policy forms; periodic examinations of the affairs of companies; annual and other reports required to be filed on the financial condition of companies or for other purposes; fixing maximum interest rates on life insurance policy loans and minimum rates for accumulation of surrender values; and the adequacy of reserves and other necessary provisions for unearned premiums, unpaid losses and loss adjustment expenses and other liabilities, both reported and unreported.
Most states have enacted legislation that regulates insurance holding company systems such as The Hartford. This legislation provides that each insurance company in the system is required to register with the insurance department of its state of domicile and furnish information concerning the operations of companies within the holding company system that may materially affect the operations, management or financial condition of the insurers within the system. All transactions within a holding company system affecting insurers must be fair and equitable. Notice to the insurance departments is required prior to the consummation of transactions affecting the ownership or control of an insurer and of certain material transactions between an insurer and any entity in its holding company system. In addition, certain of such transactions cannot be consummated without the applicable insurance department’s prior approval. In the jurisdictions in which the Company’s insurance company subsidiaries are domiciled, the acquisition of more than 10% of The Hartford’s outstanding common stock would require the acquiring party to make various regulatory filings.
Certain of the Company’s life insurance subsidiaries sell variable life insurance, variable annuity, and some fixed guaranteed products that are “securities” registered with the SEC under the Securities Act of 1933, as amended. Some of the products have separate accounts that are registered as investment companies under the Investment Company Act of 1940 and/or are regulated by state law. Separate account investment products are also subject to state insurance regulation. Moreover, each separate account is generally divided into sub-accounts, some of which invest in underlying mutual funds which are themselves registered as investment companies under the Investment Company Act of 1940 (“Underlying Funds”). The Company offers these Underlying Funds and retail mutual funds that are registered with and regulated by the SEC.
In addition, other subsidiaries of the Company are involved in the offering, selling and distribution of the Company’s variable insurance products, Underlying Funds and retail mutual funds as broker dealers and are subject to regulation promulgated and enforced by the Financial Industry Regulatory Authority (“FINRA”), the SEC and/or in, some instances, state securities administrators. Other entities operate as investment advisers registered with the SEC under the Investment Advisers Act of 1940 and are registered as investment advisers under certain state laws, as applicable. One subsidiary is an investment company registered under the Investment Company Act of 1940. Because federal and state laws and regulations are primarily intended to protect investors in securities markets, they generally grant regulators broad rulemaking and enforcement authority. Some of these regulations include among other things regulations impacting sales methods, trading practices, suitability of investments, use and safekeeping of customers’ funds, corporate governance, capital, record keeping, and reporting requirements.

 

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The extent of insurance regulation on business outside the United States varies significantly among the countries in which The Hartford operates. Some countries have minimal regulatory requirements, while others regulate insurers extensively. Foreign insurers in certain countries are faced with greater restrictions than domestic competitors domiciled in that particular jurisdiction. The Hartford’s international operations are comprised of insurers licensed in their respective countries.
In 2009, the Company acquired Federal Trust Corporation, a thrift holding company, and as a result is subject to regulations by the Office of Thrift Supervision (“OTS”). Under the Dodd-Frank Act, the OTS will be dissolved. The Federal Reserve will assume regulatory authority over our holding company, and our thrift subsidiary, Federal Trust Bank, will be regulated by the Office of Controller of the Currency (“OCC”).
Failure to comply with federal and state laws and regulations may result in censure, fines, the issuance of cease-and-desist orders or suspension, termination or limitation of the activities of our operations and/or our employees. We cannot predict the impact of these actions on our businesses, results of operations or financial condition.
Intellectual Property
We rely on a combination of contractual rights and copyright, trademark, patent and trade secret laws to establish and protect our intellectual property.
We have a worldwide trademark portfolio that we consider important in the marketing of our products and services, including, among others, the trademarks of The Hartford name, the Stag Logo and the combination of these two marks. The duration of trademark registrations varies from country to country and may be renewed indefinitely subject to country-specific use and registration requirements. We regard our trademarks as extremely valuable assets in marketing our products and services and vigorously seek to protect them against infringement.
Employees
The Hartford had approximately 26,800 employees as of December 31, 2010.
Available Information
The Hartford makes available, free of charge, on or through its Internet website (http://www.thehartford.com) The Hartford’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) of the Exchange Act as soon as reasonably practicable after The Hartford electronically files such material with, or furnishes it to, the SEC. These reports may be read and copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549 or by calling the SEC at 1-800-SEC-0330. In addition the SEC maintains an internet website (http://sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.

 

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Item 1A. RISK FACTORS
Investing in The Hartford involves risk. In deciding whether to invest in The Hartford, you should carefully consider the following risk factors, any of which could have a significant or material adverse effect on the business, financial condition, operating results or liquidity of The Hartford. This information should be considered carefully together with the other information contained in this report and the other reports and materials filed by The Hartford with the Securities and Exchange Commission (“SEC”).
Our operating environment remains subject to uncertainty about the timing and strength of an economic recovery. The steps we have taken to realign our businesses and strengthen our capital position may not be adequate to mitigate the financial, competitive and other risks associated with our operating environment which could adversely affect our business and results of operations.
Uncertainty about the timing and strength of a recovery in the global economy continued to affect our operating environment in 2010. High unemployment, lower family income, lower business investment and lower consumer spending in most geographic markets we serve have adversely affected the demand for financial and insurance products, as well as their profitability in some cases. Our results, financial condition and statutory capital remain sensitive to equity and credit market performance and effects of foreign currency, and we expect that market conditions will put pressure on returns in our life and property and casualty investment portfolios and that our hedging costs will remain higher than historical levels. Unless all economic conditions continue to improve, we would expect to experience realized and unrealized investment losses, particularly in the commercial real estate sector where market value declines and risk premiums still exist, which reflects the future uncertainty in the real estate market. Negative rating agency actions with respect to our investments could also indirectly adversely affect our statutory capital and risk-based capital (“RBC”) ratios, which could in turn have other negative consequences for our business and results.
The steps we have taken to realign our businesses and strengthen our capital position may not be adequate if economic conditions do not continue to improve in line with our forecasts. These steps include ongoing initiatives, particularly the execution risk relating to the continued repositioning of our investment portfolios and the continuing realignment of our macro hedge programs for our variable annuity business. In addition, we modified our variable annuity product offerings, launching a new variable annuity product in October 2009, and a second variable annuity product launch expected in the second quarter of 2011. However, the future success of these new variable annuity products will be dependent on market acceptance. The level of market acceptance of these new products will directly affect the level of variable annuity sales of the Company in the future. In addition, as the Company and our distribution partners transition to these new products, there will be downward pressure on new deposits, and management expects to continue to be in a net outflow position. If our actions are not adequate, our ability to support the scale of our business and to absorb operating losses and liabilities under our customer contracts could be impaired, which would in turn adversely affect our overall competitiveness and the capital position of the Company.
Even if the measures we have taken (or take in the future) are effective to mitigate the risks associated with our current operating environment, they may have unintended consequences. For example, rebalancing our hedging program may better protect our statutory surplus, but also result in greater earnings volatility under accounting principles generally accepted in the U.S. (“U.S. GAAP”). We could be required to consider actions to manage our capital position and liquidity or further reduce our exposure to market and financial risks. We may also be forced to sell assets on unfavorable terms that could cause us to incur charges or lose the potential for market upside on those assets in a market recovery. We could also face other pressures, such as employee recruitment and retention issues and potential loss of distribution for our products. Additionally, if there was concern over the Company’s capital position creating an anticipation of the Company issuing additional common stock or equity linked instruments, trading prices for our common stock could decline.
We are exposed to significant financial and capital markets risk, including changes in interest rates, credit spreads, equity prices, foreign exchange rates and global real estate market deterioration that may have a material adverse effect on our results of operations, financial condition and liquidity.
We are exposed to significant financial and capital markets risk, including changes in interest rates, credit spreads, equity prices, foreign currency exchange rates and global real estate market deterioration.
One important exposure to equity risk relates to the potential for lower earnings associated with certain of our wealth management businesses, such as variable annuities, where fee income is earned based upon the fair value of the assets under management. Should equity markets decline from current levels, assets under management and related fee income will be reduced. In addition, certain of our products offer guaranteed benefits that increase our potential obligation and statutory capital exposure should equity markets decline. Sustained declines in equity markets may result in the need to devote significant additional capital to support these products. We are also exposed to interest rate and equity risk based upon the discount rate and expected long-term rate of return assumptions associated with our pension and other post-retirement benefit obligations. Sustained declines in long-term interest rates or equity returns are likely to have a negative effect on the funded status of these plans.

 

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Our exposure to interest rate risk relates primarily to the market price and cash flow variability associated with changes in interest rates. A rise in interest rates, in the absence of other countervailing changes, will increase the net unrealized loss position of our investment portfolio and, if long-term interest rates rise dramatically within a six-to-twelve month time period, certain of our wealth management businesses may be exposed to disintermediation risk. Disintermediation risk refers to the risk that our policyholders may surrender their contracts in a rising interest rate environment, requiring us to liquidate assets in an unrealized loss position. Although our products have features such as surrender charges, market-value adjustments and put options on certain retirement plans, we are subject to disintermediation risk. An increase in interest rates can also impact our tax planning strategies and in particular our ability to utilize tax benefits to offset certain previously recognized realized capital losses. In a declining rate environment, due to the long-term nature of the liabilities associated with certain of our life businesses, such as structured settlements and guaranteed benefits on variable annuities, sustained declines in long-term interest rates may subject us to reinvestment risks, increased hedging costs, spread compression and capital volatility. Our exposure to credit spreads primarily relates to market price and cash flow variability associated with changes in credit spreads. If issuer credit spreads widen significantly or retain historically wide levels over an extended period of time, additional other-than-temporary impairments and increases in the net unrealized loss position of our investment portfolio will likely result. In addition, losses have also occurred due to the volatility in credit spreads. When credit spreads widen, we incur losses associated with the credit derivatives where the Company assumes exposure. When credit spreads tighten, we incur losses associated with derivatives where the Company has purchased credit protection. If credit spreads tighten significantly, the Company’s net investment income associated with new purchases of fixed maturities may be reduced. In addition, a reduction in market liquidity can make it difficult to value certain of our securities when trading becomes less frequent. As such, valuations may include assumptions or estimates that may be more susceptible to significant period-to-period changes, which could have a material adverse effect on our consolidated results of operations or financial condition.
Our statutory surplus is also affected by widening credit spreads as a result of the accounting for the assets and liabilities on our fixed MVA annuities. Statutory separate account assets supporting the fixed MVA annuities are recorded at fair value. In determining the statutory reserve for the fixed MVA annuities we are required to use current crediting rates in the U.S. and Japanese LIBOR in Japan. In many capital market scenarios, current crediting rates in the U.S. are highly correlated with market rates implicit in the fair value of statutory separate account assets. As a result, the change in the statutory reserve from period to period will likely substantially offset the change in the fair value of the statutory separate account assets. However, in periods of volatile credit markets, actual credit spreads on investment assets may increase sharply for certain sub-sectors of the overall credit market, resulting in statutory separate account asset market value losses. As actual credit spreads are not fully reflected in current crediting rates in the U.S. or Japanese LIBOR in Japan, the calculation of statutory reserves will not substantially offset the change in fair value of the statutory separate account assets resulting in reductions in statutory surplus. This has resulted and may continue to result in the need to devote significant additional capital to support the fixed MVA product.
Our primary foreign currency exchange risk is related to certain guaranteed benefits associated with the Japan and U.K. variable annuities. The strengthening of the yen compared with other currencies will substantially increase our exposure to pay yen denominated obligations. In addition our foreign currency exchange risk relates to net income from foreign operations, non-U.S. dollar denominated investments, investments in foreign subsidiaries, and our yen-denominated individual fixed annuity product. In general, the weakening of foreign currencies versus the U.S. dollar will unfavorably affect net income from foreign operations, the value of non-U.S. dollar denominated investments, investments in foreign subsidiaries and realized gains or losses on the yen denominated annuity products. A strengthening of the U.S. dollar compared to foreign currencies will increase our exposure to the U.S. variable annuity guarantee benefits where policyholders have elected to invest in international funds, generating losses and statutory surplus strain.
Our real estate market exposure includes investments in commercial mortgage-backed securities, residential mortgage-backed securities, commercial real estate collateralized debt obligations, mortgage and real estate partnerships, and mortgage loans. Significant deterioration in the real estate market in the past couple of years adversely affected our business and results of operations. Further deterioration in the real estate market, including increases in property vacancy rates, delinquencies and foreclosures, could have a negative impact on property values and sources of refinancing resulting in reduced market liquidity and higher risk premiums. This could result in impairments of real estate backed securities, a reduction in net investment income associated with real estate partnerships, and increases in our valuation allowance for mortgage loans.
Significant declines in equity prices, changes in U.S. interest rates, changes in credit spreads, inflation, the strengthening or weakening of foreign currencies against the U.S. dollar, or global real estate market deterioration, individually or in combination, could have a material adverse effect on our consolidated results of operations, financial condition and liquidity.

 

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Our adjustment of our risk management program relating to products we offer with guaranteed benefits to emphasize protection of statutory surplus will likely result in greater U.S. GAAP volatility in our earnings and potentially material charges to net income in periods of rising equity market pricing levels.
Some of the products offered by our Wealth Management businesses, especially variable annuities, offer guaranteed benefits which, in the event of a decline in equity markets, would not only result in lower earnings, but will also increase our exposure to liability for benefit claims. We are also subject to equity market volatility related to these benefits, including the guaranteed minimum withdrawal benefit (“GMWB”), guaranteed minimum accumulation benefit (“GMAB”), guaranteed minimum death benefit (“GMDB”) and guaranteed minimum income benefit (“GMIB”) offered with variable annuity products. We use reinsurance structures and have modified benefit features to mitigate the exposure associated with GMDB. We also use reinsurance in combination with a modification of benefit features and derivative instruments to attempt to minimize the claim exposure and to reduce the volatility of net income associated with the GMWB liability. However, due to the severe economic conditions in the fourth quarter of 2008, we adjusted our risk management program to place greater relative emphasis on the protection of statutory surplus. This shift in relative emphasis has resulted in greater U.S. GAAP earnings volatility in 2009 and 2010 and, based upon the types of hedging instruments used, can result in potentially material charges to net income in periods of rising equity market pricing levels, lower interest rates, rises in implied volatility and weakening of the yen against other currencies. While we believe that these actions have improved the efficiency of our risk management related to these benefits, we remain liable for the guaranteed benefits in the event that reinsurers or derivative counterparties are unable or unwilling to pay. We are also subject to the risk that these management procedures prove ineffective or that unanticipated policyholder behavior, combined with adverse market events, produces economic losses beyond the scope of the risk management techniques employed, which individually or collectively may have a material adverse effect on our consolidated results of operations, financial condition and cash flows.
The amount of statutory capital that we have and the amount of statutory capital that we must hold to maintain our financial strength and credit ratings and meet other requirements can vary significantly from time to time and is sensitive to a number of factors outside of our control, including equity market, credit market, interest rate and foreign currency conditions, changes in policyholder behavior and changes in rating agency models.
We conduct the vast majority of our business through licensed insurance company subsidiaries. Accounting standards and statutory capital and reserve requirements for these entities are prescribed by the applicable insurance regulators and the National Association of Insurance Commissioners (“NAIC”). Insurance regulators have established regulations that provide minimum capitalization requirements based on RBC formulas for both life and property and casualty companies. The RBC formula for life companies establishes capital requirements relating to insurance, business, asset and interest rate risks, including equity, interest rate and expense recovery risks associated with variable annuities and group annuities that contain death benefits or certain living benefits. The RBC formula for property and casualty companies adjusts statutory surplus levels for certain underwriting, asset, credit and off-balance sheet risks.
In any particular year, statutory surplus amounts and RBC ratios may increase or decrease depending on a variety of factors, including the amount of statutory income or losses generated by our insurance subsidiaries (which itself is sensitive to equity market and credit market conditions), the amount of additional capital our insurance subsidiaries must hold to support business growth, changes in equity market levels, the value of certain fixed-income and equity securities in our investment portfolio, the value of certain derivative instruments, changes in interest rates and foreign currency exchange rates, the impact of internal reinsurance arrangements, and changes to the NAIC RBC formulas. Most of these factors are outside of the Company’s control. The Company’s financial strength and credit ratings are significantly influenced by the statutory surplus amounts and RBC ratios of our insurance company subsidiaries. In addition, rating agencies may implement changes to their internal models that have the effect of increasing the amount of statutory capital we must hold in order to maintain our current ratings. Also, in extreme scenarios of equity market declines and other capital market volatility, the amount of additional statutory reserves that we are required to hold for our variable annuity guarantees increases at a greater than linear rate. This reduces the statutory surplus used in calculating our RBC ratios. When equity markets increase, surplus levels and RBC ratios will generally increase. This may be offset, however, as a result of a number of factors and market conditions, including the level of hedging costs and other risk transfer activities, reserve requirements for death and living benefit guarantees and RBC requirements could also increase, lowering RBC ratios. Due to these factors, projecting statutory capital and the related RBC ratios is complex. If our statutory capital resources are insufficient to maintain a particular rating by one or more rating agencies, we may seek to raise capital through public or private equity or debt financing. If we were not to raise additional capital, either at our discretion or because we were unable to do so, our financial strength and credit ratings might be downgraded by one or more rating agencies.
Downgrades in our financial strength or credit ratings, which may make our products less attractive, could increase our cost of capital and inhibit our ability to refinance our debt, which would have a material adverse effect on our business, results of operations, financial condition and liquidity.
Financial strength and credit ratings, including commercial paper ratings, are important in establishing the competitive position of insurance companies. In 2009, our financial strength and credit ratings were downgraded by multiple rating agencies. Rating agencies assign ratings based upon several factors. While most of the factors relate to the rated company, some of the factors relate to the views of the rating agency, general economic conditions, and circumstances outside the rated company’s control. In addition, rating agencies may employ different models and formulas to assess the financial strength of a rated company, and from time to time rating agencies have, at their discretion, altered these models. Changes to the models, general economic conditions, or circumstances outside our control could impact a rating agency’s judgment of its rating and the rating it assigns us. We cannot predict what actions rating agencies may take, or what actions we may take in response to the actions of rating agencies, which may adversely affect us.

 

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Our financial strength ratings, which are intended to measure our ability to meet policyholder obligations, are an important factor affecting public confidence in most of our products and, as a result, our competitiveness. A downgrade or a potential downgrade in the rating of our financial strength or of one of our principal insurance subsidiaries could affect our competitive position and reduce future sales of our products.
Our credit ratings also affect our cost of capital. A downgrade or a potential downgrade of our credit ratings could make it more difficult or costly to refinance maturing debt obligations, to support business growth at our insurance subsidiaries and to maintain or improve the financial strength ratings of our principal insurance subsidiaries. Downgrades could begin to trigger potentially material collateral calls on certain of our derivative instruments and counterparty rights to terminate derivative relationships, both of which could limit our ability to purchase additional derivative instruments. These events could materially adversely affect our business, results of operations, financial condition and liquidity.
Our valuations of many of our financial instruments include methodologies, estimations and assumptions that are subject to differing interpretations and could result in changes to investment valuations that may materially adversely affect our results of operations and financial condition.
The following financial instruments are carried at fair value in the Company’s consolidated financial statements: fixed maturities, equity securities, freestanding and embedded derivatives, and separate account assets. The determination of fair values is made at a specific point in time, based on available market information and judgments about financial instruments, including estimates of the timing and amounts of expected future cash flows and the credit standing of the issuer or counterparty. The use of different methodologies and assumptions may have a material effect on the estimated fair value amounts.
During periods of market disruption, including periods of rapidly widening credit spreads or illiquidity, it may be difficult to value certain of our securities if trading becomes less frequent and/or market data becomes less observable. There may be certain asset classes that were in active markets with significant observable data that become illiquid due to the financial environment. In such cases, securities may require more subjectivity and management judgment in determining their fair values and those fair values may differ materially from the value at which the investments may be ultimately sold. Further, rapidly changing and unprecedented credit and equity market conditions could materially impact the valuation of securities and the period-to-period changes in value could vary significantly. Decreases in value could have a material adverse effect on our results of operations and financial condition.
Evaluation of available-for-sale securities for other-than-temporary impairment involves subjective determinations and could materially impact our results of operations.
The evaluation of impairments is a quantitative and qualitative process, which is subject to risks and uncertainties and is intended to determine whether a credit and/or non-credit impairment exists and whether an impairment should be recognized in current period earnings or in other comprehensive income. The risks and uncertainties include changes in general economic conditions, the issuer’s financial condition or future recovery prospects, the effects of changes in interest rates or credit spreads and the expected recovery period. For securitized financial assets with contractual cash flows, the Company currently uses its best estimate of cash flows over the life of the security. In addition, estimating future cash flows involves incorporating information received from third-party sources and making internal assumptions and judgments regarding the future performance of the underlying collateral and assessing the probability that an adverse change in future cash flows has occurred. The determination of the amount of other-than-temporary impairments is based upon our quarterly evaluation and assessment of known and inherent risks associated with the respective asset class. Such evaluations and assessments are revised as conditions change and new information becomes available.
Additionally, our management considers a wide range of factors about the security issuer and uses their best judgment in evaluating the cause of the decline in the estimated fair value of the security and in assessing the prospects for recovery. Inherent in management’s evaluation of the security are assumptions and estimates about the operations of the issuer and its future earnings potential. Considerations in the impairment evaluation process include, but are not limited to:
   
the length of time and the extent to which the fair value has been less than cost or amortized cost;
   
changes in the financial condition, credit rating and near-term prospects of the issuer;
   
whether the issuer is current on contractually obligated interest and principal payments;
   
changes in the financial condition of the security’s underlying collateral;
   
the payment structure of the security;
   
the potential for impairments in an entire industry sector or sub-sector;
   
the potential for impairments in certain economically depressed geographic locations;
   
the potential for impairments of securities where the issuer, series of issuers or industry has suffered a catastrophic type of loss or has exhausted natural resources;
   
unfavorable changes in forecasted cash flows on mortgage-backed and asset-backed securities;
   
for mortgage-backed and asset-backed securities, commercial and residential property value declines that vary by property type and location and average cumulative collateral loss rates that vary by vintage year;
   
other subjective factors, including concentrations and information obtained from regulators and rating agencies;
   
our intent to sell a debt or an equity security with debt-like characteristics (collectively, “debt security”) or whether it is more likely than not that the Company will be required to sell the debt security before its anticipated recovery; and
   
our intent and ability to retain an equity security without debt-like characteristics for a period of time sufficient to allow for the recovery of its value.
Impairment losses in earnings could materially adversely affect our results of operation and financial condition.

 

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Losses due to nonperformance or defaults by others, including issuers of investment securities (which include structured securities such as commercial mortgage backed securities and residential mortgage backed securities or other high yielding bonds) mortgage loans or reinsurance and derivative instrument counterparties, could have a material adverse effect on the value of our investments, results of operations, financial condition and cash flows.
Issuers or borrowers whose securities or loans we hold, customers, trading counterparties, counterparties under swaps and other derivative contracts, reinsurers, clearing agents, exchanges, clearing houses and other financial intermediaries and guarantors may default on their obligations to us due to bankruptcy, insolvency, lack of liquidity, adverse economic conditions, operational failure, fraud, government intervention or other reasons. Such defaults could have a material adverse effect on our results of operations, financial condition and cash flows. Additionally, the underlying assets supporting our structured securities or loans may deteriorate causing these securities or loans to incur losses.
Our investment portfolio includes securities backed by real estate assets the value of which have been adversely impacted by the recent recessionary period and the associated property value declines, resulting in a reduction in expected future cash flow for certain securities. Further property value declines and loss rates that exceed our current estimates, as outlined in Part II, Item 7, MD&A — Investment Credit Risk — Other-Than-Temporary Impairments, could have a material adverse effect on our results of operations, financial condition and cash flows.
The Company is not exposed to any credit concentration risk of a single issuer greater than 10% of the Company’s stockholders’ equity other than U.S. government and U.S. government agencies backed by the full faith and credit of the U.S. government. However, if issuers of securities or loans we hold are acquired, merge or otherwise consolidate with other issuers of securities or loans held by the Company, the Company’s credit concentration risk could increase above the 10% threshold, for a period of time, until the Company is able to sell securities to get back in compliance with the established investment credit policies.
If assumptions used in estimating future gross profits differ from actual experience, we may be required to accelerate the amortization of DAC and increase reserves for guaranteed minimum death and income benefits, which could have a material adverse effect on our results of operations and financial condition.
The Company defers acquisition costs associated with the sales of its universal and variable life and variable annuity products. These costs are amortized over the expected life of the contracts. The remaining deferred but not yet amortized cost is referred to as the Deferred Acquisition Cost (“DAC”) asset. We amortize these costs in proportion to the present value of estimated gross profits (“EGPs”). The Company evaluates the EGPs compared to the DAC asset to determine if an impairment exists. The Company also establishes reserves for GMDB and GMIB using components of EGPs. The projection of estimated gross profits or components of estimated gross profits requires the use of certain assumptions, principally related to separate account fund returns in excess of amounts credited to policyholders, surrender and lapse rates, interest margin (including impairments), mortality, benefit utilization, annuitization and hedging costs. Of these factors, we anticipate that changes in investment returns are most likely to impact the rate of amortization of such costs. However, other factors such as those the Company might employ to reduce risk, such as the cost of hedging or other risk mitigating techniques, could also significantly reduce estimates of future gross profits. Estimating future gross profits is a complex process requiring considerable judgment and the forecasting of events well into the future. If our assumptions regarding policyholder behavior, including lapse rates, benefit utilization, surrenders, and annuitization, hedging costs or costs to employ other risk mitigating techniques prove to be inaccurate or if significant or sustained equity market declines occur, we could be required to accelerate the amortization of DAC related to variable annuity and variable universal life contracts, and increase reserves for GMDB and GMIB which would result in a charge to net income. Such adjustments could have a material adverse effect on our results of operations and financial condition.
If our businesses do not perform well, we may be required to recognize an impairment of our goodwill or to establish a valuation allowance against the deferred income tax asset, which could have a material adverse effect on our results of operations and financial condition.
Goodwill represents the excess of the amounts we paid to acquire subsidiaries and other businesses over the fair value of their net assets at the date of acquisition. We test goodwill at least annually for impairment. Impairment testing is performed based upon estimates of the fair value of the “reporting unit” to which the goodwill relates. The reporting unit is the operating segment or a business one level below that operating segment if discrete financial information is prepared and regularly reviewed by management at that level. The fair value of the reporting unit is impacted by the performance of the business and could be adversely impacted by any efforts made by the Company to limit risk. If it is determined that the goodwill has been impaired, the Company must write down the goodwill by the amount of the impairment, with a corresponding charge to net income. These write downs could have a material adverse effect on our results of operations or financial condition.
Deferred income tax represents the tax effect of the differences between the book and tax basis of assets and liabilities. Deferred tax assets are assessed periodically by management to determine if they are realizable. Factors in management’s determination include the performance of the business including the ability to generate capital gains, to offset previously recognized capital losses, from a variety of sources and tax planning strategies. If based on available information, it is more likely than not that we are unable to recognize a full tax benefit on realized capital losses, then a valuation allowance will be established with a corresponding charge to net income. Charges to increase our valuation allowance could have a material adverse effect on our results of operations and financial condition.

 

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The occurrence of one or more terrorist attacks in the geographic areas we serve or the threat of terrorism in general may have a material adverse effect on our business, consolidated operating results, financial condition and liquidity.
The occurrence of one or more terrorist attacks in the geographic areas we serve could result in substantially higher claims under our insurance policies than we have anticipated. Private sector catastrophe reinsurance is extremely limited and generally unavailable for terrorism losses caused by attacks with nuclear, biological, chemical or radiological weapons. Reinsurance coverage from the federal government under the Terrorism Risk Insurance Program Reauthorization Act of 2007 is also limited. Accordingly, the effects of a terrorist attack in the geographic areas we serve may result in claims and related losses for which we do not have adequate reinsurance. This would likely cause us to increase our reserves, adversely affect our earnings during the period or periods affected and, could adversely affect our liquidity and financial condition. Further, the continued threat of terrorism and the occurrence of terrorist attacks, as well as heightened security measures and military action in response to these threats and attacks, may cause significant volatility in global financial markets, disruptions to commerce and reduced economic activity. These consequences could have an adverse effect on the value of the assets in our investment portfolio as well as those in our separate accounts. The continued threat of terrorism also could result in increased reinsurance prices and potentially cause us to retain more risk than we otherwise would retain if we were able to obtain reinsurance at lower prices. Terrorist attacks also could disrupt our operations centers in the U.S. or abroad. As a result, it is possible that any, or a combination of all, of these factors may have a material adverse effect on our business, consolidated operating results, financial condition and liquidity.
It is difficult for us to predict our potential exposure for asbestos and environmental claims, and our ultimate liability may exceed our currently recorded reserves, which may have a material adverse effect on our operating results, financial condition and liquidity.
We continue to receive asbestos and environmental claims. Significant uncertainty limits the ability of insurers and reinsurers to estimate the ultimate reserves necessary for unpaid losses and related expenses for both environmental and particularly asbestos claims. For some asbestos and environmental claims, we believe that the actuarial tools and other techniques we employ to estimate the ultimate cost of claims for more traditional kinds of insurance exposure are less precise in estimating reserves for our asbestos and environmental exposures. Accordingly, the degree of variability of reserve estimates for these exposures is significantly greater than for other more traditional exposures. It is also not possible to predict changes in the legal and legislative environment and their effect on the future development of asbestos and environmental claims. Because of the significant uncertainties that limit the ability of insurers and reinsurers to estimate the ultimate reserves necessary for unpaid losses and related expenses for both environmental and particularly asbestos claims, the ultimate liabilities may exceed the currently recorded reserves. Any such additional liability cannot be reasonably estimated now but could have a material adverse effect on our consolidated operating results, financial condition and liquidity.
We are particularly vulnerable to losses from catastrophes, both natural and man-made, which could materially and adversely affect our financial condition, results of operations and liquidity.
Our insurance operations expose us to claims arising out of catastrophes. Catastrophes can be caused by various unpredictable events, including earthquakes, hurricanes, hailstorms, severe winter weather, fires, tornadoes, explosions, pandemics and other natural or man-made disasters. The geographic distribution of our business subjects us to catastrophe exposure for natural events occurring in a number of areas, including, but not limited to, hurricanes in Florida, the Gulf Coast, the Northeast and the Atlantic coast regions of the United States, and earthquakes in California and the New Madrid region of the United States. We expect that increases in the values and concentrations of insured property in these areas will continue to increase the severity of catastrophic events in the future. Starting in 2004 and 2005, third-party catastrophe loss models for hurricane loss events have incorporated medium-term forecasts of increased hurricane frequency and severity — reflecting the potential influence of multi-decadal climate patterns within the Atlantic. In addition, changing climate conditions across longer time scales, including the potential risk of broader climate change, may be increasing, or may in the future increase, the severity of certain natural catastrophe losses across various geographic regions. In addition, changing climate conditions, primarily rising global temperatures, may be increasing, or may in the future increase, the frequency and severity of natural catastrophes such as hurricanes. Potential examples of the impact of climate change on catastrophe exposure include, but are not limited to the following: an increase in the frequency or severity of wind and thunderstorm and tornado/hailstorm events due to increased convection in the atmosphere, more frequent brush fires in certain geographies due to prolonged periods of drought, higher incidence of deluge flooding, and the potential for an increase in severity of the largest hurricane events due to higher sea surface temperatures. Our operations are also exposed to risk of loss from catastrophes associated with pandemics and other events that could significantly increase our mortality and morbidity exposures. Policyholders may be unable to meet their obligations to pay premiums on our insurance policies or make deposits on our investment products.
Our liquidity could be constrained by a catastrophe, or multiple catastrophes, which could result in extraordinary losses. In addition, in part because accounting rules do not permit insurers to reserve for such catastrophic events until they occur, claims from catastrophic events could have a material adverse effect on our financial condition, consolidated results of operations, liquidity and cash flows. To the extent that loss experience unfolds or models improve, we will seek to reflect any increased risk in the design and pricing of our products. However, the Company may be exposed to regulatory or legislative actions that prevent a full accounting of loss expectations in the design or price of our products or result in additional risk-shifting to the insurance industry.

 

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We may incur losses due to our reinsurers’ unwillingness or inability to meet their obligations under reinsurance contracts and the availability, pricing and adequacy of reinsurance may not be sufficient to protect us against losses.
As an insurer, we frequently seek to reduce the losses that may arise from catastrophes, or other events that can cause unfavorable results of operations, through reinsurance. Under these reinsurance arrangements, other insurers assume a portion of our losses and related expenses; however, we remain liable as the direct insurer on all risks reinsured. Consequently, ceded reinsurance arrangements do not eliminate our obligation to pay claims, and we are subject to our reinsurers’ credit risk with respect to our ability to recover amounts due from them. Although we regularly evaluate the financial condition of our reinsurers to minimize our exposure to significant losses from reinsurer insolvencies, our reinsurers may become financially unsound or choose to dispute their contractual obligations by the time their financial obligations become due. The inability or unwillingness of any reinsurer to meet its financial obligations to us could have a material adverse effect on our consolidated operating results. In addition, market conditions beyond our control determine the availability and cost of the reinsurance we are able to purchase. Historically, reinsurance pricing has changed significantly from time to time. No assurances can be made that reinsurance will remain continuously available to us to the same extent and on the same terms as are currently available. If we were unable to maintain our current level of reinsurance or purchase new reinsurance protection in amounts that we consider sufficient and at prices that we consider acceptable, we would have to either accept an increase in our net liability exposure, reduce the amount of business we write, or develop other alternatives to reinsurance.
Our consolidated results of operations, financial condition and cash flows may be materially adversely affected by unfavorable loss development.
Our success, in part, depends upon our ability to accurately assess the risks associated with the businesses that we insure. We establish loss reserves to cover our estimated liability for the payment of all unpaid losses and loss expenses incurred with respect to premiums earned on the policies that we write. Loss reserves do not represent an exact calculation of liability. Rather, loss reserves are estimates of what we expect the ultimate settlement and administration of claims will cost, less what has been paid to date. These estimates are based upon actuarial and statistical projections and on our assessment of currently available data, as well as estimates of claims severity and frequency, legal theories of liability and other factors. Loss reserve estimates are refined periodically as experience develops and claims are reported and settled. Establishing an appropriate level of loss reserves is an inherently uncertain process. Because of this uncertainty, it is possible that our reserves at any given time will prove inadequate. Furthermore, since estimates of aggregate loss costs for prior accident years are used in pricing our insurance products, we could later determine that our products were not priced adequately to cover actual losses and related loss expenses in order to generate a profit. To the extent we determine that losses and related loss expenses are emerging unfavorably to our initial expectations, we will be required to increase reserves. Increases in reserves would be recognized as an expense during the period or periods in which these determinations are made, thereby adversely affecting our results of operations for the related period or periods. Depending on the severity and timing of any changes in these estimated losses, such determinations could have a material adverse effect on our consolidated results of operations, financial condition and cash flows.
Competitive activity may adversely affect our market share and financial results, which could have a material adverse effect on our business, results of operations and financial condition.
The insurance industry is highly competitive. Our competitors include other insurers and, because many of our products include an investment component, securities firms, investment advisers, mutual funds, banks and other financial institutions. In recent years, there has been substantial consolidation and convergence among companies in the insurance and financial services industries resulting in increased competition from large, well-capitalized insurance and financial services firms that market products and services similar to ours. These competitors compete with us for producers such as brokers and independent agents and for our employees. Larger competitors may have lower operating costs and an ability to absorb greater risk while maintaining their financial strength ratings, thereby allowing them to price their products more competitively. These highly competitive pressures could result in increased pricing pressures on a number of our products and services and may harm our ability to maintain or increase our profitability. In addition, as actual or potential future downgrades occur, and if our competitors have not been affected by similar ratings actions, sales of our products could be significantly reduced. Because of the highly competitive nature of the insurance industry, there can be no assurance that we will continue to effectively compete with our industry rivals, or that competitive pressure will not have a material adverse effect on our business, results of operations and financial condition.

 

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As a savings and loan holding company, we remain subject to certain restrictions, oversight and costs that could materially affect our business, results and prospects.
We are a savings and loan holding company by virtue of our ownership of Federal Trust Bank (“FTB”), a federally chartered, FDIC-insured thrift. As a savings and loan holding company, we are subject to various restrictions, oversight and costs and other potential consequences that could materially affect our business, results and prospects. For example, we are subject to regulation, supervision and examination by the OTS, including with respect to required capital, cash flow, organizational structure, risk management and earnings at the parent company level, and to the OTS reporting requirements. All of our activities must be financially-related activities as defined by federal law (which includes insurance activities), and the OTS has enforcement authority over us, including the right to pursue administrative orders or penalties and the right to restrict or prohibit activities determined by the OTS to be a serious risk to FTB. We must also be a source of strength to FTB, which could require further capital contributions. We will be subject to similar, potentially stricter, requirements when regulatory authority over us transfers to The Federal Reserve (for our holding company) and the Office of the Controller of the Currency (“OCC”) (for FTB).
We cannot predict the scope or impact of future regulatory initiatives, including, but not limited to, the impact on required levels of regulatory capital or the cost and complexity of our compliance programs.
The impact of regulatory initiatives, including the enactment of The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), could have a material adverse impact on our results of operations and liquidity.
Regulatory developments relating to the recent financial crisis may significantly affect our operations and prospects in ways that we cannot predict. U.S. and overseas governmental and regulatory authorities, including the SEC, the OTS, The Federal Reserve, the Office of the Controller of the Currency (“OCC”), the New York Stock Exchange and the Financial Industry Regulatory Authority are considering enhanced or new regulatory requirements intended to prevent future crises or otherwise stabilize the institutions under their supervision. Such measures are likely to lead to stricter regulation of financial institutions generally, and heightened prudential requirements for systemically important companies in particular. Such measures could include taxation of financial transactions and restrictions on employee compensation.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) was enacted on July 21, 2010, mandating changes to the regulation of the financial services industry. The Dodd-Frank Act may affect our operations and governance in ways that could adversely affect our financial condition and results of operations.
In particular, the Dodd-Frank Act vests a newly created Financial Services Oversight Council with the power to designate “systemically important” institutions, which will be subject to special regulatory supervision and other provisions intended to prevent, or mitigate the impact of, future disruptions in the U.S. financial system. Systemically important institutions are limited to nonbank financial companies that are so important that their potential failure could “pose a threat to the financial stability of the United States.” If we are designated as a systemically important institution, we could be subject to higher capital requirements and additional regulatory oversight imposed by The Federal Reserve, as well as to post-event assessments imposed by the Federal Deposit Insurance Corporation (“FDIC”) to recoup the costs associated with the orderly resolution of other systemically important institutions in the event one or more such institutions fails. Further, the FDIC is authorized to petition a state court to commence an insolvency proceeding to liquidate an insurance company that fails in the event the insurer’s state regulator fails to act. Other provisions will require central clearing of, and/or impose new margin and capital requirements on, derivatives transactions, which we expect will increase the costs of our hedging program.
A number of provisions of the Dodd-Frank Act affect us solely due to our status as a savings & loan holding company. For example, under the Dodd-Frank Act, the OTS will be dissolved. The Federal Reserve will regulate us as a holding company, and the OCC will regulate our thrift subsidiary, Federal Trust Bank. Because of our status as a savings and loan holding company or if we are designated a systemically important institution, the Dodd-Frank Act may also restrict us from sponsoring and investing in private equity and hedge funds, which would limit our discretion in managing our general account. The Dodd-Frank Act will also impose new minimum capital standards on a consolidated basis for holding companies that, like us, control insured depository institutions.
Other provisions in the Dodd-Frank Act that may impact us, irrespective of whether or not we are a savings and loan holding company include: the possibility that regulators could break up firms that are considered “too big to fail;” a new “Federal Insurance Office” within Treasury to, among other things, conduct a study of how to improve insurance regulation in the United States; new means for regulators to limit the activities of financial firms; discretionary authority for the SEC to impose a harmonized standard of care for investment advisers and broker-dealers who provide personalized advice about securities to retail customers; additional regulation of compensation in the financial services industry; and enhancements to corporate governance, especially regarding risk management.
The changes resulting from the Dodd-Frank Act could adversely affect our results of operation and financial condition.

 

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We may experience unfavorable judicial or legislative developments involving claim litigation that could have a material adverse effect on our results of operations, financial condition and liquidity.
The Hartford 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 Hartford accounts for such activity through the establishment of unpaid loss and loss adjustment expense reserves. The Company is also involved in legal actions that do not arise in the ordinary course of business, some of which assert claims for substantial amounts. Pervasive or significant changes in the judicial environment relating to matters such as trends in the size of jury awards, developments in the law relating to the liability of insurers or tort defendants, and rulings concerning the availability or amount of certain types of damages could cause our ultimate liabilities to change from our current expectations. Changes in federal or state tort litigation laws or other applicable law could have a similar effect. It is not possible to predict changes in the judicial and legislative environment and their impact on the future development of the adequacy of our loss reserves, particularly reserves for longer-tailed lines of business, including asbestos and environmental reserves, and how those changes might adversely affect our ability to price our products appropriately. Our results, financial condition and liquidity could also be adversely affected if judicial or legislative developments cause our ultimate liabilities to increase from current expectations.
Potential changes in domestic and foreign regulation may increase our business costs and required capital levels, which could have a material adverse effect on our business, consolidated operating results, financial condition and liquidity.
We are subject to extensive U.S. and non-U.S. laws and regulations that are complex, subject to change and often conflicting in their approach or intended outcomes. Compliance with these laws and regulations is costly and can affect our strategy, as well as the demand for and profitability of the products we offer. There is also a risk that any particular regulator’s or enforcement authority’s interpretation of a legal issue may change over time to our detriment, or expose us to different or additional regulatory risks.
State insurance laws regulate most aspects of our U.S. insurance businesses, and our insurance subsidiaries are regulated by the insurance departments of the states in which they are domiciled, licensed or authorized to conduct business. U.S. state laws grant insurance regulatory authorities broad administrative powers with respect to, among other things:
 
licensing companies and agents to transact business;
 
calculating the value of assets to determine compliance with statutory requirements;
 
mandating certain insurance benefits;
 
regulating certain premium rates;
 
reviewing and approving policy forms;
 
regulating unfair trade and claims practices, including through the imposition of restrictions on marketing and sales practices, distribution arrangements and payment of inducements;
 
establishing statutory capital and reserve requirements and solvency standards;
 
fixing maximum interest rates on insurance policy loans and minimum rates for guaranteed crediting rates on life insurance policies and annuity contracts;
 
approving changes in control of insurance companies;
 
restricting the payment of dividends and other transactions between affiliates;
 
establishing assessments and surcharges for guaranty funds, second-injury funds and other mandatory pooling arrangements;
 
requiring insurers to dividend to policy holders any excess profits; and
 
regulating the types, amounts and valuation of investments.
State insurance regulators and the NAIC regularly re-examine existing laws and regulations applicable to insurance companies and their products. Our international operations are subject to regulation in the relevant jurisdictions in which they operate, which in many ways is similar to the state regulation outlined above, with similar related restrictions and obligations. Our asset management businesses are also subject to extensive regulation in the various jurisdictions where they operate.
In addition, future regulatory initiatives could be adopted at the federal or state level that could impact the profitability of our businesses. For example, the Obama administration has proposed a financial crisis responsibility tax that would be levied on the largest financial institutions in terms of assets.
These laws and regulations are primarily intended to protect investors in the securities markets or investment advisory clients and generally grant supervisory authorities broad administrative powers. Compliance with these laws and regulations is costly, time consuming and personnel intensive, and may have an adverse effect on our business, consolidated operating results, financial condition and liquidity.

 

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We may experience difficulty in marketing and distributing products through our current and future distribution channels.
We distribute our annuity, life and property and casualty insurance products through a variety of distribution channels, including brokers, independent agents, broker-dealers, banks, wholesalers, affinity partners, our own internal sales force and other third-party organizations. In some areas of our business, we generate a significant portion of our business through or in connection with individual third-party arrangements. For example, we market our Consumer Markets products in part through an exclusive licensing arrangement with AARP that continues through January 2020. Our ability to distribute products through affinity partners may be adversely impacted by membership levels and the pace of membership growth. Moreover, we periodically negotiate provisions and renewals of these relationships, and there can be no assurance that such terms will remain acceptable to us or such third parties. An interruption in our continuing relationship with certain of these third parties could materially affect our ability to market our products and could have a material adverse effect on our business, operating results and financial condition.
Our business, results of operations, financial condition and liquidity may be adversely affected by the emergence of unexpected and unintended claim and coverage issues.
As industry practices and legal, judicial, social and other environmental conditions change, unexpected and unintended issues related to claims and coverage may emerge. These issues may either extend coverage beyond our underwriting intent or increase the frequency or severity of claims. In some instances, these changes may not become apparent until some time after we have issued insurance contracts that are affected by the changes. As a result, the full extent of liability under our insurance contracts may not be known for many years after a contract is issued, and this liability may have a material adverse effect on our business, results of operations, financial condition and liquidity at the time it becomes known.
Our ability to declare and pay dividends is subject to limitations.
The payment of future dividends on our capital stock is subject to the discretion of our board of directors, which considers, among other factors our operating results, overall financial condition, credit-risk considerations and capital requirements, as well as general business and market conditions.
Moreover, as a holding company that is separate and distinct from our insurance subsidiaries, we have no significant business operations of our own. Therefore, we rely on dividends from our insurance company subsidiaries and other subsidiaries as the principal source of cash flow to meet our obligations. These obligations include payments on our debt securities and the payment of dividends on our capital stock. The Connecticut insurance holding company laws limit the payment of dividends by Connecticut-domiciled insurers. In addition, these laws require notice to and approval by the state insurance commissioner for the declaration or payment by those subsidiaries of any dividend if the dividend and other dividends or distributions made within the preceding 12 months exceeds the greater of:
 
10% of the insurer’s policyholder surplus as of December 31 of the preceding year, and
 
net income, or net gain from operations if the subsidiary is a life insurance company, for the previous calendar year, in each case determined under statutory insurance accounting principles.
In addition, if any dividend of a Connecticut-domiciled insurer exceeds the insurer’s earned surplus, it requires the prior approval of the Connecticut Insurance Commissioner.
The insurance holding company laws of the other jurisdictions in which our insurance subsidiaries are incorporated, or deemed commercially domiciled, generally contain similar, and in some instances more restrictive, limitations on the payment of dividends. Our property-casualty insurance subsidiaries are permitted to pay up to a maximum of approximately $1.5 billion in dividends to us in 2011 without prior approval from the applicable insurance commissioner. The Company’s life insurance subsidiaries are permitted to pay up to a maximum of approximately $83 in dividends to Hartford Life, Inc. (“HLI”) in 2011 without prior approval from the applicable insurance commissioner. The aggregate of these amounts, net of amounts required by HLI, is the maximum the insurance subsidiaries could pay to HFSG Holding Company in 2011. In 2010, HFSG Holding Company and HLI received no dividends from the life insurance subsidiaries, and HFSG Holding Company received $1.0 billion in dividends from its property-casualty insurance subsidiaries.
Our rights to participate in any distribution of the assets of any of our subsidiaries, for example, upon their liquidation or reorganization, and the ability of holders of our common stock to benefit indirectly from a distribution, are subject to the prior claims of creditors of the applicable subsidiary, except to the extent that we may be a creditor of that subsidiary. Claims on these subsidiaries by persons other than us include, as of December, 2010, claims by policyholders for benefits payable amounting to $116.9 billion, claims by separate account holders of $159.7 billion, and other liabilities including claims of trade creditors, claims from guaranty associations and claims from holders of debt obligations, amounting to $13.9 billion.
In addition, as a savings and loan holding company, we are subject to regulation, supervision and examination by the OTS, including with respect to required capital, cash flow, organization structure, risk management and earnings at the parent company level. We will be subject to similar, potentially stricter, requirements when regulatory authority over us transfers to The Federal Reserve (for our holding company) and the OCC (for FTB).

 

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Holders of our capital stock are only entitled to receive such dividends as our board of directors may declare out of funds legally available for such payments. Moreover, our common stockholders are subject to the prior dividend rights of any holders of our preferred stock or depositary shares representing such preferred stock then outstanding. As of December 31, 2010, there were 575,000 shares of our Series F Preferred Stock issued and outstanding. Under the terms of the Series F Preferred Stock, our ability to declare and pay dividends on or repurchase our common stock will be subject to restrictions in the event we fail to declare and pay (or set aside for payment) full dividends on the Series F Preferred Stock.
The terms of our outstanding junior subordinated debt securities also prohibit us from declaring or paying any dividends or distributions on our capital stock or purchasing, acquiring, or making a liquidation payment on such stock, if we have given notice of our election to defer interest payments but the related deferral period has not yet commenced or a deferral period is continuing.
As a property and casualty insurer, the premium rates we are able to charge and the profits we are able to obtain are affected by the actions of state insurance departments that regulate our business, the cyclical nature of the business in which we compete and our ability to adequately price the risks we underwrite, which may have a material adverse effect on our consolidated results of operations, financial condition and cash flows.
Pricing adequacy depends on a number of factors, including the ability to obtain regulatory approval for rate changes, proper evaluation of underwriting risks, the ability to project future loss cost frequency and severity based on historical loss experience adjusted for known trends, our response to rate actions taken by competitors, and expectations about regulatory and legal developments and expense levels. We seek to price our property and casualty insurance policies such that insurance premiums and future net investment income earned on premiums received will provide for an acceptable profit in excess of underwriting expenses and the cost of paying claims.
State insurance departments that regulate us often propose premium rate changes for the benefit of the consumer at the expense of the insurer and may not allow us to reach targeted levels of profitability. In addition to regulating rates, certain states have enacted laws that require a property and casualty insurer conducting business in that state to participate in assigned risk plans, reinsurance facilities, joint underwriting associations and other residual market plans, or to offer coverage to all consumers and often restrict an insurer’s ability to charge the price it might otherwise charge. In these markets, we may be compelled to underwrite significant amounts of business at lower than desired rates, participate in the operating losses of residual market plans or pay assessments to fund operating deficits of state-sponsored funds, possibly leading to an unacceptable returns on equity. The laws and regulations of many states also limit an insurer’s ability to withdraw from one or more lines of insurance in the state, except pursuant to a plan that is approved by the state’s insurance department. Additionally, certain states require insurers to participate in guaranty funds for impaired or insolvent insurance companies. These funds periodically assess losses against all insurance companies doing business in the state. Any of these factors could have a material adverse effect on our consolidated results of operations, financial condition and cash flows.
Additionally, the property and casualty insurance market is historically cyclical, experiencing periods characterized by relatively high levels of price competition, less restrictive underwriting standards and relatively low premium rates, followed by periods of relatively low levels of competition, more selective underwriting standards and relatively high premium rates. Prices tend to increase for a particular line of business when insurance carriers have incurred significant losses in that line of business in the recent past or when the industry as a whole commits less of its capital to writing exposures in that line of business. Prices tend to decrease when recent loss experience has been favorable or when competition among insurance carriers increases. In a number of product lines and states, we continue to experience premium rate reductions. In these product lines and states, there is a risk that the premium we charge may ultimately prove to be inadequate as reported losses emerge. Even in a period of rate increases, there is a risk that regulatory constraints, price competition or incorrect pricing assumptions could prevent us from achieving targeted returns. Inadequate pricing could have a material adverse effect on our consolidated results of operations.
If we are unable to maintain the availability of our systems and safeguard the security of our data due to the occurrence of disasters or other unanticipated events, our ability to conduct business may be compromised, which may have a material adverse effect on our business, consolidated results of operations, financial condition or cash flows.
We use computer systems to store, retrieve, evaluate and utilize customer and company data and information. Our computer, information technology and telecommunications systems, in turn, interface with and rely upon third-party systems. Our business is highly dependent on our ability, and the ability of certain affiliated third parties, to access these systems to perform necessary business functions, including, without limitation, providing insurance quotes, processing premium payments, making changes to existing policies, filing and paying claims, administering variable annuity products and mutual funds, providing customer support and managing our investment portfolios and hedging programs. Systems failures or outages could compromise our ability to perform these functions in a timely manner, which could harm our ability to conduct business and hurt our relationships with our business partners and customers. In the event of a disaster such as a natural catastrophe, an industrial accident, a blackout, a computer virus, a terrorist attack or war, our systems may be inaccessible to our employees, customers or business partners for an extended period of time. Even if our employees are able to report to work, they may be unable to perform their duties for an extended period of time if our data or systems are disabled or destroyed. Our systems could also be subject to physical and electronic break-ins, and subject to similar disruptions from unauthorized tampering with our systems. This may impede or interrupt our business operations and may have a material adverse effect on our business, consolidated operating results, financial condition or cash flows.

 

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Our framework for managing business risks may not be effective in mitigating risk and loss to us that could adversely affect our businesses.
Our business performance is highly dependent on our ability to manage risks that arise from a large number of day-to-day business activities, including insurance underwriting, claims processing, servicing, investment, financial and tax reporting, compliance with regulatory requirements and other activities, many of which are very complex and for some of which we rely on third parties. We seek to monitor and control our exposure to risks arising out of these activities through a risk control framework encompassing a variety of reporting systems, internal controls, management review processes and other mechanisms. We cannot be completely confident that these processes and procedures will effectively control all known risks or effectively identify unforeseen risks, or that our employees and third-party agents will effectively implement them. Management of business risks can fail for a number of reasons, including design failure, systems failure, failures to perform or unlawful activities on the part of employees or third parties. In the event that our controls are not effective or not properly implemented, we could suffer financial or other loss, disruption of our businesses, regulatory sanctions or damage to our reputation. Losses resulting from these failures can vary significantly in size, scope and scale and may have material adverse effects on our financial condition or results of operations.
If we experience difficulties arising from outsourcing relationships, our ability to conduct business may be compromised.
We outsource certain technology and business functions to third parties and expect to do so selectively in the future. If we do not effectively develop and implement our outsourcing strategy, third-party providers do not perform as anticipated, or we experience problems with a transition, we may experience operational difficulties, inability to meet obligations, including, but not limited to, policyholder obligations, increased costs and a loss of business that may have a material adverse effect on our consolidated results of operations.
Potential changes in federal or state tax laws, including changes impacting the availability of the separate account dividend received deduction, could adversely affect our business, consolidated operating results or financial condition or liquidity.
Many of the products that the Company sells benefit from one or more forms of tax-favored status under current federal and state income tax regimes. For example, the Company sells life insurance policies that benefit from the deferral or elimination of taxation on earnings accrued under the policy, as well as permanent exclusion of certain death benefits that may be paid to policyholders’ beneficiaries. We also sell annuity contracts that allow the policyholders to defer the recognition of taxable income earned within the contract. Other products that the Company sells also enjoy similar, as well as other, types of tax advantages. The Company also benefits from certain tax items, including but not limited to, tax-exempt bond interest, dividends-received deductions, tax credits (such as foreign tax credits), and insurance reserve deductions.
Due in large part to the recent financial crisis that has affected many governments, there is an increasing risk that federal and/or state tax legislation could be enacted that would result in higher taxes on insurance companies and/or their policyholders. Although the specific form of any such potential legislation is uncertain, it could include lessening or eliminating some or all of the tax advantages currently benefiting the Company or its policyholders including, but not limited to, those mentioned above. This could occur in the context of deficit reduction or other tax reforms. The effects of any such changes could result in materially lower product sales, lapses of policies currently held, and/or our incurrence of materially higher corporate taxes.
Changes in accounting principles and financial reporting requirements could result in material changes to our reported results and financial condition.
U.S. GAAP and related financial reporting requirements are complex, continually evolving and may be subject to varied interpretation by the relevant authoritative bodies. Such varied interpretations could result from differing views related to specific facts and circumstances. Changes in U.S. GAAP and financial reporting requirements, or in the interpretation of U.S. GAAP or those requirements, could result in material changes to our reported results and financial condition. Moreover, the SEC is currently evaluating International Financial Reporting Standards (“IFRS”) to determine whether IFRS should be incorporated into the financial reporting system for U.S. issuers. Certain of these standards could result in material changes to our reported results of operation.
We may not be able to protect our intellectual property and may be subject to infringement claims.
We rely on a combination of contractual rights and copyright, trademark, patent and trade secret laws to establish and protect our intellectual property. Although we use a broad range of measures to protect our intellectual property rights, third parties may infringe or misappropriate our intellectual property. We may have to litigate to enforce and protect our copyrights, trademarks, patents, trade secrets and know-how or to determine their scope, validity or enforceability, which represents a diversion of resources that may be significant in amount and may not prove successful. The loss of intellectual property protection or the inability to secure or enforce the protection of our intellectual property assets could have a material adverse effect on our business and our ability to compete.
We also may be subject to costly litigation in the event that another party alleges our operations or activities infringe upon another party’s intellectual property rights. Third parties may have, or may eventually be issued, patents that could be infringed by our products, methods, processes or services. Any party that holds such a patent could make a claim of infringement against us. We may also be subject to claims by third parties for breach of copyright, trademark, trade secret or license usage rights. Any such claims and any resulting litigation could result in significant liability for damages. If we were found to have infringed a third-party patent or other intellectual property rights, we could incur substantial liability, and in some circumstances could be enjoined from providing certain products or services to our customers or utilizing and benefiting from certain methods, processes, copyrights, trademarks, trade secrets or licenses, or alternatively could be required to enter into costly licensing arrangements with third parties, all of which could have a material adverse effect on our business, results of operations and financial condition.

 

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Item 1B. UNRESOLVED STAFF COMMENTS
None.
Item 2. PROPERTIES
As of December 31, 2010, The Hartford owned building space of approximately 3.2 million square feet, of which approximately 2.9 million square feet, comprised its Hartford, Connecticut location and other properties within the greater Hartford, Connecticut area. In addition, as of December 31, 2010, The Hartford leased approximately 3.5 million square feet, throughout the United States of America, and approximately 203 thousand square feet, in other countries. All of the properties owned or leased are used by one or more of all seven reporting segments, depending on the location. For more information on reporting segments, see Part I, Item 1, Business of The Hartford — Reporting Segments. The Company believes its properties and facilities are suitable and adequate for current operations.
Item 3. LEGAL PROCEEDINGS
Litigation
The Hartford 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 Hartford accounts for such activity through the establishment of unpaid loss and loss adjustment expense reserves. Subject to the uncertainties discussed below under the caption “Asbestos and Environmental Claims,” management expects that the ultimate liability, if any, with respect to such ordinary-course claims litigation, after consideration of provisions made for potential losses and costs of defense, will not be material to the consolidated financial condition, results of operations or cash flows of The Hartford.
The Hartford is also involved in other kinds of legal actions, some of which assert claims for substantial amounts. These actions include, among others, putative state and federal class actions seeking certification of a state or national class. Such putative class actions have alleged, for example, underpayment of claims or improper underwriting practices in connection with various kinds of insurance policies, such as personal and commercial automobile, property, life and inland marine; improper sales practices in connection with the sale of life insurance and other investment products; and improper fee arrangements in connection with investment products. The Hartford also is involved in individual actions in which punitive damages are sought, such as claims alleging bad faith in the handling of insurance claims. Like many other insurers, The Hartford also has been joined in actions by asbestos plaintiffs asserting, among other things, that insurers had a duty to protect the public from the dangers of asbestos and that insurers committed unfair trade practices by asserting defenses on behalf of their policyholders in the underlying asbestos cases. 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 Hartford. 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 Company’s consolidated results of operations or cash flows in particular quarterly or annual periods.
Broker Compensation Litigation — Following the New York Attorney General’s 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. Two consolidated amended complaints were 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 dismissed the Sherman Act and RICO claims in both complaints for failure to state a claim and granted the defendants’ motions for summary judgment on the ERISA claims in the group-benefits products complaint. The district court further declined to exercise supplemental jurisdiction over the state law claims and dismissed those claims without prejudice. The plaintiffs appealed the dismissal of the claims in both consolidated amended complaints, except the ERISA claims. In August 2010, the United States Court of Appeals for the Third Circuit affirmed the dismissal of the Sherman Act and RICO claims against the Company. The Third Circuit vacated the dismissal of the Sherman Act and RICO claims against some defendants in the property casualty insurance case and vacated the dismissal of the state-law claims as to all defendants in light of the reinstatement of the federal claims. In September 2010, the district court entered final judgment for the defendants in the group benefits case. The defendants have moved to dismiss the remaining claims in the property casualty insurance case.

 

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Investment and Savings Plan ERISA and Shareholder Securities Class Action Litigation — In November and December 2008, following a decline in the share price of the Company’s common stock, seven putative class action lawsuits were filed in the United States District Court for the District of Connecticut on behalf of certain participants in the Company’s Investment and Savings Plan (the “Plan”), which offers the Company’s common stock as one of many investment options. These lawsuits have been consolidated, and a consolidated amended class-action complaint was filed on March 23, 2009, alleging that the Company and certain of its officers and employees violated ERISA by allowing the Plan’s participants to invest in the Company’s common stock and by failing to disclose to the Plan’s participants information about the Company’s financial condition. The lawsuit seeks restitution or damages for losses arising from the investment of the Plan’s assets in the Company’s common stock during the period from December 10, 2007 to the present. In January 2010, the district court denied the Company’s motion to dismiss the consolidated amended complaint. In February 2011, the parties reached an agreement in principle to settle on a class basis for an immaterial amount. The settlement is contingent upon the execution of a final settlement agreement and preliminary and final court approval.
The Company and certain of its present or former officers are defendants in a putative securities class action lawsuit filed in the United States District Court for the Southern District of New York in March 2010. The operative complaint, filed in October 2010, is brought on behalf of persons who acquired Hartford common stock during the period of July 28, 2008 through February 5, 2009, and alleges that the defendants violated Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5, by making false or misleading statements during the alleged class period about the Company’s valuation of certain asset-backed securities and its effect on the Company’s capital position. The Company disputes the allegations and has moved to dismiss the complaint.
Fair Credit Reporting Act Class Action — In February 2007, the United States District Court for the District of Oregon gave final approval of the Company’s settlement of a lawsuit brought on behalf of a class of homeowners and automobile policy holders alleging that the Company willfully violated the Fair Credit Reporting Act by failing to send appropriate notices to new customers whose initial rates were higher than they would have been had the customer had a more favorable credit report. The Company paid approximately $84.3 to eligible claimants and their counsel in connection with the settlement, and sought reimbursement from the Company’s Excess Professional Liability Insurance Program for the portion of the settlement in excess of the Company’s $10 self-insured retention. Certain insurance carriers participating in that program disputed coverage for the settlement, and one of the excess insurers commenced an arbitration that resulted in an award in the Company’s favor and payments to the Company of approximately $30.1, thereby exhausting the primary and first-layer excess policies. In June 2009, the second-layer excess carriers commenced an arbitration to resolve the dispute over coverage for the remainder of the amounts paid by the Company. The arbitration hearing is scheduled for May 2011. Management believes it is probable that the Company’s coverage position ultimately will be sustained.
Mutual Funds Litigation — In October 2010, a derivative action was brought on behalf of six Hartford retail mutual funds in the United States District Court for the District of Delaware, alleging that Hartford Investment Financial Services, LLC received excessive advisory and distribution fees in violation of its statutory fiduciary duty under Section 36(b) of the Investment Company Act of 1940. Plaintiff seeks to rescind the investment management agreements and distribution plans between the Company and the six mutual funds and to recover the total fees charged thereunder or, in the alternative, to recover any improper compensation the Company received. The Company disputes the allegations and has moved to dismiss the complaint.
Structured Settlement Class Action — 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 alleged that since 1997 the Company 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 asserted claims under the Racketeer Influenced and Corrupt Organizations Act (“RICO”) and state law. The district court certified a class for the RICO and fraud claims in March 2009, and the Company’s 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. In April 2010, the parties reached an agreement in principle to settle on a nationwide class basis, under which the Company would pay $72.5 in exchange for a full release and dismissal of the litigation. The $72.5 was accrued in the first quarter of 2010. The settlement received final court approval in September 2010 and was paid in the third quarter of 2010.
Asbestos and Environmental Claims — As discussed in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations under the caption “Reserving for Asbestos and Environmental Claims within Other Operations,” The Hartford continues to receive asbestos and environmental claims that involve significant uncertainty regarding policy coverage issues. Regarding these claims, The Hartford continually reviews its overall reserve levels and reinsurance coverages, as well as the methodologies it uses to estimate its exposures. Because of the significant uncertainties that limit the ability of insurers and reinsurers to estimate the ultimate reserves necessary for unpaid losses and related expenses, particularly those related to asbestos, the ultimate liabilities may exceed the currently recorded reserves. Any such additional liability cannot be reasonably estimated now but could be material to The Hartford’s consolidated operating results, financial condition and liquidity.

 

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Item 4. (Removed and Reserved)
PART II
Item 5.   MARKET FOR THE HARTFORD’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Hartford’s common stock is traded on the New York Stock Exchange (“NYSE”) under the trading symbol “HIG”.
The following table presents the high and low closing prices for the common stock of The Hartford on the NYSE for the periods indicated, and the quarterly dividends declared per share.
                                 
    1st Qtr.     2nd Qtr.     3rd Qtr.     4th Qtr.  
2010
                               
Common Stock Price
                               
High
  $ 28.58     $ 29.64     $ 24.12     $ 27.43  
Low
  $ 22.34     $ 22.13     $ 19.09     $ 22.26  
Dividends Declared
  $ 0.05     $ 0.05     $ 0.05     $ 0.05  
2009
                               
Common Stock Price
                               
High
  $ 19.68     $ 18.16     $ 28.62     $ 29.20  
Low
  $ 3.62     $ 7.67     $ 10.18     $ 23.16  
Dividends Declared
  $ 0.05     $ 0.05     $ 0.05     $ 0.05  
On February 2, 2011, The Hartford’s Board of Directors declared a quarterly dividend of $0.10 per common share payable on April 1, 2011 to common shareholders of record as of March 1, 2011.
As of February 18, 2011, the Company had approximately 223,500 shareholders. The closing price of The Hartford’s common stock on the NYSE on February 18, 2011 was $30.80.
The Company’s Chief Executive Officer has certified to the NYSE that he is not aware of any violation by the Company of NYSE corporate governance listing standards, as required by Section 303A.12(a) of the NYSE’s Listed Company Manual.
There are also various legal and regulatory limitations governing the extent to which The Hartford’s insurance subsidiaries may extend credit, pay dividends or otherwise provide funds to The Hartford Financial Services Group, Inc. as discussed in Part II, Item 7, MD&A — Capital Resources and Liquidity — Liquidity Requirements and Sources of Capital.
See Part III, Item 12, Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters, for information related to securities authorized for issuance under equity compensation plans.
Purchases of Equity Securities by the Issuer
The following table summarizes the Company’s repurchases of its common stock for the three months ended December 31, 2010:
                                 
                    Total Number of     Approximate Dollar  
                    Shares Purchased as     Value of Shares that  
    Total Number     Average Price     Part of Publicly     May Yet Be  
    of Shares     Paid Per     Announced Plans or     Purchased Under  
Period   Purchased [1]     Share     Programs     the Plans or Programs  
                            (in millions)  
October 1, 2010 – October 31, 2010
    6,351     $ 23.53           $ 807  
November 1, 2010 – November 30, 2010
    4,820     $ 23.95           $ 807  
December 1, 2010 – December 31, 2010
        $           $ 807  
 
                       
Total
    11,171     $ 23.71             N/A  
 
                       
     
[1]  
Represents shares acquired from employees of the Company for tax withholding purposes in connection with the Company’s stock compensation plans.
The Hartford’s Board of Directors has authorized a $1 billion stock repurchase program. The Company’s repurchase authorization permits purchases of common stock, which may be in the open market or through privately negotiated transactions. The Company also may enter into derivative transactions to facilitate future repurchases of common stock. The timing of any future repurchases will be dependent upon several factors, including the market price of the Company’s securities, the Company’s capital position, consideration of the effect of any repurchases on the Company’s financial strength or credit ratings, and other corporate considerations. The repurchase program may be modified, extended or terminated by the Board of Directors at any time.

 

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Total Return to Shareholders
The following tables present The Hartford’s annual percentage return and five-year total return on its common stock including reinvestment of dividends in comparison to the S&P 500 and the S&P Insurance Composite Index.
Annual Return Percentage
                                         
    For the Years Ended  
Company/Index   2006     2007     2008     2009     2010  
The Hartford Financial Services Group, Inc.
    10.82 %     (4.55 %)     (79.99 %)     43.91 %     14.89 %
S&P 500 Index
    15.79 %     5.49 %     (37.00 %)     26.46 %     15.06 %
S&P Insurance Composite Index
    10.91 %     (6.31 %)     (58.14 %)     13.90 %     15.80 %
Cumulative Five-Year Total Return
                                                 
    Base Period     For the Years Ended  
Company/Index   2005     2006     2007     2008     2009     2010  
The Hartford Financial Services Group, Inc.
  $ 100     $ 110.82     $ 105.77     $ 21.16     $ 30.46     $ 34.99  
S&P 500 Index
  $ 100     $ 115.79     $ 122.16     $ 76.96     $ 97.33     $ 111.99  
S&P Insurance Composite Index
  $ 100     $ 110.91     $ 103.92     $ 43.50     $ 49.54     $ 57.37  
(PERFORMANCE GRAPH)

 

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Item 6. SELECTED FINANCIAL DATA
(In millions, except for per share data and combined ratios)
                                         
    2010     2009     2008     2007     2006  
Income Statement Data
                                       
Earned premiums
  $ 14,055     $ 14,424     $ 15,503     $ 15,619     $ 15,023  
Fee income
    4,784       4,576       5,135       5,436       4,739  
Net investment income (loss):
                                       
Securities available-for-sale and other
    4,392       4,031       4,335       5,214       4,691  
Equity securities, trading
    (774 )     3,188       (10,340 )     145       1,824  
 
                             
Total net investment income (loss)
    3,618       7,219       (6,005 )     5,359       6,515  
Net realized capital losses:
                                       
Total other-than-temporary impairment (“OTTI”) losses
    (852 )     (2,191 )     (3,964 )     (483 )     (121 )
OTTI losses recognized in other comprehensive income
    418       683                    
 
                             
Net OTTI losses recognized in earnings
    (434 )     (1,508 )     (3,964 )     (483 )     (121 )
Net realized capital losses, excluding net OTTI losses recognized in earnings
    (120 )     (502 )     (1,954 )     (511 )     (130 )
 
                             
Total net realized capital gains (losses)
    (554 )     (2,010 )     (5,918 )     (994 )     (251 )
Other revenues
    480       492       504       496       474  
 
                             
Total revenues
    22,383       24,701       9,219       25,916       26,500  
Benefits, losses and loss adjustment expenses
    13,025       13,831       14,088       13,919       13,218  
Benefits, losses and loss adjustment expenses — returns credited on international variable annuities
    (774 )     3,188       (10,340 )     145       1,824  
Amortization of deferred policy acquisition costs and present value of future profits
    2,544       4,267       4,271       2,989       3,558  
Insurance operating costs and other expenses
    4,663       4,635       4,703       4,595       4,021  
Interest expense
    508       476       343       263       277  
Goodwill impairment
    153       32       745              
 
                             
Total benefits, losses and expenses
    20,119       26,429       13,810       21,911       22,898  
Income (loss) before income taxes
    2,264       (1,728 )     (4,591 )     4,005       3,602  
Income tax expense (benefit)
    584       (841 )     (1,842 )     1,056       857  
 
                             
Net income (loss)
    1,680       (887 )     (2,749 )     2,949       2,745  
Preferred stock dividends and accretion of discount
    515       127       8              
 
                             
Net income (loss) available to common shareholders
  $ 1,165     $ (1,014 )   $ (2,757 )   $ 2,949     $ 2,745  
 
                             
Balance Sheet Data
                                       
Separate account assets
  $ 159,742     $ 150,394     $ 130,184     $ 199,946     $ 180,484  
Total assets
    318,346       307,717       287,583       360,361       326,544  
Short-term debt
    400       343       398       1,365       599  
Long-term debt
    6,207       5,496       5,823       3,142       3,504  
Separate account liabilities
    159,742       150,394       130,184       199,946       180,484  
Stockholders’ equity, excluding AOCI
    21,312       21,177       16,788       20,062       18,698  
AOCI, net of tax
    (1,001 )     (3,312 )     (7,520 )     (858 )     178  
Total stockholders’ equity
    20,311       17,865       9,268       19,204       18,876  
 
                             
Earnings (Loss) Per Common Share Data
                                       
Basic
  $ 2.70     $ (2.93 )   $ (8.99 )   $ 9.32     $ 8.89  
Diluted
    2.49       (2.93 )     (8.99 )     9.24       8.69  
Cash dividends declared per common share
    0.20       0.20       1.91       2.03       1.70  
 
                             
Other Data
                                       
Total revenues, excluding net investment income on equity securities, trading, and total OTTI losses
  $ 24,009     $ 23,704     $ 23,523     $ 26,254     $ 24,797  
DAC Unlock benefit (charge), after-tax
  $ 111     $ (1,034 )   $ (932 )   $ 213     $ (76 )
Total investments, excluding equity securities, trading
  $ 98,175     $ 93,235     $ 89,287     $ 94,904     $ 89,778  
 
                             

 

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Item 7.  
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollar amounts in millions, except for per share data, unless otherwise stated)
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) addresses the financial condition of The Hartford Financial Services Group, Inc. and its subsidiaries (collectively, “The Hartford” or the “Company”) as of December 31, 2010, compared with December 31, 2009, and its results of operations for each of the three years in the period ended December 31, 2010. This discussion should be read in conjunction with the Consolidated Financial Statements and related Notes beginning on page F-1. The Hartford made changes to its reporting segments in 2010 to reflect the manner in which the Company is currently organized for purposes of making operating decisions and assessing performance. Accordingly, segment data for prior reporting periods has been adjusted to reflect the new segment reporting, see Note 3 of the Notes to Consolidated Financial Statement for further discussion. Additionally, certain reclassifications have been made to prior year financial information to conform to the current year presentation. The Hartford defines increases or decreases greater than or equal to 200%, or changes from a net gain to a net loss position, or vice versa, as “NM” or not meaningful.
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CONSOLIDATED RESULTS OF OPERATIONS
                                         
                            Increase     Increase  
                            (Decrease) From     (Decrease) From  
Segment Results   2010     2009     2008     2009 to 2010     2008 to 2009  
Property & Casualty Commercial
  $ 995     $ 899     $ 133     $ 96     $ 766  
Group Benefits
    185       193       (6 )     (8 )     199  
 
                             
Commercial Markets
    1,180       1,092       127       88       965  
 
                                       
Consumer Markets
    143       140       102       3       38  
 
                                       
Global Annuity
    404       (1,166 )     (2,287 )     1,570       1,121  
Life Insurance
    262       39       (19 )     223       58  
Retirement Plans
    47       (222 )     (157 )     269       (65 )
Mutual Funds
    132       34       37       98       (3 )
 
                             
Wealth Management
    845       (1,315 )     (2,426 )     2,160       1,111  
 
                                       
Corporate and Other
    (488 )     (804 )     (552 )     316       (252 )
 
                             
Net income (loss)
  $ 1,680     $ (887 )   $ (2,749 )   $ 2,567     $ 1,862  
 
                             
Year ended December 31, 2010 compared to the year ended December 31, 2009
The change from consolidated net loss to consolidated net income was primarily due to a DAC Unlock charge of $1.0 billion, after-tax, in 2009 compared to a benefit of $111, after-tax, in 2010, net realized capital losses of $1.7 billion, after-tax, in 2009 compared to losses of $184, after-tax, in 2010, partially offset by a goodwill impairment of approximately $32, after-tax, in 2009, compared to approximately $100, after-tax, in 2010.
Excluding the after-tax impacts of net realized capital losses, DAC Unlocks and goodwill impairments, earnings decreased $46 from 2009 to 2010. See the segment sections of the MD&A for a discussion on their respective performances.
Year ended December 31, 2009 compared to the year ended December 31, 2008
The decrease in consolidated net loss was primarily due to a decrease in net realized losses, which included other-than-temporary impairments of $1.5 billion in 2009 compared to $4.0 billion in 2008, and gains on the variable annuity hedge program of $631 in 2009 compared to losses of $639 in 2008. Partially offsetting the decrease in realized losses was approximately $300 in net realized capital losses in 2009 related to the settlement of a contingent obligation to Allianz SE (“Allianz”). Goodwill impairments of $32, after-tax, in 2009 compared to impairments of $597, after-tax, in 2008 also contributed to the decrease in net loss.
Excluding the after-tax impacts of net realized capital losses and goodwill impairments, earnings decreased $608 from 2008 to 2009 driven by decreases in fee income due to lower average assets under management primarily in Global Annuity, lower net investment income on available-for-sale and other securities primarily due to lower income on fixed maturities, and restructuring costs. See the segment sections of the MD&A for a discussion on their respective performances.
Income Taxes
The effective tax rates for 2010, 2009 and 2008 were 26%, 49%, and 40%, respectively. The principal causes of the differences between the effective rate and the U.S. statutory rate of 35% for 2010, 2009 and 2008 were tax-exempt interest earned on invested assets and the separate account dividends received deduction (“DRD”). This caused a decrease in the tax expense on the 2010 pre-tax income and an increase in the tax benefit on the 2009 and 2008 pre-tax losses. The effective tax rate for 2010 also includes the effect of an increase in the valuation allowance on the deferred tax asset and the effective tax rate for 2009 includes the tax effect of a non-deductible expense related to the settlement of a contingent obligation to Allianz. For additional information, see Note 13 of the Notes to Consolidated Financial Statements.
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 distribution from these mutual funds, amounts of short-term capital gains at the mutual fund level and the Company’s taxable income before the DRD. The Company recorded benefits of $145, $181 and $176 related to the separate account DRD in the years ended December 31, 2010, 2009 and 2008, respectively. These amounts included benefits (charges) related to prior years’ tax returns of $(3), $29 and $9 in 2010, 2009 and 2008, respectively.

 

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In Revenue Ruling 2007-61, issued on September 25, 2007, the IRS announced its intention to issue regulations with respect to certain computational aspects of the DRD on separate account assets held in connection with variable annuity contracts. Revenue Ruling 2007-61 suspended Revenue Ruling 2007-54, issued in August 2007 that purported to change accepted industry and IRS interpretations of the statutes governing these computational questions. Any regulations that the IRS may ultimately propose for issuance in this area will be subject to public notice and comment, at which time insurance companies and other members of the public will have the opportunity to raise legal and practical questions about the content, scope and application of such regulations. As a result, the ultimate timing and substance of any such regulations are unknown, but they could result in the elimination of some or all of the separate account DRD tax benefit that the Company receives. Management believes that it is highly likely that any such regulations would apply prospectively only.
The Company receives a foreign tax credit against its U.S. tax liability for foreign taxes paid by the Company including payments from its separate account assets. The separate account foreign tax credit is estimated for the current year using information from the most recent filed return, adjusted for the change in the allocation of separate account investments to the international equity markets during the current year. The actual current year foreign tax credit can vary from the estimates due to actual foreign tax credits passed through by the mutual funds. The Company recorded benefits of $4, $16 and $16 related to the separate account foreign tax credit in the years ended December 31, 2010, 2009 and 2008, respectively. These amounts included benefits (charges) related to prior years’ tax returns of $(4), $3 and $4 in 2010, 2009 and 2008, respectively.
The Company’s unrecognized tax benefits were unchanged during 2010, remaining at $48 as of December 31, 2010. This entire amount, if it were recognized, would affect the effective tax rate.

 

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OUTLOOKS
The Hartford provides projections and other forward-looking information in the following discussions, which contain many forward-looking statements, particularly relating to the Company’s future financial performance. These forward-looking statements are estimates based on information currently available to the Company, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and are subject to the precautionary statements set forth on page 3 of this Form 10-K. Actual results are likely to differ, and in the past have differed, materially from those forecast by the Company, depending on the outcome of various factors, including, but not limited to, those set forth in each discussion below and in Item 1A, Risk Factors.
In 2011, The Hartford will continue to focus on growing its three customer-oriented divisions, Commercial Markets, Consumer Markets, and Wealth Management, through enhanced product development, leveraging synergies of the divisions’ product offerings to meet customer needs, and increased efficiencies throughout the organization. The speed and extent of economic and employment expansion may impact the asset protection businesses where insureds may change their level of insurance, and asset accumulation businesses may see customers changing their level of savings based on anticipated economic conditions. The performance of The Hartford’s divisions is subject to uncertainty due to market conditions, which impact the earnings of its asset management businesses and the valuation and earnings on its investment portfolio.
Commercial Markets
Commercial Markets will continue to focus on growth through market-differentiated products and services while maintaining a disciplined underwriting approach. In the Property & Casualty Commercial insurance marketplace, improving market conditions are expected to allow for moderate price increases, while a slowly-recovering economy will result in an increase in insurance exposures. Within Property & Casualty Commercial, the Company expects low to mid single-digit written premium growth in 2011, due to an increase in pricing, higher new business premium and an increase in premium retention. Additionally, Property & Casualty Commercial is expected to continue to grow policy counts, particularly for our small commercial business, led by an increase in workers’ compensation in force. This growth potential reflects the combination of our current market position, a broadening of underwriting expertise focused on selected industries, a leveraging of the payroll model, and numerous initiatives launched in the past several years. Initiatives include programs aimed at improving policy count retention, the rollout of new product offerings and the introduction of ease of doing business technology for our small commercial business. The Property & Casualty Commercial combined ratio before catastrophes and prior accident year development is expected to be slightly higher in 2011 than the 93.4 achieved in 2010 as pricing increases are expected to largely offset loss cost changes. In the Group Benefits, the economic downturn, combined with the potential for employees to lessen spending on the Company’s products and the overall competitive environment, reduced premium levels in 2010. Premium levels are expected to remain relatively flat in 2011, or until there is economic expansion with lower unemployment rates compared to 2010 levels. Over time, as employers design benefit strategies to attract and retain employees, while attempting to control their benefit costs, management believes that the need for the Company’s products will continue to expand. This combined with the significant number of employees who currently do not have coverage or adequate levels of coverage, creates continued opportunities for our products and services. The Company experienced higher disability loss ratios in 2010. The Company anticipates loss ratios to remain essentially flat in 2011.
Consumer Markets
In 2011, Consumer Markets expects to increase its business written with AARP members and enter into new affinity relationships. Management expects new business will primarily be generated from continued direct marketing to AARP members, marketing to households associated with other affinity groups, expanding the sale of the Open Road Advantage auto product through independent agents and introducing an enhanced homeowners product called Hartford Home Advantage. The Company distributes its discounted AARP Open Road Advantage auto product through those independent agents who are authorized to offer the AARP product and, beginning in 2011, will distribute its Hartford Home Advantage product on a discounted basis through those same authorized agents. The Company expects non-AARP member Agency earned premium to decline in 2011 as the result of continued pricing and underwriting actions to improve profitability, including efforts to reposition the book into more business for insureds aged 40+. As of December 31, 2010, the Open Road Advantage auto product was available in 33 states and the Company expects the product to be available to authorized agents in 42 states by the end of the second quarter of 2011. The Company began rolling out its Hartford Home Advantage product during the first quarter of 2011 and expects the product to be available in 39 states by the end of 2011. Management expects that the combined ratio before catastrophes and prior accident year development will improve in 2011, driven by earned pricing increases, slightly improving claim frequency and modest claim severity in both auto and home as the Company expects to benefit from a continued shift to a more preferred mix of business.

 

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Wealth Management
The partial equity market recovery over the last eighteen months has driven an increase in deposits and assets under management; however profitability rates are not consistent with historical levels. The current market conditions and market volatility have increased the cost and volatility of hedging programs, and the level of capital needed to support living benefit guarantees when compared to historical levels. Management is committed to the U.S. variable annuity marketplace and will continue to evaluate the benefits offered within its variable annuities, and ensure the product portfolio meets customer needs within the risk tolerances of The Hartford. Wealth Management seeks to achieve scale through increased deposits and market improvements along with a focus on expense reductions. Wealth Management will focus on product development to increase sales of its products and services to the “baby boomer” generation. The Company expects that many “baby boomers” will be looking to provide more stability to the value of their accumulated wealth and will focus more on identifying and creating dependable and certain income streams that can provide known payments throughout their retirement. As the mutual fund 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. Wealth Management will increase future sales of its Life Insurance products by implementing strategies to expand distribution capabilities, including utilizing independent agents and continuing to build on the strong relationships within the financial institution marketplace. Retirement Plans looks to continue to focus on our clients’ increasing needs for retirement income security given the recent volatility in the financial markets and to provide products that respond to the needs of plan sponsors to manage risk and stretch their benefit dollars.

 

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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, and in the past has differed, 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:
 
property and casualty insurance product reserves, net of reinsurance;
 
estimated gross profits used in the valuation and amortization of assets and liabilities associated with variable annuity and other universal life-type contracts;
 
evaluation of other-than-temporary impairments on available-for-sale securities and valuation allowances on investments;
 
living benefits required to be fair valued (in other policyholder funds and benefits payable);
 
goodwill impairment;
 
valuation of investments and derivative instruments;
 
pension and other postretirement benefit obligations;
 
valuation allowance on deferred tax assets; and
 
contingencies relating to corporate litigation 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 a material impact on the 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.
Property and Casualty Insurance Product Reserves, Net of Reinsurance
The Hartford establishes reserves on its property and casualty insurance products to provide for the estimated costs of paying claims under insurance policies written by the Company. These reserves include estimates for both claims that have been reported and those that have not yet been reported, and include estimates of all expenses associated with processing and settling these claims. Incurred but not reported (“IBNR”) reserves represent the difference between the estimated ultimate cost of all claims and the actual reported loss and loss adjustment expenses (“reported losses”). Reported losses represent cumulative loss and loss adjustment expenses paid plus case reserves for outstanding reported claims. Company actuaries evaluate the total reserves (IBNR and case reserves) on an accident year basis. An accident year is the calendar year in which a loss is incurred, or, in the case of claims-made policies, the calendar year in which a loss is reported.
Reserve estimates can change over time because of unexpected changes in the external environment. Potential external factors include (1) changes in the inflation rate for goods and services related to covered damages such as medical care, hospital care, auto parts, wages and home repair; (2) changes in the general economic environment that could cause unanticipated changes in the claim frequency per unit insured; (3) changes in the litigation environment as evidenced by changes in claimant attorney representation in the claims negotiation and settlement process; (4) changes in the judicial environment regarding the interpretation of policy provisions relating to the determination of coverage and/or the amount of damages awarded for certain types of damages; (5) changes in the social environment regarding the general attitude of juries in the determination of liability and damages; (6) changes in the legislative environment regarding the definition of damages; and (7) new types of injuries caused by new types of injurious exposure: past examples include lead paint, construction defects and tainted Chinese-made drywall.
Reserve estimates can also change over time because of changes in internal Company operations. Potential internal factors include (1) periodic changes in claims handling procedures; (2) growth in new lines of business where exposure and loss development patterns are not well established; or (3) changes in the quality of risk selection in the underwriting process. In the case of assumed reinsurance, all of the above risks apply. In addition, changes in ceding company case reserving and reporting patterns can create additional factors that need to be considered in estimating the reserves. Due to the inherent complexity of the assumptions used, final claim settlements may vary significantly from the present estimates, particularly when those settlements may not occur until well into the future.
Through both facultative and treaty reinsurance agreements, the Company cedes a share of the risks it has underwritten to other insurance companies. The Company’s net reserves for loss and loss adjustment expenses include anticipated recovery from reinsurers on unpaid claims. The estimated amount of the anticipated recovery, or reinsurance recoverable, is net of an allowance for uncollectible reinsurance.

 

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Reinsurance recoverables include an estimate of the amount of gross loss and loss adjustment expense reserves that may be ceded under the terms of the reinsurance agreements, including IBNR unpaid losses. The Company calculates its ceded reinsurance projection based on the terms of any applicable facultative and treaty reinsurance, including an estimate by reinsurance agreement of how IBNR losses will ultimately be ceded.
The Company provides an allowance for uncollectible reinsurance, reflecting management’s best estimate of reinsurance cessions that may be uncollectible in the future due to reinsurers’ unwillingness or inability to pay. The Company analyzes recent developments in commutation activity between reinsurers and cedants, recent trends in arbitration and litigation outcomes in disputes between reinsurers and cedants and the overall credit quality of the Company’s reinsurers. Where its contracts permit, the Company secures future claim obligations with various forms of collateral, including irrevocable letters of credit, secured trusts, funds held accounts and group-wide offsets. The allowance for uncollectible reinsurance was $290 as of December 31, 2010, including $79 related to Property & Casualty Commercial and $211 related to Other Operations.
The Company’s estimate of reinsurance recoverables, net of an allowance for uncollectible reinsurance, is subject to similar risks and uncertainties as the estimate of the gross reserve for unpaid losses and loss adjustment expenses.
The Hartford, like other insurance companies, categorizes and tracks its insurance reserves for its segments by “line of business”. Furthermore, The Hartford regularly reviews the appropriateness of reserve levels at the line of business level, taking into consideration the variety of trends that impact the ultimate settlement of claims for the subsets of claims in each particular line of business. In addition, the Other Operations operating segment, within Corporate and Other, includes reserves for asbestos and environmental (“A&E”) claims. Adjustments to previously established reserves, which may be material, are reflected in the operating results of the period in which the adjustment is determined to be necessary. In the judgment of management, information currently available has been properly considered in the reserves established for losses and loss adjustment expenses.
The following table shows loss and loss adjustment expense reserves by line of business as of December 31, 2010, net of reinsurance:
                                 
    Property & Casualty     Consumer     Corporate and     Total Property and  
    Commercial     Markets     Other     Casualty Insurance  
Reserve Line of Business
                               
Commercial property
  $ 162     $     $     $ 162  
Homeowners’
          435             435  
Auto physical damage
    13       15             28  
Auto liability
    587       1,674             2,261  
Package business
    1,256                   1,256  
Workers’ compensation
    6,701                   6,701  
General liability
    2,720       34             2,754  
Professional liability
    644                   644  
Fidelity and surety
    269                   269  
Assumed reinsurance [1]
                400       400  
All other non-A&E
                901       901  
A&E
    14       2       2,121       2,137  
 
                       
Total reserves-net
    12,366       2,160       3,422       17,948  
Reinsurance and other recoverables
    2,361       17       699       3,077  
 
                       
Total reserves-gross
  $ 14,727     $ 2,177     $ 4,121     $ 21,025  
 
                       
     
[1]  
These net loss and loss adjustment expense reserves relate to assumed reinsurance that was moved into Other Operations (formerly known as “HartRe”).
Reserving Methodology
(See Reserving for Asbestos and Environmental Claims within Other Operations for a discussion of how A&E reserves are set)
How reserves are set
Reserves are set by line of business within the various segments. A single line of business may be written in more than one segment. Case reserves are established by a claims handler on each individual claim and are adjusted as new information becomes known during the course of handling the claim. Lines of business for which loss data (e.g., paid losses and case reserves) emerge (i.e., is reported) over a long period of time are referred to as long-tail lines of business. Lines of business for which loss data emerge more quickly are referred to as short-tail lines of business. The Company’s shortest-tail lines of business are property and auto physical damage. The longest tail lines of business include workers’ compensation, general liability, professional liability and assumed reinsurance. For short-tail lines of business, emergence of paid loss and case reserves is credible and likely indicative of ultimate losses. For long-tail lines of business, emergence of paid losses and case reserves is less credible in the early periods and, accordingly, may not be indicative of ultimate losses.

 

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Company reserving actuaries, who are independent of the business units, regularly review reserves for both current and prior accident years using the most current claim data. For most lines of business, these reserve reviews incorporate a variety of actuarial methods and judgments and involve rigorous analysis. These selections incorporate input, as judged by the reserving actuaries to be appropriate, from claims personnel, pricing actuaries and operating management on reported loss cost trends and other factors that could affect the reserve estimates. Most reserves are reviewed fully each quarter, including loss and loss adjustment expense reserves for property, auto physical damage, auto liability, package business, workers’ compensation, most general liability, professional liability and fidelity and surety. Other reserves are reviewed semi-annually (twice per year) or annually. These include, but are not limited to, reserves for losses incurred before 1990, assumed reinsurance, latent exposures such as construction defects, unallocated loss adjustment expense and all other non-A&E exposures. For reserves that are reviewed semi-annually or annually, management monitors the emergence of paid and reported losses in the intervening quarters to either confirm that the estimate of ultimate losses should not change or, if necessary, perform a reserve review to determine whether the reserve estimate should change.
An expected loss ratio is used in initially recording the reserves for both short-tail and long-tail lines of business. This expected loss ratio is determined through a review of prior accident years’ loss ratios and expected changes to earned pricing, loss costs, mix of business, ceded reinsurance and other factors that are expected to impact the loss ratio for the current accident year. For short-tail lines, IBNR for the current accident year is initially recorded as the product of the expected loss ratio for the period, earned premium for the period and the proportion of losses expected to be reported in future calendar periods for the current accident period. For long-tailed lines, IBNR reserves for the current accident year are initially recorded as the product of the expected loss ratio for the period and the earned premium for the period, less reported losses for the period.
In addition to the expected loss ratio, the actuarial techniques or methods used primarily include paid and reported loss development and frequency / severity techniques as well as the Bornhuetter-Ferguson method (a combination of the expected loss ratio and paid development or reported development method). Within any one line of business, the methods that are given more influence vary based primarily on the maturity of the accident year, the mix of business and the particular internal and external influences impacting the claims experience or the methods. The output of the reserve reviews are reserve estimates that are referred to herein as the “actuarial indication”.
As of December 31, 2010 and 2009, net property and casualty insurance product reserves for losses and loss adjustment expenses reported under accounting principles generally accepted in the United States of America (“U.S. GAAP”) were approximately equal to net reserves reported on a statutory basis. Under U.S. GAAP, liabilities for unpaid losses for permanently disabled workers’ compensation claimants are discounted at rates that are no higher than risk-free interest rates and which generally exceed the statutory discount rates set by regulators, such that workers’ compensation reserves for statutory reporting are higher than the reserves for U.S. GAAP reporting. Largely offsetting the effect of the difference in discounting is that a portion of the U.S. GAAP provision for uncollectible reinsurance is not recognized under statutory accounting. Most of the Company’s property and casualty insurance product reserves are not discounted. However, the Company has discounted liabilities funded through structured settlements and has discounted certain reserves for indemnity payments due to permanently disabled claimants under workers’ compensation policies.
Provided below is a general discussion of which methods are preferred by line of business. Because the actuarial estimates are generated at a much finer level of detail than line of business (e.g., by distribution channel, coverage, accident period), this description should not be assumed to apply to each coverage and accident year within a line of business. Also, as circumstances change, the methods that are given more influence will change.
Property and Auto Physical Damage. These lines are fast-developing and paid and reported development techniques are used as these methods use historical data to develop paid and reported loss development patterns, which are then applied to current paid and reported losses by accident period to estimate ultimate losses. The Company relies primarily on reported development techniques although a review of frequency and severity and the initial loss expectation based on the expected loss ratio is used for the most immature accident months. The advantage of frequency / severity techniques is that frequency estimates are generally easier to predict and external information can be used to supplement internal data in making severity estimates.
Personal Auto Liability. For auto liability, and bodily injury in particular, the Company performs a greater number of techniques than it does for property and auto physical damage. In addition, because the paid development technique is affected by changes in claim closure patterns and the reported development method is affected by changes in case reserving practices, the Company uses Berquist-Sherman techniques which adjust these patterns to reflect current settlement rates and case reserving techniques. The Company generally uses the reported development method for older accident years as a higher percentage of ultimate losses are reflected in reported losses than in cumulative paid losses and the frequency/severity and Berquist-Sherman methods for more recent accident years. Recent periods are influenced by changes in case reserve practices and changing disposal rates; the frequency/severity techniques are not affected as much by these changes and the Berquist-Sherman techniques specifically adjust for these changes.
Auto Liability for Commercial Lines and Short-Tailed General Liability. The Company performs a variety of techniques, including the paid and reported development methods and frequency / severity techniques. For older, more mature accident years, management finds that reported development techniques are best. For more recent accident years, management typically prefers frequency / severity techniques that make separate assumptions about loss activity above and below a selected capping level.
Long-Tailed General Liability, Fidelity and Surety and Large Deductible Workers’ Compensation. For these long-tailed lines of business, the Company generally relies on the expected loss ratio and reported development techniques. Management generally weights these techniques together, relying more heavily on the expected loss ratio method at early ages of development and more on the reported development method as an accident year matures.

 

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Workers’ Compensation. Workers’ compensation is the Company’s single largest reserve line of business so a wide range of methods are reviewed in the reserve analysis. Methods performed include paid and reported development, variations on expected loss ratio methods, and an in-depth analysis on the largest states. Historically, paid development patterns in the Company’s workers’ compensation business have been stable, so paid techniques are preferred for older accident periods. For more recent periods, paid techniques are less predictive of the ultimate liability since such a low percentage of ultimate losses are paid in early periods of development. Accordingly, for more recent accident periods, the Company generally relies more heavily on a state-by-state analysis and the expected loss ratio approach.
Professional Liability. Reported and paid loss developments patterns for this line tend to be volatile. Therefore, the Company typically relies on frequency and severity techniques.
Assumed Reinsurance and All Other. For these lines, management tends to rely on the reported development techniques. In assumed reinsurance, assumptions are influenced by information gained from claim and underwriting audits.
Allocated Loss Adjustment Expenses (ALAE). For some lines of business (e.g., professional liability and assumed reinsurance), ALAE and losses are analyzed together. For most lines of business, however, ALAE is analyzed separately, using paid development techniques and an analysis of the relationship between ALAE and loss payments.
Unallocated Loss Adjustment Expense (ULAE). ULAE is analyzed separately from loss and ALAE. For most lines of business, incurred ULAE costs to be paid in the future are projected based on an expected cost per claim year and the anticipated claim closure pattern and the ratio of paid ULAE to paid loss.
The final step in the reserve review process involves a comprehensive review by senior reserving actuaries who apply their judgment and, in concert with senior management, determine the appropriate level of reserves based on the information that has been accumulated. Numerous factors are considered in this process including, but not limited to, the assessed reliability of key loss trends and assumptions that may be significantly influencing the current actuarial indications, pertinent trends observed over the recent past, the level of volatility within a particular line of business, and the improvement or deterioration of actuarial indications in the current period as compared to the prior periods. Total recorded net reserves, excluding asbestos and environmental, were 3.2% higher than the actuarial indication of the reserves as of December 31, 2010.
See the Reserve Development section for a discussion of changes to reserve estimates recorded in 2010.
Current trends contributing to reserve uncertainty
The Hartford is a multi-line company in the property and casualty insurance business. The Hartford is therefore subject to reserve uncertainty stemming from a number of conditions, including but not limited to those noted above, any of which could be material at any point in time. Certain issues may become more or less important over time as conditions change. As various market conditions develop, management must assess whether those conditions constitute a long-term trend that should result in a reserving action (i.e., increasing or decreasing the reserve).
Within Property & Casualty Commercial and Other Operations, the Company has exposure to claims asserted for bodily injury as a result of long-term or continuous exposure to harmful products or substances. Examples include, but are not limited to, pharmaceutical products, silica and lead paint. The Company also has exposure to claims from construction defects, where property damage or bodily injury from negligent construction is alleged. In addition, the Company has exposure to claims asserted against religious institutions and other organizations relating to molestation or abuse. Such exposures may involve potentially long latency periods and may implicate coverage in multiple policy periods. These factors make reserves for such claims more uncertain than other bodily injury or property damage claims. With regard to these exposures, the Company is monitoring trends in litigation, the external environment, the similarities to other mass torts and the potential impact on the Company’s reserves.
In Consumer Markets, reserving estimates are generally less variable than for the Company’s other property and casualty segments because of the coverages having relatively shorter periods of loss emergence. Estimates, however, can still vary due to a number of factors, including interpretations of frequency and severity trends and their impact on recorded reserve levels. Severity trends can be impacted by changes in internal claim handling and case reserving practices in addition to changes in the external environment. These changes in claim practices increase the uncertainty in the interpretation of case reserve data, which increases the uncertainty in recorded reserve levels. In addition, the introduction of new products has led to a different mix of business by type of insured than the Company experienced in the past. Such changes in mix increase the uncertainty of the reserve projections, since historical data and reporting patterns may not be applicable to the new business.
In standard commercial lines, workers’ compensation is the Company’s single biggest line of business and the line of business with the longest pattern of loss emergence. Reserve estimates for workers’ compensation are particularly sensitive to changes in medical inflation, the changing use of medical care procedures and changes in state legislative and regulatory environments. Medical costs make up more than 50% of workers’ compensation payments and it is possible that federal health care reform will impact medical payments in workers’ compensation. These changes increase the uncertainty in the application of development patterns. In addition, over the past several accident years, the Company has experienced favorable claim frequency on workers’ compensation claims. The Company’s reserve estimates assume that severity will not be adversely impacted by the lower volume of reported claims.

 

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In specialty lines, many lines of insurance are “long-tail”, including large deductible workers’ compensation insurance, as such, reserve estimates for these lines are more difficult to determine than reserve estimates for shorter-tail lines of insurance. Estimating required reserve levels for large deductible workers’ compensation insurance is further complicated by the uncertainty of whether losses that are attributable to the deductible amount will be paid by the insured; if such losses are not paid by the insured due to financial difficulties, the Company would be contractually liable. Another example of reserve variability relates to reserves for directors’ and officers’ insurance. There is potential volatility in the required level of reserves due to the continued uncertainty regarding the number and severity of class action suits, including uncertainty regarding the Company’s exposure to losses arising from the collapse of the sub-prime mortgage market. Additionally, the Company’s exposure to losses under directors’ and officers’ insurance policies is primarily in excess layers, making estimates of loss more complex. The recent financial market turmoil has increased the number of shareholder class action lawsuits against our insureds or their directors and officers and this trend could continue for some period of time.
Impact of changes in key assumptions on reserve volatility
As stated above, the Company’s practice is to estimate reserves using a variety of methods, assumptions and data elements. Within its reserve estimation process for reserves other than asbestos and environmental, the Company does not consistently use statistical loss distributions or confidence levels around its reserve estimate and, as a result, does not disclose reserve ranges.
The reserve estimation process includes assumptions about a number of factors in the internal and external environment. Across most lines of business, the most important assumptions are future loss development factors applied to paid or reported losses to date. The trend in loss costs is also a key assumption, particularly in the most recent accident years, where loss development factors are less credible.
The following discussion includes disclosure of possible variation from current estimates of loss reserves due to a change in certain key indicators of potential losses. Each of the impacts described below is estimated individually, without consideration for any correlation among key indicators or among lines of business. Therefore, it would be inappropriate to take each of the amounts described below and add them together in an attempt to estimate volatility for the Company’s reserves in total. The estimated variation in reserves due to changes in key indicators is a reasonable estimate of possible variation that may occur in the future, likely over a period of several calendar years. It is important to note that the variation discussed is not meant to be a worst-case scenario, and therefore, it is possible that future variation may be more than the amounts discussed below.
Recorded reserves for auto liability, net of reinsurance, are $2.3 billion across all lines, $1.7 billion of which is in Consumer Markets. Personal auto liability reserves are shorter-tailed than other lines of business (such as workers’ compensation) and, therefore, less volatile. However, the size of the reserve base means that future changes in estimates could be material to the Company’s results of operations in any given period. The key indicator for Consumer Markets auto liability is the annual loss cost trend, particularly the severity trend component of loss costs. A 2.5 point change in annual severity for the two most recent accident years would change the estimated net reserve need by $90, in either direction. A 2.5 point change in annual severity is within the Company’s historical variation.
Recorded reserves for workers’ compensation, net of reinsurance, are $6.7 billion. Loss development patterns are a key indicator for this line of business, particularly for more mature accident years. Historically, loss development patterns have been impacted by, among other things, medical cost inflation. The Company has reviewed the historical variation in reported loss development patterns. If the reported loss development patterns change by 3%, the estimated net reserve need would change by $400, in either direction. A 3% change in reported loss development patterns is within the Company’s historical variation, as measured by the variation around the average development factors as reported in statutory accident year reports.
Recorded reserves for general liability, net of reinsurance, are $2.8 billion. Loss development patterns are a key indicator for this line of business, particularly for more mature accident years. Historically, loss development patterns have been impacted by, among other things, emergence of new types of claims (e.g., construction defect claims) or a shift in the mixture between smaller, more routine claims and larger, more complex claims. The Company has reviewed the historical variation in reported loss development patterns. If the reported loss development patterns change by 9%, the estimated net reserve need would change by $200, in either direction. A 9% change in reported loss development patterns is within the Company’s historical variation, as measured by the variation around the average development factors as reported in statutory accident year reports.
Similar to general liability, assumed casualty reinsurance is affected by reported loss development patterns. In addition to the items identified above that would affect both direct and reinsurance liability claim development patterns, there is also an impact to reporting patterns for any changes in claim notification from ceding companies to the reinsurer. Recorded net reserves for HartRe assumed reinsurance business, excluding asbestos and environmental liabilities, within Other Operations were $400 as of December 31, 2010. If the reported loss development patterns underlying the Company’s net reserves for HartRe assumed casualty reinsurance change by 10%, the estimated net reserve need would change by $215, in either direction. A 10% change in reported loss development patterns is within the Company’s historical variation, as measured by the variation around the average development factors as reported in statutory accident year reports.

 

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Reserving for Asbestos and Environmental Claims within Other Operations
How A&E reserves are set
In establishing reserves for asbestos claims, the Company evaluates its insureds’ estimated liabilities for such claims using a ground-up approach. The Company considers a variety of factors, including the jurisdictions where underlying claims have been brought, past, pending and anticipated future claim activity, disease mix, past settlement values of similar claims, dismissal rates, allocated loss adjustment expense, and potential bankruptcy impact.
Similarly, a ground-up exposure review approach is used to establish environmental reserves. The Company’s evaluation of its insureds’ estimated liabilities for environmental claims involves consideration of several factors, including historical values of similar claims, the number of sites involved, the insureds’ alleged activities at each site, the alleged environmental damage at each site, the respective shares of liability of potentially responsible parties at each site, the appropriateness and cost of remediation at each site, the nature of governmental enforcement activities at each site, and potential bankruptcy impact.
Having evaluated its insureds’ probable liabilities for asbestos and/or environmental claims, the Company then evaluates its insureds’ insurance coverage programs for such claims. The Company considers its insureds’ total available insurance coverage, including the coverage issued by the Company. The Company also considers relevant judicial interpretations of policy language and applicable coverage defenses or determinations, if any.
Evaluation of both the insureds’ estimated liabilities and the Company’s exposure to the insureds depends heavily on an analysis of the relevant legal issues and litigation environment. This analysis is conducted by the Company’s lawyers and is subject to applicable privileges.
For both asbestos and environmental reserves, the Company also compares its historical direct net loss and expense paid and reported experience, and net loss and expense paid and reported experience year by year, to assess any emerging trends, fluctuations or characteristics suggested by the aggregate paid and reported activity.
Once the gross ultimate exposure for indemnity and allocated loss adjustment expense is determined for its insureds by each policy year, the Company calculates its ceded reinsurance projection based on any applicable facultative and treaty reinsurance and the Company’s experience with reinsurance collections.
Uncertainties Regarding Adequacy of Asbestos and Environmental Reserves
A number of factors affect the variability of estimates for asbestos and environmental reserves including assumptions with respect to the frequency of claims, the average severity of those claims settled with payment, the dismissal rate of claims with no payment and the expense to indemnity ratio. The uncertainty with respect to the underlying reserve assumptions for asbestos and environmental adds a greater degree of variability to these reserve estimates than reserve estimates for more traditional exposures. While this variability is reflected in part in the size of the range of reserves developed by the Company, that range may still not be indicative of the potential variance between the ultimate outcome and the recorded reserves. The recorded net reserves as of December 31, 2010 of $2.14 billion ($1.80 billion and $339 for asbestos and environmental, respectively) is within an estimated range, unadjusted for covariance, of $1.67 billion to $2.44 billion. The process of estimating asbestos and environmental reserves remains subject to a wide variety of uncertainties, which are detailed in Note 12 of Notes to Consolidated Financial Statements. The Company believes that its current asbestos and environmental reserves are appropriate. However, analyses of future developments could cause the Company to change its estimates and ranges of its asbestos and environmental reserves, and the effect of these changes could be material to the Company’s consolidated operating results, financial condition and liquidity. Consistent with the Company’s long-standing reserving practices, the Company will continue to review and monitor its reserves in Other Operations regularly and, where future developments indicate, make appropriate adjustments to the reserves.
Total Property and Casualty Insurance Product Reserves, Net of Reinsurance, Results
In the opinion of management, based upon the known facts and current law, the reserves recorded for the Company’s property and casualty businesses at December 31, 2010 represent the Company’s best estimate of its ultimate liability for losses and loss adjustment expenses related to losses covered by policies written by the Company. However, because of the significant uncertainties surrounding reserves, and particularly asbestos exposures, it is possible that management’s estimate of the ultimate liabilities for these claims may change and that the required adjustment to recorded reserves could exceed the currently recorded reserves by an amount that could be material to the Company’s results of operations, financial condition and liquidity.

 

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Reserve Roll-forwards and Development
Based on the results of the quarterly reserve review process, the Company determines the appropriate reserve adjustments, if any, to record. Recorded reserve estimates are changed after consideration of numerous factors, including but not limited to, the magnitude of the difference between the actuarial indication and the recorded reserves, improvement or deterioration of actuarial indications in the period, the maturity of the accident year, trends observed over the recent past and the level of volatility within a particular line of business. In general, adjustments are made more quickly to more mature accident years and less volatile lines of business. Such adjustments of reserves are referred to as “reserve development”. Reserve development that increases previous estimates of ultimate cost is called “reserve strengthening”. Reserve development that decreases previous estimates of ultimate cost is called “reserve releases”. Reserve development can influence the comparability of year over year underwriting results and is set forth in the paragraphs and tables that follow.
A roll-forward follows of property and casualty insurance product liabilities for unpaid losses and loss adjustment expenses for the year ended December 31, 2010:
For the year ended December 31, 2010
                                 
                            Total  
    Property &                     Property and  
    Casualty     Consumer     Corporate and     Casualty  
    Commercial     Markets     Other     Insurance  
Beginning liabilities for unpaid losses and loss adjustment expenses, gross
  $ 15,051     $ 2,109     $ 4,491     $ 21,651  
Reinsurance and other recoverables
    2,570       11       860       3,441  
 
                       
Beginning liabilities for unpaid losses and loss adjustment expenses, net
    12,481       2,098       3,631       18,210  
 
                       
Provision for unpaid losses and loss adjustment expenses
                               
Current accident year before catastrophes
    3,579       2,737             6,316  
Current accident year catastrophes
    152       300             452  
Prior accident years
    (361 )     (86 )     251       (196 )
 
                       
Total provision for unpaid losses and loss adjustment expenses
    3,370       2,951       251       6,572  
Payments
    (3,485 )     (2,889 )     (460 )     (6,834 )
 
                       
Ending liabilities for unpaid losses and loss adjustment expenses, net
    12,366       2,160       3,422       17,948  
Reinsurance and other recoverables
    2,361       17       699       3,077  
 
                       
Ending liabilities for unpaid losses and loss adjustment expenses, gross
  $ 14,727     $ 2,177     $ 4,121     $ 21,025  
 
                       
Earned premiums
  $ 5,744     $ 3,947                  
Loss and loss expense paid ratio [1]
    60.7       73.2                  
Loss and loss expense incurred ratio
    58.7       74.8                  
Prior accident years development (pts) [2]
    (6.3 )     (2.2 )                
     
[1]  
The “loss and loss expense paid ratio” represents the ratio of paid losses and loss adjustment expenses to earned premiums.
 
[2]  
“Prior accident years development (pts)” represents the ratio of prior accident years development to earned premiums.

 

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Prior accident years development recorded in 2010
Included within prior accident years development for the year ended December 31, 2010 were the following reserve strengthenings (releases):
For the year ended December 31, 2010
                                 
    Property & Casualty     Consumer     Corporate and     Total Property and  
    Commercial     Markets     Other     Casualty Insurance  
Auto liability
  $ (54 )   $ (115 )   $     $ (169 )
Professional liability
    (88 )                 (88 )
Workers’ compensation
    (70 )                 (70 )
General liability, umbrella and high hazard liability
    (66 )                 (66 )
General liability, excluding umbrella and high hazard liability
    (42 )                 (42 )
Package business
    (19 )                 (19 )
Commercial property
    (16 )                 (16 )
Fidelity and surety
    (5 )                 (5 )
Homeowners
          23             23  
Net environmental reserves
                67       67  
Net asbestos reserves
                189       189  
All other non-A&E within Other Operations
                11       11  
Uncollectible reinsurance
    (30 )                 (30 )
Discount accretion on workers’ compensation
    26                   26  
Catastrophes
    1       10             11  
Other reserve re-estimates, net
    2       (4 )     (16 )     (18 )
 
                       
Total prior accident years development
  $ (361 )   $ (86 )   $ 251     $ (196 )
 
                       
During 2010, the Company’s re-estimates of prior accident years reserves included the following significant reserve changes:
 
Released reserves for commercial auto claims as the Company lowered its reserve estimate to recognize a lower severity trend during 2009 that continued into 2010 on larger claims in accident years 2002 to 2009.
 
 
Released reserves for personal auto liability claims. Favorable trends in reported severity have persisted, most notably for accident years 2008 and 2009. As these accident years develop, the uncertainty around the ultimate losses is reduced and management places more weight on the emerged experience. The reserve releases impact accident years 2004 through 2009, as some of the older years are also showing improvements in reported severity.
 
 
Released reserves for professional liability claims, primarily related to directors’ and officers’ (“D&O”) claims in accident years 2008 and prior. For these accident years, reported losses for claims under D&O policies have been emerging favorably to initial expectations due to lower than expected claim severity.
 
 
Released reserves for workers’ compensation business, primarily related to accident years 2006 and 2007. Management updated reviews of state reforms affecting these accident years and determined impacts to be more favorable than previously estimated. Accordingly, management reduced reserve estimates for these years.
 
 
Released reserves for general liability claims, primarily related to accident years 2005 through 2008. Claim emergence for these accident years continues to be lower than anticipated. Management now believes this lower level of claim activity will continue into the future and has reduced its reserve estimate in response to these favorable trends. Partially offsetting this reserve release is strengthening on loss adjustment expense reserves during the second quarter of 2010 due to higher than expected allocated loss expenses for claims in accident years 2000 and prior.
 
 
Released reserves for package business claims, primarily related to accident years 2005 through 2009. Claim emergence within the liability portion of the package coverage for these accident years continues to be lower than anticipated. Management now believes this lower level of claim activity will continue into the future and has reduced its reserve estimate in response to these favorable trends.
 
 
Strengthened reserves for homeowners’ claims. During 2010, the Company observed a lengthening of the claim reporting period for homeowners’ claims for prior accident years which resulted in increasing management’s estimate of the ultimate cost to settle these claims. The Company is also spending more on independent adjuster fees to better assess property damages.
 
 
The Company reviewed its allowance for uncollectible reinsurance in the second quarter of 2010 and reduced its allowance, in part, by a reduction in gross ceded loss recoverables.
 
 
Refer to the Other Operations Claims section for further discussion concerning the Company’s annual evaluations of net environmental and net asbestos reserves, and related reinsurance.

 

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A roll-forward follows of property and casualty insurance product liabilities for unpaid losses and loss adjustment expenses for the year ended December 31, 2009:
For the year ended December 31, 2009
                                 
                            Total  
    Property &                     Property and  
    Casualty     Consumer     Corporate and     Casualty  
    Commercial     Markets     Other     Insurance  
Beginning liabilities for unpaid losses and loss adjustment expenses, gross
  $ 15,273     $ 2,083     $ 4,577     $ 21,933  
Reinsurance and other recoverables
    2,742       46       798       3,586  
 
                       
Beginning liabilities for unpaid losses and loss adjustment expenses, net
    12,531       2,037       3,779       18,347  
 
                       
Provision for unpaid losses and loss adjustment expenses
                               
Current accident year before catastrophes
    3,582       2,707       1       6,290  
Current accident year catastrophes
    78       228             306  
Prior accident years
    (394 )     (33 )     241       (186 )
 
                       
Total provision for unpaid losses and loss adjustment expenses
    3,266       2,902       242       6,410  
Payments
    (3,316 )     (2,841 )     (390 )     (6,547 )
 
                       
Ending liabilities for unpaid losses and loss adjustment expenses, net
    12,481       2,098       3,631       18,210  
Reinsurance and other recoverables
    2,570       11       860       3,441  
 
                       
Ending liabilities for unpaid losses and loss adjustment expenses, gross
  $ 15,051     $ 2,109     $ 4,491     $ 21,651  
 
                       
Earned premiums
  $ 5,903     $ 3,959                  
Loss and loss expense paid ratio [1]
    56.2       71.8                  
Loss and loss expense incurred ratio
    55.3       73.3                  
Prior accident years development (pts) [2]
    (6.7 )     (0.8 )                
     
[1]  
The “loss and loss expense paid ratio” represents the ratio of paid losses and loss adjustment expenses to earned premiums.
 
[2]  
“Prior accident years development (pts)” represents the ratio of prior accident years development to earned premiums.
Prior accident years development recorded in 2009
Included within prior accident years development for the year ended December 31, 2009 were the following reserve strengthenings (releases):
For the year ended December 31, 2009
                                 
    Property & Casualty     Consumer     Corporate and     Total Property and  
    Commercial     Markets     Other     Casualty Insurance  
Auto liability
  $ (47 )   $ (77 )   $     $ (124 )
Professional liability
    (127 )                 (127 )
General liability, umbrella and high hazard liability
    (112 )                 (112 )
Workers’ compensation
    (92 )                 (92 )
Package business
    38                   38  
Fidelity and surety
    28                   28  
Homeowners
          18             18  
Net environmental reserves
                75       75  
Net asbestos reserves
                138       138  
All other non-A&E within Other Operations
                35       35  
Uncollectible reinsurance
    (20 )           (20 )     (40 )
Discount accretion on workers’ compensation
    24                   24  
Catastrophes
    (23 )                 (23 )
Other reserve re-estimates, net
    (63 )     26       13       (24 )
 
                       
Total prior accident years development
  $ (394 )   $ (33 )   $ 241     $ (186 )
 
                       
During 2009, the Company’s re-estimates of prior accident years reserves included the following significant reserve changes:
 
Released reserves for personal auto liability claims, as in the beginning in the first quarter of 2008, management observed an improvement in emerged claim severity for the 2005 through 2007 accident years attributed, in part, to changes made in claim handling procedures in 2007. During 2009, the Company recognized that favorable development in reported severity was a sustained trend for those accident years and, accordingly, management reduced its reserve estimate. In the third and fourth quarters of 2009, management also recognized sustained favorable development trends in AARP for accident years 2006 to 2008 and released reserves for those accident years.
 
 
Released reserves for commercial auto liability claims, primarily related to accident years 2003 to 2008. In the fourth quarter of 2009, the Company recognized that the full value of large auto liability claims was being recognized as case reserves at an earlier age. The increased adequacy of case reserves caused the Company to decrease its estimate of reserves for IBNR loss and loss adjustment expenses.

 

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While the Company expects its losses from the sub-prime mortgage and credit crisis, as well as its exposure to the Madoff and Stanford cases to be manageable, there is nonetheless the risk that claims under professional liability, otherwise known as directors’ and officers’ (“D&O”) and errors and omissions (“E&O”), insurance policies incurred in the 2007 and 2008 accident years may develop adversely as the claims are settled. However, so far, the Company has seen no evidence of adverse loss experience related to these events. In fact, reported losses to date for claims under D&O and E&O policies for the 2007 accident year have been emerging favorably to initial expectations. In addition, for the 2003 to 2006 accident years, reported losses for claims under D&O and E&O policies have been emerging favorably to initial expectations due to lower than expected claim severity. The Company released reserves for D&O and E&O claims in 2009 related to the 2003 to 2008 accident years. Any continued favorable emergence of claims under D&O and E&O insurance policies for the 2008 and prior accident years could lead the Company to reduce reserves for these liabilities in future quarters.
 
 
Released reserves for general liability claims, primarily related to accident years 2003 to 2007. Beginning in the third quarter of 2007, the Company observed that reported losses for high hazard and umbrella general liability claims, primarily related to the 2001 to 2006 accident years, were emerging favorably and this caused management to reduce its estimate of the cost of future reported claims for these accident years, resulting in a reserve release in each quarter since the third quarter of 2007. During 2009, management determined that the lower level of loss emergence was also evident in accident year 2007 and had continued for accident years 2003 to 2006 and, as a result, the Company reduced the reserves. In addition, during the third quarter of 2009, the Company recognized that the cost of late emerging exposures were likely to be higher than previously expected. Also in the third quarter, the Company recognized additional ceded losses on accident years 1999 and prior. These third quarter events were largely offsetting.
 
 
Released workers’ compensation reserves, primarily related to additional ceded losses on accident years 1999 and prior and lower allocated loss adjustment expense reserves in accident years 2003 to 2007. During the first quarter of 2009, the Company observed lower than expected allocated loss adjustment expense payments on older accident years. As a result, the Company reduced its estimate for future expense payments on more recent accident years.
 
 
Strengthened reserves for liability claims under package policies, primarily related to allocated loss adjustment expenses for accident years 2000 to 2005 and 2007 and 2008. During the first quarter of 2009, the Company identified higher than expected expense payments on older accident years related to the liability coverage. Additional analysis in the second quarter of 2009 showed that this higher level of loss adjustment expense is likely to continue into more recent accident years. As a result, in the second quarter of 2009, the Company increased its estimates for future expense payments for the 2007 and 2008 accident years. In addition, during the third quarter of 2009, the Company recognized the cost of late emerging exposures were likely to be higher than previously expected. Also in the third quarter, the Company recognized a lower than expected frequency of high severity claims. These third quarter events were largely offsetting.
 
 
Strengthened reserves for surety business, primarily related to accident years 2004 to 2007. The net strengthening consisted of $55 strengthening of reserves for customs bonds, partially offset by a $27 release of reserves for contract surety claims. During 2008, the Company became aware that there were a large number of late reported surety claims related to customs bonds. Continued high volume of late reported claims during 2009 caused the Company to strengthen the reserves. Because the pattern of claim reporting for customs bonds has not been similar to the reporting pattern of other surety bonds, future claim activity is difficult to predict. It is possible that as additional claim activity emerges, our estimate of both the number of future claims and the cost of those claims could change substantially.
 
 
Strengthened reserves for property in personal homeowners’ claims, primarily driven by increased claim settlement costs in recent accident years and increased losses from underground storage tanks in older accident years. In 2008, the Company began to observe increasing claim settlement costs for the 2005 to 2008 accident years and, in the first quarter of 2009, determined that this higher cost level would continue, resulting in reserve strengthening for these accident years. In addition, beginning in 2008, the Company observed unfavorable emergence of homeowners’ casualty claims for accident years 2003 and prior, primarily related to underground storage tanks. Following a detailed review of these claims in the first quarter of 2009, management increased its estimate of the magnitude of this exposure and strengthened homeowners’ casualty claim reserves.
 
 
The Company reviewed its allowance for uncollectible reinsurance for Property & Casualty Commercial in the second quarter of 2009 and reduced its allowance for Property & Casualty Commercial driven, in part, by a reduction in gross ceded loss recoverables.
 
 
Refer to the Other Operations Claims section for further discussion concerning the Company’s annual evaluations of net environmental and net asbestos reserves, and related reinsurance.

 

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A roll-forward follows of property and casualty insurance product liabilities for unpaid losses and loss adjustment expenses for the year ended December 31, 2008:
For the year ended December 31, 2008
                                 
                            Total  
    Property &                     Property and  
    Casualty     Consumer     Corporate and     Casualty  
    Commercial     Markets     Other     Insurance  
Beginning liabilities for unpaid losses and loss adjustment expenses, gross
  $ 15,020       2,065       5,068       22,153  
Reinsurance and other recoverables
    2,917       67       938       3,922  
 
                       
Beginning liabilities for unpaid losses and loss adjustment expenses, net
    12,103       1,998       4,130       18,231  
 
                       
Provision for unpaid losses and loss adjustment expenses
                               
Current accident year before catastrophes
    3,835       2,552       3       6,390  
Current accident year catastrophes
    285       258             543  
Prior accident years
    (298 )     (52 )     124       (226 )
 
                       
Total provision for unpaid losses and loss adjustment expenses
    3,822       2,758       127       6,707  
Payments
    (3,394 )     (2,719 )     (478 )     (6,591 )
 
                       
Ending liabilities for unpaid losses and loss adjustment expenses, net
    12,531       2,037       3,779       18,347  
Reinsurance and other recoverables
    2,742       46       798       3,586  
 
                       
Ending liabilities for unpaid losses and loss adjustment expenses, gross
  $ 15,273     $ 2,083     $ 4,577     $ 21,933  
 
                       
Earned premiums
  $ 6,395     $ 3,935                  
Loss and loss expense paid ratio [1]
    53.0       69.1                  
Loss and loss expense incurred ratio
    59.8       70.1                  
Prior accident years development (pts) [2]
    (4.7 )     (1.3 )                
     
[1]  
The “loss and loss expense paid ratio” represents the ratio of paid losses and loss adjustment expenses to earned premiums.
 
[2]  
“Prior accident years development (pts)” represents the ratio of prior accident years development to earned premiums.
Current accident year catastrophes
For 2008, net current accident year catastrophe loss and loss adjustment expenses totaled $543, of which $237 related to hurricane Ike. In addition to the $237 of net catastrophe loss and loss adjustment expenses from hurricane Ike, the Company incurred $20 of assessments due to hurricane Ike. The following table shows total current accident year catastrophe impacts in the year ended December 31, 2008:
For the year ended December 31, 2008
                                 
    Property & Casualty     Consumer     Corporate and     Total Property and  
    Commercial     Markets     Other     Casualty Insurance  
Gross incurred claim and claim adjustment expenses for current accident year catastrophes
  $ 312     $ 260     $     $ 572  
Ceded claim and claim adjustment expenses for current accident year catastrophes
    27       2             29  
 
                       
Net incurred claim and claim adjustment expenses for current accident year catastrophes
    285       258             543  
Assessments owed to Texas Windstorm Insurance Association due to hurricane Ike
    10       10             20  
Reinstatement premium ceded to reinsurers due to hurricane Ike
          1             1  
 
                       
Total current accident year catastrophe impacts
  $ 295     $ 269     $     $ 564  
 
                       
A portion of the gross incurred loss and loss adjustment expenses are recoverable from reinsurers under the Company’s principal catastrophe reinsurance program in addition to other reinsurance programs. Reinsurance recoveries under the Company’s principal catastrophe reinsurance program, which covers multiple lines of business, are allocated to the segments in accordance with a pre-established methodology that is consistent with the method used to allocate the ceded premium to each segment.
The Company’s estimate of ultimate loss and loss expenses arising from hurricanes and other catastrophes is based on covered losses under the terms of the policies. The Company does not provide residential flood insurance on its homeowners policies so the Company’s estimate of hurricane losses on homeowners’ business does not include any provision for damages arising from flood waters. The Company acts as an administrator for the Write Your Own flood program on behalf of the National Flood Insurance Program under FEMA, for which it earns a fee for collecting premiums and processing claims. Under the program, the Company services both personal lines and commercial lines flood insurance policies and does not assume any underwriting risk. As a result, catastrophe losses in the above table do not include any losses related to the Write Your Own flood program.

 

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Prior accident years development recorded in 2008
Included within prior accident years development for the year ended December 31, 2008 were the following reserve strengthenings (releases):
For the year ended December 31, 2008
                                 
    Property & Casualty     Consumer     Corporate and     Total Property and  
    Commercial     Markets     Other     Casualty Insurance  
Auto liability
  $ (27 )   $ (46 )   $     $ (73 )
Workers’ compensation
    (156 )                 (156 )
General liability, umbrella and high hazard liability
    (105 )                 (105 )
General liability and products liability
    67                     67  
Professional liability
    (75 )                 (75 )
Extra-contractual liability claims under non-standard personal auto policies
          (24 )           (24 )
Construction defect claims
    (10 )                 (10 )
National account general liability allocated loss adjustment expense reserves
    25                   25  
Net environmental reserves
                53       53  
Net asbestos reserves
                50       50  
Discount accretion on workers’ compensation
    26                   26  
Catastrophes
    (27 )                 (27 )
Other reserve re-estimates, net
    (16 )     18       21       23  
 
                       
Total prior accident years development
  $ (298 )   $ (52 )   $ 124     $ (226 )
 
                       
During 2008, the Company’s re-estimates of prior accident year reserves included the following significant reserve changes:
 
Released commercial auto liability reserves, primarily related to accident years 2002 to 2007. Management has observed fewer than previously expected large losses in accident years 2006 and 2007 and lower than previously expected severity on large claims in accident years 2002 to 2005. In 2008, management recognized that favorable development in reported claim severity was a sustained trend and, accordingly, management reduced its estimate of the reserves.
 
 
Released reserves for personal auto liability claims, principally related to AARP business for the 2005 through 2007 accident years. Beginning in the first quarter of 2008, management observed an improvement in emerged claim severity for the 2005 through 2007 accident years attributed, in part, to changes made in claim handling procedures in 2007. In the third and fourth quarter of 2008, the Company recognized that favorable development in reported severity was a sustained trend and, accordingly, management reduced its reserve estimate.
 
 
Released workers’ compensation reserves primarily related to accident years 2000 to 2007. These reserve releases are a continuation of favorable developments first recognized in 2005 and recognized in both 2006 and 2007. The reserve releases in 2008 resulted from a determination that workers’ compensation losses continue to develop even more favorably from prior expectations due, in part, to state legal reforms, including in California and Florida, and underwriting actions as well as cost reduction initiatives first instituted in 2003. In particular, the state legal reforms and underwriting actions have resulted in lower than expected medical claim severity.
 
 
Released reserves for general liability claims primarily related to the 2001 to 2007 accident years. Beginning in the third quarter of 2007, the Company observed that reported losses for high hazard and umbrella general liability claims, primarily related to the 2001 to 2006 accident years, were emerging favorably and this caused management to reduce its estimate of the cost of future reported claims for these accident years, resulting in a reserve release in each quarter since the third quarter of 2007. During 2008, the Company observed that this favorable trend continued with the 2007 accident year. The number of reported claims for this line of business has been lower than expected, a trend first observed in 2005. Over time, management has come to believe that the lower than expected number of claims reported to date will not be offset by a higher than expected number of late reported claims.
 
 
Strengthened reserves for general liability and products liability claims primarily for accident years 2004 and prior for losses expected to emerge after 20 years of development. In 2007, management observed that long outstanding general liability claims have been settling for more than previously anticipated and, during the first quarter of 2008, the Company increased the estimate of late development of general liability claims.
 
 
Released reserves for professional liability claims for accident years 2003 to 2006. During 2008, the Company updated its analysis of certain professional liability claims and the new analysis showed that claim severity for directors and officers losses in the 2003 to 2006 accident years were favorable to previous expectations, resulting in a reduction of reserves. The analysis also showed favorable emergence of claim severity on errors and omission policy claims for the 2004 and 2005 accident years, resulting in a release of reserves.

 

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Released reserves for extra-contractual liability claims under non-standard personal auto policies. As part of the agreement to sell its non-standard auto insurance business in November, 2006, the Company continues to be obligated for certain extra-contractual liability claims arising prior to the date of sale. Reserve estimates for extra-contractual liability claims are subject to significant variability depending on the expected settlement of individually large claims and, during 2008, the Company determined that the settlement value of a number of these claims was expected to be less than previously anticipated, resulting in a $24 release of reserves.
 
 
Released reserves for construction defect claims for accident years 2005 and prior due to lower than expected reported claim activity. Lower than expected claim activity was first noted in the first quarter of 2007 and continued throughout 2007. In the first quarter of 2008, management determined that this was a verifiable trend and reduced reserves accordingly.
 
 
Strengthened reserves for allocated loss adjustment expenses on national account general liability claims. Allocated loss adjustment expense reserves on general liability excess and umbrella claims were strengthened for accident years 2004 and prior as the Company observed that the cost of settling these claims has exceeded previous expectations.
 
 
Refer to the Other Operations Claims section for further discussion concerning the Company’s annual evaluations of net environmental and net asbestos reserves, and related reinsurance.

 

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Other Operations Claims
Reserve Activity
Reserves and reserve activity in the Other Operations operating segment, within Corporate and Other, are categorized and reported as asbestos, environmental, or “all other”. The “all other” category of reserves covers a wide range of insurance and assumed reinsurance coverages, including, but not limited to, potential liability for construction defects, lead paint, silica, pharmaceutical products, molestation and other long-tail liabilities.
The following table presents reserve activity, inclusive of estimates for both reported and incurred but not reported claims, net of reinsurance, for Other Operations, categorized by asbestos, environmental and all other claims, for the years ended December 31, 2010, 2009 and 2008.
Other Operations Losses and Loss Adjustment Expenses
                                 
    Asbestos     Environmental     All Other [1]     Total  
2010
                               
Beginning liability — net [2] [3]
  $ 1,892     $ 307     $ 1,432     $ 3,631  
Losses and loss adjustment expenses incurred
    189       67       (5 )     251  
Losses and loss adjustment expenses paid
    (294 )     (40 )     (125 )     (459 )
 
                       
Ending liability — net [2] [3]
  $ 1,787 [4]   $ 334     $ 1,302     $ 3,423  
 
                       
2009
                               
Beginning liability — net [2] [3]
  $ 1,884     $ 269     $ 1,628     $ 3,781  
Losses and loss adjustment expenses incurred
    138       75       29       242  
Losses and loss adjustment expenses paid
    (181 )     (40 )     (171 )     (392 )
Reclassification of asbestos and environmental liabilities
    51       3       (54 )      
 
                       
Ending liability — net [2] [3]
  $ 1,892     $ 307     $ 1,432     $ 3,631  
 
                       
2008
                               
Beginning liability — net [2] [3]
  $ 1,998     $ 251     $ 1,888     $ 4,137  
Losses and loss adjustment expenses incurred
    68       54       7       129  
Losses and loss adjustment expenses paid
    (182 )     (36 )     (267 )     (485 )
 
                       
Ending liability — net [2] [3]
  $ 1,884     $ 269     $ 1,628     $ 3,781  
 
                       
     
[1]  
“All Other” includes unallocated loss adjustment expense reserves. “All Other” also includes The Company’s allowance for uncollectible reinsurance. When the Company commutes a ceded reinsurance contract or settles a ceded reinsurance dispute, the portion of the allowance for uncollectible reinsurance attributable to that commutation or settlement, if any, is reclassified to the appropriate cause of loss.
 
[2]  
Excludes amounts reported in Property & Casualty Commercial and Consumer Markets reporting segments for asbestos and environmental net liabilities of $11 and $5, respectively, as of December 31, 2010, $10 and $5, respectively, as of December 31, 2009, and $12 and $6, respectively, as of December 31, 2008; total net losses and loss adjustment expenses incurred for the years ended December 31, 2010, 2009 and 2008 of $15, $16 and $16, respectively, related to asbestos and environmental claims; and total net losses and loss adjustment expenses paid for the years ended December 31, 2010, 2009 and 2008 of $14, $19 and $13, respectively, related to asbestos and environmental claims.
 
[3]  
Gross of reinsurance, asbestos and environmental reserves, including liabilities in Property & Casualty Commercial and Commercial Markets, were $2,308 and $378, respectively, as of December 31, 2010; $2,484 and $367, respectively, as of December 31, 2009; and $2,498 and $309, respectively, as of December 31, 2008.
 
[4]  
The one year and average three year net paid amounts for asbestos claims, including Ongoing Operations, were $300 and $227, respectively, resulting in a one year net survival ratio of 6.0 and a three year net survival ratio of 7.9. Net survival ratio is the quotient of the net carried reserves divided by the average annual payment amount and is an indication of the number of years that the net carried reserve would last (i.e. survive) if the future annual claim payments were consistent with the calculated historical average.
For paid and incurred losses and loss adjustment expenses reporting, the Company classifies its asbestos and environmental reserves into three categories: Direct, Assumed Reinsurance and London Market. Direct insurance includes primary and excess coverage. Assumed reinsurance includes both “treaty” reinsurance (covering broad categories of claims or blocks of business) and “facultative” reinsurance (covering specific risks or individual policies of primary or excess insurance companies). London Market business includes the business written by one or more of the Company’s subsidiaries in the United Kingdom, which are no longer active in the insurance or reinsurance business. Such business includes both direct insurance and assumed reinsurance.
Of the three categories of claims (Direct, Assumed Reinsurance and London Market), direct policies tend to have the greatest factual development from which to estimate the Company’s exposures.
Assumed reinsurance exposures are inherently less predictable than direct insurance exposures because the Company may not receive notice of a reinsurance claim until the underlying direct insurance claim is mature. This causes a delay in the receipt of information at the reinsurer level and adds to the uncertainty of estimating related reserves.
London Market exposures are the most uncertain of the three categories of claims. As a participant in the London Market (comprised of both Lloyd’s of London and London Market companies), certain subsidiaries of the Company wrote business on a subscription basis, with those subsidiaries’ involvement being limited to a relatively small percentage of a total contract placement. Claims are reported, via a broker, to the “lead” underwriter and, once agreed to, are presented to the following markets for concurrence. This reporting and claim agreement process makes estimating liabilities for this business the most uncertain of the three categories of claims.

 

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The following table sets forth, for the years ended December 31, 2010, 2009 and 2008, paid and incurred loss activity by the three categories of claims for asbestos and environmental.
Paid and Incurred Losses and Loss Adjustment Expenses (“LAE”) Development — Asbestos and Environmental
                                 
    Asbestos [1]     Environmental [1]  
    Paid     Incurred     Paid     Incurred  
    Losses & LAE     Losses & LAE     Losses & LAE     Losses & LAE  
2010
                               
Gross
                               
Direct
  $ 201     $ 209     $ 35     $ 50  
Assumed Reinsurance
    128             12       5  
London Market
    42       (15 )     7       10  
 
                       
Total
    371       194       54       65  
Ceded
    (77 )     (5 )     (14 )     2  
 
                       
Net
  $ 294     $ 189     $ 40     $ 67  
 
                       
2009
                               
Gross
                               
Direct
  $ 160     $ 117     $ 29     $ 92  
Assumed Reinsurance
    56       52       7        
London Market
    18             10       12  
 
                       
Total
    234       169       46       104  
Ceded
    (53 )     (31 )     (6 )     (29 )
 
                       
Net prior to reclassification
    181       138       40       75  
 
                       
Reclassification of asbestos and environmental liabilities [2]
          51             3  
 
                       
Net
  $ 181     $ 189     $ 40     $ 78  
 
                       
2008
                               
Gross
                               
Direct
  $ 207     $ 76     $ 32     $ 69  
Assumed — Domestic
    61             9       (17 )
London Market
    19             6       13  
 
                       
Total
    287       76       47       65  
Ceded
    (105 )     (8 )     (11 )     (11 )
 
                       
Net
  $ 182     $ 68     $ 36     $ 54  
 
                       
     
[1]  
Excludes asbestos and environmental paid and incurred loss and LAE reported in Property & Casualty Commercial. Total gross losses and LAE incurred in Property & Casualty Commercial for the years ended December 31, 2010, 2009 and 2008 includes $15, $17 and $15, respectively, related to asbestos and environmental claims. Total gross losses and LAE paid in Property & Casualty Commercial for the years ended December 31, 2010, 2009 and 2008 includes $14, $20 and $12, respectively, related to asbestos and environmental claims.
 
[2]  
During the three months ended June 30, 2009, the Company reclassified liabilities of $54 that were previously classified as “All Other” to “Asbestos” and “Environmental”.
In the fourth quarters of 2010, 2009 and 2008, the Company completed evaluations of certain of its non-asbestos and environmental reserves, including its assumed reinsurance liabilities. Based on this evaluation in 2010, the Company recognized unfavorable prior year development of $11. In 2009, the Company recognized unfavorable prior year development of $35, principally driven by higher projected unallocated loss adjustment expenses. The Company recognized favorable prior year development of $30 in 2008 for its HartRe assumed reinsurance liabilities principally driven by lower than expected reported losses. In 2008, the favorable HartRe assumed reinsurance prior year development was offset by unfavorable other non-asbestos and environmental prior year development of $30, including $25 of adverse development for assumed reinsurance obligations of the Company’s Bermuda operations.
During the third quarters of 2010, 2009 and 2008, the Company completed its annual ground up environmental reserve evaluations. In each of these evaluations, the Company reviewed all of its open direct domestic insurance accounts exposed to environmental liability as well as assumed reinsurance accounts and its London Market exposures for both direct and assumed reinsurance. During the third quarter of 2010, the Company found estimates for some individual accounts increased based upon unfavorable litigation results and increased clean-up or expense costs, with the vast majority of this deterioration emanating from a limited number of insureds. In 2009, the Company found estimates for some individual accounts increased based upon additional sites identified, litigation developments and new damage and defense cost information obtained on these accounts since the last review. In 2008, the Company found that the decline in the reporting of new accounts and sites has been slower than anticipated in the previous review. The net effect of these account-specific changes as well as actuarial evaluations of new account emergence and historical loss and expense paid experience resulted in $62, $75 and $53 increases in net environmental liabilities in 2010, 2009 and 2008, respectively. The Company currently expects to continue to perform an evaluation of its environmental liabilities annually.

 

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In reporting environmental results, the Company classifies its gross exposure into Direct, Assumed Reinsurance, and London Market. The following table displays gross environmental reserves and other statistics by category as of December 31, 2010.
Summary of Environmental Reserves
As of December 31, 2010
         
    Total Reserves  
Gross [1] [2]
       
Direct
  $ 273  
Assumed Reinsurance
    47  
London Market
    58  
 
     
Total
    378  
Ceded
    (39 )
 
     
Net
  $ 339  
 
     
     
[1]  
The one year gross paid amount for total environmental claims is $61, resulting in a one year gross survival ratio of 6.2.
 
[2]  
The three year average gross paid amount for total environmental claims is $56, resulting in a three year gross survival ratio of 6.8.
During the second quarters of 2010, 2009 and 2008, the Company completed its annual ground-up asbestos reserve evaluations. As part of these evaluations, the Company reviewed all of its open direct domestic insurance accounts exposed to asbestos liability, as well as assumed reinsurance accounts and its London Market exposures for both direct insurance and assumed reinsurance. Based on this evaluation, the Company increased its net asbestos reserves by $169 in second quarter 2010. During 2010 and 2009, for certain direct policyholders, the Company experienced increases in claim severity and expense. Increases in severity and expense were driven by litigation in certain jurisdictions and, to a lesser extent, development on primarily peripheral accounts. The Company also experienced unfavorable development on its assumed reinsurance accounts driven largely by the same factors experienced by the direct policyholders. The net effect of these changes in 2009 resulted in a $138 increase in net asbestos reserves. In the second quarter of 2008, the Company found estimates for individual cases changed based upon the particular circumstances of each account. These changes were case specific and not as a result of any underlying change in the current environment. The net effect of these changes resulted in a $50 increase in net asbestos reserves. The Company currently expects to continue to perform an evaluation of its asbestos liabilities annually.
The Company classifies its gross asbestos exposures into Direct, Assumed Reinsurance and London Market. The Company further classifies its direct asbestos exposures into the following categories: Major Asbestos Defendants (the “Top 70” accounts in Tillinghast’s published Tiers 1 and 2 and Wellington accounts), which are subdivided further as: Structured Settlements, Wellington, Other Major Asbestos Defendants, Accounts with Future Expected Exposures greater than $2.5, Accounts with Future Expected Exposures less than $2.5, and Unallocated.
 
Structured Settlements are those accounts where the Company has reached an agreement with the insured as to the amount and timing of the claim payments to be made to the insured.
 
 
The Wellington subcategory includes insureds that entered into the “Wellington Agreement” dated June 19, 1985. The Wellington Agreement provided terms and conditions for how the signatory asbestos producers would access their coverage from the signatory insurers.
 
 
The Other Major Asbestos Defendants subcategory represents insureds included in Tiers 1 and 2, as defined by Tillinghast that are not Wellington signatories and have not entered into structured settlements with The Hartford. The Tier 1 and 2 classifications are meant to capture the insureds for which there is expected to be significant exposure to asbestos claims.
 
 
Accounts with future expected exposures greater or less than $2.5 include accounts that are not major asbestos defendants.
 
 
The Unallocated category includes an estimate of the reserves necessary for asbestos claims related to direct insureds that have not previously tendered asbestos claims to the Company and exposures related to liability claims that may not be subject to an aggregate limit under the applicable policies.
An account may move between categories from one evaluation to the next. For example, an account with future expected exposure of greater than $2.5 in one evaluation may be reevaluated due to changing conditions and recategorized as less than $2.5 in a subsequent evaluation or vice versa.

 

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The following table displays gross asbestos reserves and other statistics by policyholder category as of December 31, 2010.
Summary of Gross Asbestos Reserves
As of December 31, 2010
                                 
    Number of     All Time     Total     All Time  
    Accounts [2]     Paid [3]     Reserves     Ultimate [3]  
Gross Asbestos Reserves as of June 30, 2010 [1]
                               
Major asbestos defendants [5]
                               
Structured settlements (includes 4 Wellington accounts) [6]
    7     $ 312     $ 428     $ 740  
Wellington (direct only)
    29       908       44       952  
Other major asbestos defendants
    29       476       132       608  
No known policies (includes 3 Wellington accounts)
    5                    
Accounts with future exposure > $2.5
    77       832       585       1,417  
Accounts with future exposure < $2.5
    1,122       409       133       542  
Unallocated [7]
            1,766       446       2,212  
 
                       
Total Direct
            4,703       1,768       6,471  
Assumed Reinsurance
            1,199       469       1,668  
London Market
            605       308       913  
 
                       
Total as of June 30, 2010 [1]
            6,507       2,545       9,052  
 
                       
Gross paid loss activity for the third quarter and fourth quarter 2010
            242       (242 )      
Gross incurred loss activity for the third quarter and fourth quarter 2010
                    5       5  
 
                       
Total as of December 31, 2010 [4]
          $ 6,749     $ 2,308     $ 9,057  
 
                       
     
[1]  
Gross Asbestos Reserves based on the second quarter 2010 asbestos reserve study.
 
[2]  
An account may move between categories from one evaluation to the next. Reclassifications were made as a result of the reserve evaluation completed in the second quarter of 2010.
 
[3]  
“All Time Paid” represents the total payments with respect to the indicated claim type that have already been made by the Company as of the indicated balance sheet date. “All Time Ultimate” represents the Company’s estimate, as of the indicated balance sheet date, of the total payments that are ultimately expected to be made to fully settle the indicated payment type. The amount is the sum of the amounts already paid (e.g. “All Time Paid”) and the estimated future payments (e.g. the amount shown in the column labeled “Total Reserves”).
 
[4]  
Survival ratio is a commonly used industry ratio for comparing reserve levels between companies. While the method is commonly used, it is not a predictive technique. Survival ratios may vary over time for numerous reasons such as large payments due to the final resolution of certain asbestos liabilities, or reserve re-estimates. The survival ratio is computed by dividing the recorded reserves by the average of the past three years of payments. The ratio is the calculated number of years the recorded reserves would survive if future annual payments were equal to the average annual payments for the past three years. The 3-year gross survival ratio of 7.5 as of December 31, 2010 is computed based on total paid losses of $917 for the period from January 1, 2008 to December 31, 2010. As of December 31, 2010, the one year gross paid amount for total asbestos claims is $378 resulting in a one year gross survival ratio of 6.1.
 
[5]  
Includes 25 open accounts at June 30, 2010. Included 25 open accounts at June 30, 2009.
 
[6]  
Structured settlements include the Company’s reserves related to PPG Industries, Inc. (“PPG”). In January 2009, the Company, along with approximately three dozen other insurers, entered into a modified agreement in principle with PPG to resolve the Company’s coverage obligations for all of its PPG asbestos liabilities, including principally those arising out of its 50% stock ownership of Pittsburgh Corning Corporation (“PCC”), a joint venture with Corning, Inc. The agreement is contingent on the fulfillment of certain conditions, including the confirmation of a PCC plan of reorganization under Section 524(g) of the Bankruptcy Code, which have not yet been met.
 
[7]  
Includes closed accounts (exclusive of Major Asbestos Defendants) and unallocated IBNR.
The Company provides an allowance for uncollectible reinsurance, reflecting management’s best estimate of reinsurance cessions that may be uncollectible in the future due to reinsurers’ unwillingness or inability to pay. During the second quarters of 2010, 2009 and 2008, the Company completed its annual evaluations of the collectability of the reinsurance recoverables and the adequacy of the allowance for uncollectible reinsurance associated with older, long-term casualty liabilities reported in the Other Operations segment. In conducting this evaluation, the Company used its most recent detailed evaluations of ceded liabilities reported in the segment. The Company analyzed the overall credit quality of the Company’s reinsurers, recent trends in arbitration and litigation outcomes in disputes between cedants and reinsurers, and recent developments in commutation activity between reinsurers and cedants. The evaluation in the second quarter of 2010 resulted in no addition to the allowance for uncollectible reinsurance. As of December 31, 2010, the allowance for uncollectible reinsurance for Other Operations totals $211. As a result of the second quarter of 2009 evaluation, the Company reduced its allowance for uncollectible reinsurance by $20 principally to reflect decreased reinsurance recoverable dispute exposure and favorable activity since the last evaluation. The evaluation in the second quarter of 2008 resulted in no addition to the allowance for uncollectible reinsurance. The Company currently expects to perform its regular comprehensive review of Other Operations reinsurance recoverables annually. Due to the inherent uncertainties as to collection and the length of time before reinsurance recoverables become due, particularly for older, long-term casualty liabilities, it is possible that future adjustments to the Company’s reinsurance recoverables, net of the allowance, could be required.
Consistent with the Company’s long-standing reserving practices, the Company will continue to review and monitor its reserves in the Other Operations segment regularly and, where future developments indicate, make appropriate adjustments to the reserves.

 

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Impact of Re-estimates
The establishment of property and casualty insurance product reserves is an estimation process, using a variety of methods, assumptions and data elements. Ultimate losses may vary significantly from the current estimates. Many factors can contribute to these variations and the need to change the previous estimate of required reserve levels. Subsequent changes can generally be thought of as being the result of the emergence of additional facts that were not known or anticipated at the time of the prior reserve estimate and/or changes in interpretations of information and trends.
The table below shows the range of annual reserve re-estimates experienced by The Hartford over the past ten years. The amount of prior accident year development (as shown in the reserve rollforward) for a given calendar year is expressed as a percent of the beginning calendar year reserves, net of reinsurance. The percentage relationships presented are significantly influenced by the facts and circumstances of each particular year and by the fact that only the last ten years are included in the range. Accordingly, these percentages are not intended to be a prediction of the range of possible future variability. See “Impact of key assumptions on reserve volatility” within this section for further discussion of the potential for variability in recorded loss reserves.
                                 
    Property & Casualty     Consumer     Corporate and     Total Property and  
    Commercial     Markets     Other     Casualty Insurance  
Range of prior accident year unfavorable (favorable) development for the ten years ended December 31, 2010 [1] [2]
    (3.1) – 1.5       (5.2) – 5.1       2.9 – 67.5       (1.2) – 21.5  
     
[1]  
Excluding the reserve strengthening for asbestos and environmental reserves, over the past ten years reserve re-estimates for total property and casualty insurance ranged from (3.0)% to 1.6%.
 
[2]  
Development for Corporate is included in Property & Casualty Commercial and Consumer Markets in 2007 and prior.
The potential variability of the Company’s property and casualty insurance product reserves would normally be expected to vary by segment and the types of loss exposures insured by those segments. Illustrative factors influencing the potential reserve variability for each of the segments are discussed above.
A table depicting the historical development of the liabilities for unpaid losses and loss adjustment expenses, net of reinsurance, follows.
Loss Development Table
Loss And Loss Adjustment Expense Liability Development — Net of Reinsurance
For the Years Ended December 31, [1]
                                                                                         
    2000     2001     2002     2003     2004     2005     2006     2007     2008     2009     2010  
Liabilities for unpaid losses and loss adjustment expenses, net of reinsurance
  $ 12,316     $ 12,860     $ 13,141     $ 16,218     $ 16,191     $ 16,863     $ 17,604     $ 18,231     $ 18,347     $ 18,210     $ 17,948  
Cumulative paid losses and loss expenses
                                                                                       
One year later
    3,272       3,339       3,480       4,415       3,594       3,702       3,727       3,703       3,771       3,882          
Two years later
    5,315       5,621       6,781       6,779       6,035       6,122       5,980       5,980       6,273                  
Three years later
    6,972       8,324       8,591       8,686       7,825       7,755       7,544       7,752                        
Four years later
    9,195       9,710       10,061       10,075       9,045       8,889       8,833                              
Five years later
    10,227       10,871       11,181       11,063       9,928       9,903                                    
Six years later
    11,140       11,832       12,015       11,821       10,798                                          
Seven years later
    11,961       12,563       12,672       12,601                                                
Eight years later
    12,616       13,166       13,385                                                      
Nine years later
    13,167       13,829                                                            
Ten years later
    13,779                                                                  
Liabilities re-estimated
                                                                                       
One year later
    12,459       13,153       15,965       16,632       16,439       17,159       17,652       18,005       18,161       18,014          
Two years later
    12,776       16,176       16,501       17,232       16,838       17,347       17,475       17,858       18,004                  
Three years later
    15,760       16,768       17,338       17,739       17,240       17,318       17,441       17,700                        
Four years later
    16,584       17,425       17,876       18,367       17,344       17,497       17,439                              
Five years later
    17,048       17,927       18,630       18,554       17,570       17,613                                    
Six years later
    17,512       18,686       18,838       18,836       17,777                                          
Seven years later
    18,216       18,892       19,126       19,063                                                
Eight years later
    18,410       19,192       19,373                                                      
Nine years later
    18,649       19,452                                                            
Ten years later
    18,922                                                                  
 
                                                                 
Deficiency (redundancy), net of reinsurance
  $ 6,606     $ 6,592     $ 6,232     $ 2,845     $ 1,586     $ 750     $ (165 )   $ (531 )   $ (343 )   $ (196 )        
 
                                                                 
     
[1]  
The above table excludes Hartford Insurance, Singapore as a result of its sale in September 2001; Hartford Seguros as a result of its sale in February 2001; and Zwolsche as a result of its sale in December 2000.

 

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The table above shows the cumulative deficiency (redundancy) of the Company’s reserves, net of reinsurance, as now estimated with the benefit of additional information. Those amounts are comprised of changes in estimates of gross losses and changes in estimates of related reinsurance recoveries.
The table below, for the periods presented, reconciles the net reserves to the gross reserves, as initially estimated and recorded, and as currently estimated and recorded, and computes the cumulative deficiency (redundancy) of the Company’s reserves before reinsurance.
Loss And Loss Adjustment Expense Liability Development — Gross
For the Years Ended December 31, [1]
                                                                                 
    2001     2002     2003     2004     2005     2006     2007     2008     2009     2010  
Net reserve, as initially estimated
  $ 12,860     $ 13,141     $ 16,218     $ 16,191     $ 16,863     $ 17,604     $ 18,231     $ 18,347     $ 18,210     $ 17,948  
 
                                                           
Reinsurance and other recoverables, as initially estimated
    4,176       3,950       5,497       5,138       5,403       4,387       3,922       3,586       3,441       3,077  
 
                                                           
Gross reserve, as initially estimated
  $ 17,036     $ 17,091     $ 21,715     $ 21,329     $ 22,266     $ 21,991     $ 22,153     $ 21,933     $ 21,651     $ 21,025  
 
                                                           
Net re-estimated reserve
  $ 19,452     $ 19,373     $ 19,063     $ 17,777     $ 17,613     $ 17,439     $ 17,700     $ 18,004     $ 18,014          
Re-estimated and other reinsurance recoverables
    5,908       5,511       5,423       5,311       5,646       4,069       3,785       3,459       2,959          
 
                                                           
Gross re-estimated reserve
  $ 25,360     $ 24,884     $ 24,486     $ 23,088     $ 23,259     $ 21,508     $ 21,485     $ 21,463     $ 20,973          
 
                                                           
Gross deficiency (redundancy)
  $ 8,324     $ 7,793     $ 2,771     $ 1,759     $ 993     $ (483 )   $ (668 )   $ (470 )   $ (678 )        
 
                                                           
     
[1]  
The above table excludes Hartford Insurance, Singapore as a result of its sale in September 2001; Hartford Seguros as a result of its sale in February 2001.
The following table is derived from the Loss Development table and summarizes the effect of reserve re-estimates, net of reinsurance, on calendar year operations for the ten-year period ended December 31, 2010. The total of each column details the amount of reserve re-estimates made in the indicated calendar year and shows the accident years to which the re-estimates are applicable. The amounts in the total accident year column on the far right represent the cumulative reserve re-estimates during the ten year period ended December 31, 2010 for the indicated accident year(s).
Effect of Net Reserve Re-estimates on Calendar Year Operations
                                                                                         
    Calendar Year  
    2001     2002     2003     2004     2005     2006     2007     2008     2009     2010     Total  
By Accident year
                                                                                       
2000 & Prior
  $ 143     $ 317     $ 2,984     $ 824     $ 464     $ 464     $ 704     $ 194     $ 239     $ 273     $ 6,606  
2001
          (24 )     39       (232 )     193       38       55       12       61       (13 )     129  
2002
                (199 )     (56 )     180       36       (5 )     2       (12 )     (13 )     (67 )
2003
                      (122 )     (237 )     (31 )     (126 )     (21 )     (6 )     (20 )     (563 )
2004
                            (352 )     (108 )     (226 )     (83 )     (56 )     (20 )     (845 )
2005
                                  (103 )     (214 )     (133 )     (47 )     (91 )     (588 )
2006
                                        (140 )     (148 )     (213 )     (118 )     (619 )
2007
                                              (49 )     (113 )     (156 )     (318 )
2008
                                                    (39 )     1       (38 )
2009
                                                          (39 )     (39 )
 
                                                                 
Total
  $ 143     $ 293     $ 2,824     $ 414     $ 248     $ 296     $ 48     $ (226 )   $ (186 )   $ (196 )   $ 3,658  
 
                                                                 
During the 2007 calendar year, the Company refined its processes for allocating incurred but not reported (“IBNR”) reserves by accident year, resulting in a reclassification of $347 of IBNR reserves from the 2003 to 2006 accident years to the 2002 and prior accident years. This reclassification of reserves by accident year had no effect on total recorded reserves within any segment or on total recorded reserves for any line of business within a segment.
Reserve changes for accident years 2000 & Prior
The largest impacts of net reserve re-estimates are shown in the “2000 & Prior” accident years. Reserve deterioration was related to calendar years, driven, in part, by deterioration of reserves for assumed casualty reinsurance and workers’ compensation claims. Numerous actuarial assumptions on assumed casualty reinsurance turned out to be low, including loss cost trends, particularly on excess of loss business, and the impact of deteriorating terms and conditions. Workers’ compensation reserves also deteriorated, as medical inflation trends were above initial expectations.
The reserve re-estimates in calendar year 2003 include an increase in reserves of $2.6 billion related to reserve strengthening based on the Company’s evaluation of its asbestos reserves. The reserve evaluation that led to the strengthening in calendar year 2003 confirmed the Company’s view of the existence of a substantial long-term deterioration in the asbestos litigation environment. The reserve re-estimates in calendar years 2004 and 2006 were largely attributable to reductions in the reinsurance recoverable asset associated with older, long-term casualty liabilities.

 

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Reserve changes for accident years 2001 and 2002
Accident years 2001 and 2002 are reasonably close to original estimates. However, each year shows some swings by calendar period, with some favorable development prior to calendar year 2005, largely offset by unfavorable development in calendar years 2005 through 2008. The release for accident year 2001 during calendar year 2004 relates primarily to reserves for the terrorist attack on September 11, 2001. Subsequent adverse developments on accident year 2001 relate to assumed casualty reinsurance and unexpected development on mature claims in both general liability and workers’ compensation. Reserve releases for accident year 2002 during calendar years 2003 and 2004 come largely from short-tail lines of business, where results emerge quickly and actual reported losses are predictive of ultimate losses. Reserve increases on accident year 2002 during calendar year 2005 were recognized, as unfavorable development on accident years prior to 2002 caused the Company to increase its estimate of unpaid losses for the 2002 accident year.
Reserve changes for accident years 2003 through 2009
Even after considering the 2007 calendar year reclassification of $347 of IBNR reserves from the 2003 to 2006 accident years to the 2002 and prior accident years, accident years 2003 through 2007 show favorable development in calendar years 2004 through 2010. A portion of the release comes from short-tail lines of business, where results emerge quickly. During calendar year 2005 and 2006, favorable re-estimates occurred for both loss and allocated loss adjustment expenses. In addition, catastrophe reserves related to the 2004 and 2005 hurricanes developed favorably in 2006. During calendar years 2005 through 2008, the Company recognized favorable re-estimates of both loss and allocated loss adjustment expenses on workers’ compensation claims driven, in part, by state legal reforms, including in California and Florida, underwriting actions and expense reduction initiatives that have had a greater impact in controlling costs than was originally estimated. In 2007, the Company released reserves for package business claims as reported losses have emerged favorably to previous expectations. In 2007 through 2009, the Company released reserves for general liability claims due to the favorable emergence of losses for high hazard and umbrella general liability claims. Reserves for professional liability claims were released in 2008 and 2009 related to the 2003 through 2007 accident years due to a lower estimate of claim severity on both directors’ and officers’ insurance claims and errors and omissions insurance claims. Reserves of auto liability claims, within Consumer Markets, were released in 2008 due largely to an improvement in emerged claim severity for the 2005 to 2007 accident years.

 

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Estimated Gross Profits Used in the Valuation and Amortization of Assets and Liabilities Associated with Variable Annuity and Other Universal Life-Type Contracts
Estimated gross profits (“EGPs”) are used in the amortization of the DAC asset, which includes the present value of future profits; sales inducement assets (“SIA”); and unearned revenue reserves (“URR”). See Note 7 of the Notes to Consolidated Financial Statements for additional information on DAC. See Note 10 of the Notes to Consolidated Financial Statements for additional information on SIA. Portions of EGPs are also used in the valuation of reserves for death and other insurance benefit features on variable annuity and universal life-type contracts. See Note 9 of the Notes to Consolidated Financial Statements for additional information on death and other insurance benefit reserves.
As of December 31, 2010 and 2009 the most significant EGP based balances that are amortized were as follows:
                                                                 
    U.S. Annuity     International Annuity     Retirement Plans     Life Insurance  
    2010     2009     2010     2009     2010     2009     2010     2009  
DAC
  $ 3,251     $ 3,114     $ 1,617     $ 1,693     $ 820     $ 701     $ 2,667     $ 2,490  
SIA
  $ 329     $ 324     $ 41     $ 28     $ 23     $ 23     $ 45     $ 42  
URR
  $ 99     $ 96     $ 43     $ 70     $     $     $ 1,383     $ 1,182  
Death and Other Insurance Benefit Reserves
  $ 1,052     $ 1,232     $ 696     $ 584     $ 1     $ 1     $ 113     $ 76  
For most contracts, the Company estimates gross profits over 20 years as EGPs emerging subsequent to that timeframe are immaterial. 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, based on future account value projections for variable annuity and variable universal life products. The projection of future account values requires the use of certain assumptions including: separate account returns; separate account fund mix; fees assessed against the contract holder’s account balance; surrender and lapse rates; interest margin; mortality; and hedging costs. Changes in these assumptions and, in addition, changes to other policyholder behavior assumptions such as resets, partial surrenders, reaction to price increases, and asset allocations causes EGPs to fluctuate which impacts earnings.
Prior to the second quarter of 2009, the Company determined EGPs using the mean derived from stochastic scenarios that had been calibrated to the estimated separate account return. The Company also completed a comprehensive assumption study, in the third quarter of each year, and revised best estimate assumptions used to estimate future gross profits when the EGPs in the Company’s models fell outside of an independently determined reasonable range of EGPs. The Company also considered, on a quarterly basis, other qualitative factors such as product, regulatory and policyholder behavior trends and would revise EGPs if those trends were expected to be significant.
Beginning with the second quarter of 2009, the Company now determines EGPs from a single deterministic reversion to mean (“RTM”) separate account return projection which is an estimation technique commonly used by insurance entities to project future separate account returns. Through this estimation technique, the Company’s DAC model is adjusted to reflect actual account values at the end of each quarter. Through consideration of recent market returns, the Company will unlock, or adjust, projected returns over a future period so that the account value returns to the long-term expected rate of return, providing that those projected returns do not exceed certain caps or floors. This DAC Unlock for future separate account returns is determined each quarter. Under RTM, the expected long term weighted average rate of return is 8.3% and 5.9% for U.S. and Japan, respectively.
In the third quarter of each year, the Company completes a comprehensive non-market related policyholder behavior assumption study and incorporates the results of those studies into its projection of future gross profits. Additionally, throughout the year, the Company evaluates various aspects of policyholder behavior and periodically revises its policyholder assumptions as credible emerging data indicates that changes are warranted. Upon completion of the assumption study or evaluation of credible new information, the Company will revise its assumptions to reflect its current best estimate. These assumption revisions will change the projected account values and the related EGPs in the DAC, SIA and URR amortization models, as well as the death and other insurance benefit reserving model.
All assumption changes that affect the estimate of future EGPs including the update of current account values, the use of the RTM estimation technique and policyholder behavior assumptions are considered an Unlock in the period of revision. An Unlock adjusts DAC, SIA, URR and death and other insurance benefit reserve balances in the Consolidated Balance Sheets with an offsetting benefit or charge in the Consolidated Statements of Operations in the period of the 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.
EGPs are also used to determine the expected excess benefits and assessments included in the measurement of death and other insurance benefit reserves. These excess benefits and assessments are derived from a range of stochastic scenarios that have been calibrated to the Company’s RTM separate account returns. The determination of death and other insurance benefit reserves is also impacted by discount rates, lapses, volatilities and mortality assumptions.

 

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An Unlock revises EGPs, on a quarterly basis, to reflect market updates of policyholder account value and the Company’s current best estimate assumptions. After each quarterly Unlock, the Company also tests the aggregate recoverability of DAC by comparing the DAC balance to the present value of future EGPs. The margin between the DAC balance and the present value of future EGPs for U.S. and Japan individual variable annuities was 29% and 38% as of December 31, 2010, respectively. If the margin between the DAC asset and the present value of future EGPs is exhausted, further reductions in EGPs would cause portions of DAC to be unrecoverable and the DAC asset would be written down to equal future EGPs.
Unlocks
The after-tax impact on the Company’s assets and liabilities as a result of the Unlocks for years ended 2010, 2009 and 2008, were:
For the year ended December 31, 2010:
                                         
                    Death and Other              
Segment                   Insurance              
After-tax (Charge) Benefit   DAC     URR     Benefit Reserves     SIA     Total  
Global Annuity
  $ 42     $ 7     $ 16     $     $ 65  
Life Insurance
    23       5       1       (1 )     28  
Retirement Plans
    18                         18  
 
                             
Total
  $ 83     $ 12     $ 17     $ (1 )   $ 111  
 
                             
The most significant contributors to the Unlock benefit recorded during the year ended December 31, 2010 were actual separate account returns being above our aggregated estimated return. Also included in the benefit are assumption updates related to benefits from withdrawals and lapses, offset by hedging, annuitization estimates on Japan products, and long-term expected rate of return updates.
For the year ended December 31, 2009:
                                         
                    Death and Other              
Segment                   Insurance              
After-tax (Charge) Benefit   DAC     URR     Benefit Reserves     SIA     Total [1]  
Global Annuity
  $ (533 )   $ 23     $ (368 )   $ (46 )   $ (924 )
Life Insurance
    (101 )     54       (4 )           (51 )
Retirement Plans
    (55 )                 (1 )     (56 )
Corporate and Other
    (3 )                       (3 )
 
                             
Total
  $ (692 )   $ 77     $ (372 )   $ (47 )   $ (1,034 )
 
                             
     
[1]  
Includes $(49) related to DAC recoverability impairment associated with the decision to suspend sales in the U.K variable annuity business.
The most significant contributors to the Unlock was a result of actual separate account returns being significantly below our aggregated estimated return for the first quarter of 2009, partially offset by actual returns being greater than our aggregated estimated return for the period from April 1, 2009 to December 31, 2009.
For the year ended December 31, 2008:
                                         
                    Death and Other              
Segment                   Insurance Benefit              
After-tax (Charge) Benefit   DAC     URR     Reserves     SIA     Total  
Global Annuity
  $ (671 )   $ 17     $ (165 )   $ (29 )   $ (848 )
Life Insurance
    (29 )     (12 )     (3 )           (44 )
Retirement Plans
    (49 )                       (49 )
Corporate and Other
    9                         9  
 
                             
Total
  $ (740 )   $ 5     $ (168 )   $ (29 )   $ (932 )
 
                             
The most significant contributors to the Unlock was a result of actual separate account returns were significantly below our aggregated estimated return. Furthermore, the Company reduced its 20 year projected separate account return assumption from 7.8% to 7.2% in the U.S. In addition, Retirement Plans reduced its estimate of future fees as plans met contractual size limits (“breakpoints”), causing a lower fee schedule to apply, and the Company increased its assumption for future deposits by existing plan participants.
Evaluation of Other-Than-Temporary Impairments on Available-for-Sale Securities and Valuation Allowances on Investments
The Company has a monitoring process overseen by a committee of investment and accounting professionals that identifies investments that are subject to an enhanced evaluation on a quarterly basis to determine if an other-than-temporary impairment (“impairment”) is present for AFS securities or a valuation allowance is required for mortgage loans. This evaluation is a quantitative and qualitative process, which is subject to risks and uncertainties. For further discussion of the accounting policies, see the Significant Investment Accounting Policies Section in Note 5 of the Notes to Consolidated Financial Statements. For a discussion of results, see the Other-Than-Temporary Impairments within the Investment Credit Risk section of the MD&A.

 

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Living Benefits Required to be Fair Valued (in Other Policyholder Funds and Benefits Payable)
Fair values for GMWB and GMAB contracts are calculated using the income approach based upon internally developed models because active, observable markets do not exist for those items. The fair value of the Company’s 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 Claims Payments; Credit Standing Adjustment; and Margins. 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 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, 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. For further discussion on the impact of fair value changes from living benefits see Note 4a of the Notes to Consolidated Financial Statements and for a discussion on the sensitivities of certain living benefits due to capital market factors see Variable Product Equity Risk within Capital Markets Risk Management.
Goodwill Impairment
Goodwill balances are reviewed for impairment at least annually or more frequently if events occur or circumstances change that would indicate that a triggering event for a potential impairment has occurred. The goodwill impairment test follows a two step process. In the first step, the fair value of a reporting unit is compared to its carrying value. If the carrying value of a reporting unit exceeds its fair value, the second step of the impairment test is performed for purposes of measuring the impairment. In the second step, the fair value of the reporting unit is allocated to all of the assets and liabilities of the reporting unit to determine an implied goodwill value. This allocation is similar to a purchase price allocation performed in purchase accounting. If the carrying amount of the reporting unit goodwill exceeds the implied goodwill value, an impairment loss shall be recognized in an amount equal to that excess.
Management’s determination of the fair value of each reporting unit incorporates multiple inputs including discounted cash flow calculations, peer company price to earnings multiples, the level of the Company’s own share price and assumptions that market participants would make in valuing the reporting unit. Other assumptions include levels of economic capital, future business growth, earnings projections, assets under management for Wealth Management reporting units and the weighted average cost of capital used for purposes of discounting. Decreases in the amount of economic capital allocated to a reporting unit, decreases in business growth, decreases in earnings projections and increases in the weighted average cost of capital will all cause the reporting unit’s fair value to decrease.
A reporting unit is defined as an operating segment or one level below an operating segment. Most of the Company’s reporting units, for which goodwill has been allocated, are equivalent to the Company’s operating segments as there is no discrete financial information available for the separate components of the segment or all of the components of the segment have similar economic characteristics. In 2010, The Hartford has changed its reporting segments with no change to reporting units. The homeowners and automobile components of Consumer Markets have been aggregated into one reporting unit; the variable life, universal life and term life components within Life Insurance have been aggregated into one reporting unit of Individual Life; the 401(k), 457 and 403(b) components of Retirement Plans have been aggregated into one reporting unit; the retail mutual funds component of Mutual Funds has been aggregated into one reporting unit; and the group disability and group life components of Group Benefits have been aggregated into one reporting unit. In circumstances where the components of an operating segment constitute a business for which discrete financial information is available and segment management regularly reviews the operating results of that component such as Hartford Financial Products, the Company has classified those components as reporting units. Goodwill associated with the June 30, 2000 buyback of Hartford Life, Inc. was allocated to each of Hartford Life’s reporting units based on the reporting units’ fair value of in-force business at the time of the buyback. Although this goodwill was allocated to each reporting unit, it is held in Corporate and Other for segment reporting. In addition Federal Trust Corporation is an immaterial operating segment where the goodwill has been included in the Corporate and Other.

 

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As of December 31, 2010, the Company had goodwill allocated to the following reporting units:
                         
    Segment     Goodwill in        
    Goodwill     Corporate and Other     Total  
Hartford Financial Products within Property & Casualty Commercial
  $ 30     $     $ 30  
Group Benefits
          138       138  
Consumer Markets
    119             119  
Individual Life within Life Insurance
    224       118       342  
Retirement Plans
    87       69       156  
Mutual Funds
    159       92       251  
Federal Trust Corporation within Corporate and Other
          15       15  
 
                 
Total
  $ 619     $ 432     $ 1,051  
 
                 
As of December 31, 2009, the Company had goodwill allocated to the following reporting units:
                         
    Segment     Goodwill in        
    Goodwill     Corporate and Other     Total  
Hartford Financial Products within Property & Casualty Commercial
  $ 30     $     $ 30  
Group Benefits
          138       138  
Consumer Markets
    119             119  
Individual Life within Life Insurance
    224       118       342  
Retirement Plans
    87       69       156  
Mutual Funds
    159       92       251  
Federal Trust Corporation within Corporate and Other
          168       168  
 
                 
Total
  $ 619     $ 585     $ 1,204  
 
                 
The Company completed its annual goodwill assessment for the Federal Trust Corporation reporting unit within Corporate and Other during the second quarter of 2010, resulting in a goodwill impairment of $153, pre-tax.
The Company completed its annual goodwill assessment for the individual reporting units within Wealth Management and Corporate and Other, except for the Federal Trust Corporation reporting unit, as of January 1, 2010, which resulted in no write-downs of goodwill in 2010. The reporting units passed the first step of their annual impairment tests with a significant margin with the exception of the Individual Life reporting unit within Life Insurance.
Individual Life completed the second step of the annual goodwill impairment test resulting in an implied goodwill value that was in excess of its carrying value. Even though the fair value of the reporting unit was lower than its carrying value, the implied level of goodwill in Individual Life exceeded the carrying amount of goodwill. In the implied purchase accounting required by the step two goodwill impairment test, the implied present value of future profits was substantially lower than that of the DAC asset removed in purchase accounting. A higher discount rate was used for calculating the present value of future profits as compared to that used for calculating the present value of estimated gross profits for DAC. As a result, in the implied purchase accounting, implied goodwill exceeded the carrying amount of goodwill. The fair value of the Individual Life reporting unit within Life Insurance is based on discounted cash flows using earnings projections on in force business and future business growth. There could be a positive or negative impact on the result of step one in future periods if actual earnings or business growth assumptions emerge differently than those used in determining fair value for the first step of the annual goodwill impairment test.
The annual goodwill assessment for the reporting units within Property & Casualty Commercial and Consumer Markets was completed during the fourth quarter of 2010, which resulted in no write-downs of goodwill for the year ended December 31, 2010. Consumer Markets passed the first step of its annual impairment test with a significant margin while the Hartford Financial Products reporting unit within Property & Casualty Commercial passed the first step of its annual impairment test with less than a 5% margin. The fair value of the Hartford Financial Products reporting unit is based on discounted cash flows using earnings projections on existing business and future business growth. To the extent that actual earnings or business growth assumptions emerge differently than those used in determining fair value for the first step of the annual goodwill impairment test, it could have a positive or negative impact on the results of step one in future periods.
See Note 8 of the Notes to Consolidated Financial Statements for information on the results of goodwill impairment tests performed in 2009 and 2008.

 

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Valuation of Investments and Derivative Instruments
The fair value of AFS securities, fixed maturities, at fair value using the fair value option (“FVO”), equity securities, trading, 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, Fixed Maturities, FVO, Equity Securities, Trading, and Short-Term Investments Section in Note 4 of the Notes to 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 4 of the Notes to Consolidated Financial Statements.
Valuation of Derivative Instruments, excluding embedded derivatives within liability contracts and reinsurance related derivatives
Derivative instruments are reported on the 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 December 31, 2010 and 2009, 97% 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 level inputs that are predominantly observable in the market with the exception of the customized swap contracts that hedge guaranteed minimum withdrawal benefits (“GMWB”) liabilities. Inputs used to value derivatives include, but are not limited to, swap interest 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.
Pension and Other Postretirement Benefit Obligations
The Company maintains a U.S. qualified defined benefit pension plan (the “Plan”) that covers substantially all employees, as well as unfunded excess plans to provide benefits in excess of amounts permitted to be paid to participants of the Plan under the provisions of the Internal Revenue Code. The Company has also entered into individual retirement agreements with certain retired directors providing for unfunded supplemental pension benefits. In addition, the Company provides certain health care and life insurance benefits for eligible retired employees. The Company maintains international plans which represent an immaterial percentage of total pension assets, liabilities and expense and, for reporting purposes, are combined with domestic plans.
Pursuant to accounting principles related to the Company’s pension and other postretirement obligations to employees under its various benefit plans, the Company is required to make a significant number of assumptions in order to calculate the related liabilities and expenses each period. The two economic assumptions that have the most impact on pension and other postretirement expense are the discount rate and the expected long-term rate of return on plan assets. In determining the discount rate assumption, the Company utilizes a discounted cash flow analysis of the Company’s pension and other postretirement obligations and currently available market and industry data. The yield curve utilized in the cash flow analysis is comprised of bonds rated Aa or higher with maturities primarily between zero and thirty years. Based on all available information, it was determined that 5.50% and 5.25% were the appropriate discount rates as of December 31, 2010 to calculate the Company’s pension and other postretirement obligations, respectively. Accordingly, the 5.50% and 5.25% discount rates will also be used to determine the Company’s 2011 pension and other postretirement expense, respectively. At December 31, 2009, the discount rate was 6.00% and 5.75% for pension and other postretirement expense, respectively.
As of December 31, 2010, a 25 basis point increase/decrease in the discount rate would decrease/increase the pension and other postretirement obligations by $137 and $9, respectively.
The Company determines the expected long-term rate of return assumption based on an analysis of the Plan portfolio’s historical compound rates of return since 1979 (the earliest date for which comparable portfolio data is available) and over 5 year and 10 year periods. The Company selected these periods, as well as shorter durations, to assess the portfolio’s volatility, duration and total returns as they relate to pension obligation characteristics, which are influenced by the Company’s workforce demographics. In addition, the Company also applies long-term market return assumptions to an investment mix that generally anticipates 60% fixed income securities, 20% equity securities and 20% alternative assets to derive an expected long-term rate of return. Based upon these analyses, management maintained the long-term rate of return assumption at 7.30% as of December 31, 2010. This assumption will be used to determine the Company’s 2011 expense. The long-term rate of return assumption at December 31, 2009, that was used to determine the Company’s 2010 expense, was 7.30%.

 

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Pension expense reflected in the Company’s results was $186, $137 and $122 in 2010, 2009 and 2008, respectively. The Company estimates its 2011 pension expense will be approximately $210, based on current assumptions. To illustrate the impact of these assumptions on annual pension expense for 2011 and going forward, a 25 basis point decrease in the discount rate will increase pension expense by approximately $15 and a 25 basis point change in the long-term asset return assumption will increase/decrease pension expense by approximately $10.
The Company uses a five-year averaging method to determine the market-related value of Plan assets, which is used to determine the expected return component of pension expense. Under this methodology, asset gains/losses that result from returns that differ from the Company’s long-term rate of return assumption are recognized in the market-related value of assets on a level basis over a five year period. The difference between actual asset returns for the plans of $434 and $184 for the years ended December 31, 2010 and 2009, respectively, as compared to expected returns of $286 and $276 for the years ended December 31, 2010 and 2009, respectively, will be fully reflected in the market-related value of plan assets over the next five years using the methodology described above. The level of actuarial net loss continues to exceed the allowable amortization corridor. Based on the 5.50% discount rate selected as of December 31, 2010 and taking into account estimated future minimum funding, the difference between actual and expected performance in 2010 will decrease annual pension expense in future years. The decrease in pension expense will be approximately $7 in 2011 and will increase ratably to a decrease of approximately $50 in 2016.
Valuation Allowance on Deferred Tax Assets
Deferred tax assets represent the tax benefit of future deductible temporary differences and operating loss and tax credit carryforwards. Deferred tax assets are measured using the enacted tax rates expected to be in effect when such benefits are realized if there is no change in tax law. Under U.S. GAAP, we test the value of deferred tax assets for impairment on a quarterly basis at the entity level within each tax jurisdiction, consistent with our filed tax returns. Deferred tax assets are reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion, or all, of the deferred tax assets will not be realized. The determination of the valuation allowance for our deferred tax assets requires management to make certain judgments and assumptions. In evaluating the ability to recover deferred tax assets, we have considered all available evidence as of December 31, 2010, including past operating results, the existence of cumulative losses in the most recent years, forecasted earnings, future taxable income, and prudent and feasible tax planning strategies. In the event we determine it is not more likely than not that we will be able to realize all or part of our deferred tax assets in the future, an increase to the valuation allowance would be charged to earnings in the period such determination is made. Likewise, if it is later determined that it is more likely than not that those deferred tax assets would be realized, the previously provided valuation allowance would be reversed. Our judgments and assumptions are subject to change given the inherent uncertainty in predicting future performance and specific industry and investment market conditions.
The Company has recorded 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. The deferred tax asset valuation allowance was $173 as of December 31, 2010 and $86 as of December 31, 2009. The increase in the valuation allowance during 2010 was triggered by the recognition of additional realized losses on investment securities which were incurred in the first quarter. 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 carryback years, as well as tax planning strategies that include holding a portion of debt securities with market value losses until recovery, selling appreciated securities to offset capital losses, business considerations, such as asset-liability matching, and the sales of certain corporate assets, including a subsidiary. Such tax planning strategies are viewed by management as prudent and feasible and will be implemented if necessary to realize the deferred tax asset. Future economic conditions and debt market volatility, including increases in interest rates, can adversely impact the Company’s tax planning strategies and in particular the Company’s ability to utilize tax benefits on previously recognized realized capital losses.
Contingencies Relating to Corporate Litigation and Regulatory Matters
Management evaluates each contingent matter separately. A loss is recorded if probable and reasonably estimable. Management establishes reserves for these contingencies at its “best estimate,” or, if no one number within the range of possible losses is more probable than any other, the Company records an estimated reserve at the low end of the range of losses.
The Company has a quarterly monitoring process involving legal and accounting professionals. Legal personnel first identify outstanding corporate litigation and regulatory matters posing a reasonable possibility of loss. These matters are then jointly reviewed by accounting and legal personnel to evaluate the facts and changes since the last review in order to determine if a provision for loss should be recorded or adjusted, the amount that should be recorded, and the appropriate disclosure. The outcomes of certain contingencies currently being evaluated by the Company, which relate to corporate litigation and regulatory matters, are inherently difficult to predict, and the reserves that have been established for the estimated settlement amounts are subject to significant changes. In view of the uncertainties regarding the outcome of these matters, as well as the tax-deductibility of payments, it is possible that the ultimate cost to the Company of these matters could exceed the reserve by an amount that would have a material adverse effect on the Company’s consolidated results of operations or cash flows in a particular quarterly or annual period.

 

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THE HARTFORD’S OPERATIONS OVERVIEW
The Hartford is a financial holding company for a group of subsidiaries that provide property and casualty and life insurance and investment products to both individual and business customers in the United States and continues to administer business previously sold in Japan and the U.K.
The Company conducts business in three customer-oriented divisions, Commercial Markets, Consumer Markets and Wealth Management, each containing reporting segments. The Commercial Markets division consists of the reporting segments of Property & Casualty Commercial and Group Benefits. The Consumer Markets division is also the reporting segment. The Wealth Management division consists of the following reporting segments: Global Annuity, Life Insurance, Retirement Plans and Mutual Funds. For additional discussion regarding The Hartford’s reporting segments, see Note 3 of the Notes to Consolidated Financial Statements.
The Company derives its revenues principally from: (a) premiums earned for insurance coverages provided to insureds; (b) fee income, including asset management fees, on separate account and mutual fund assets and mortality and expense fees, as well as cost of insurance charges; (c) net investment income; (d) fees earned for services provided to third parties; and (e) net realized capital gains and losses. Premiums charged for insurance coverages are earned principally on a pro rata basis over the terms of the related policies in-force. Asset management fees and mortality and expense fees are primarily generated from separate account assets, which are deposited through the sale of variable annuity and variable universal life products and from mutual funds. Cost of insurance charges are assessed on the net amount at risk for investment-oriented life insurance products. Service fees principally include revenues from third party claims administration services and revenues from member contact center services provided through the AARP Health program.
Profitability of Commercial and Consumer Markets operations over time is greatly influenced by the Company’s underwriting discipline, which seeks to manage exposure to loss through favorable risk selection and diversification, its management of claims, its use of reinsurance, the size of its in force block, actual mortality and morbidity experience, and its ability to manage its expense ratio which it accomplishes through economies of scale and its management of acquisition costs and other underwriting expenses.
Pricing adequacy depends on a number of factors, including the ability to obtain regulatory approval for rate changes, proper evaluation of underwriting risks, the ability to project future loss cost frequency and severity based on historical loss experience adjusted for known trends, the Company’s response to rate actions taken by competitors, and expectations about regulatory and legal developments and expense levels. The Company seeks to price its insurance policies such that insurance premiums and future net investment income earned on premiums received will cover underwriting expenses and the ultimate cost of paying claims reported on the policies and provide for a profit margin. For many of its insurance products, the Company is required to obtain approval for its premium rates from state insurance departments.
The financial results in the Company’s variable annuity, mutual fund and, to a lesser extent, variable universal life businesses, depend largely on the amount of the contract holder account value or assets under management on which it earns fees and the level of fees charged. Changes in account value or assets under management are driven by two main factors: net flows, which measure the success of the Company’s asset gathering and retention efforts, and the market return of the funds, which is heavily influenced by the return realized in the equity markets. Net flows are comprised of new sales and other deposits less surrenders, death benefits, policy charges and annuitizations of investment type contracts, such as variable annuity contracts. In the mutual fund business, net flows are known as net sales. Net sales are comprised of new sales less redemptions by mutual fund customers. The Company uses the average daily value of the S&P 500 Index as an indicator for evaluating market returns of the underlying account portfolios in the United States. Relative financial results of variable products are highly correlated to the growth in account values or assets under management since these products generally earn fee income on a daily basis. Equity market movements could also result in benefits for or charges against deferred acquisition costs.
The profitability of fixed annuities and other “spread-based” products depends largely on the Company’s ability to earn target spreads between earned investment rates on its general account assets and interest credited to policyholders. In addition, the size and persistency of gross profits from these businesses is an important driver of earnings as it affects the rate of amortization of deferred policy acquisition costs.
The investment return, or yield, on invested assets is an important element of the Company’s earnings since insurance products are priced with the assumption that premiums received can be invested for a period of time before benefits, loss and loss adjustment expenses are paid. Due to the need to maintain sufficient liquidity to satisfy claim obligations, the majority of the Company’s invested assets have been held in available-for-sale securities, including, among other asset classes, corporate bonds, municipal bonds, government debt, short-term debt, mortgage-backed securities and asset-backed securities.
The primary investment objective for the Company is to maximize economic value, consistent with acceptable risk parameters, including the management of credit risk and interest rate sensitivity of invested assets, while generating sufficient after-tax income to meet policyholder and corporate obligations. Investment strategies are developed based on a variety of factors including business needs, regulatory requirements and tax considerations.
For a discussion on how The Hartford establishes property and casualty insurance product reserves, see “Property and Casualty Insurance Product Reserves, Net of Reinsurance” in the Critical Accounting Estimates section of MD&A and for further information on DAC Unlocks, see “Estimated Gross Profits Used in the Valuation and Amortization of Assets and Liabilities Associated with Variable Annuity and Other Universal Life-Type Contracts” also in the Critical Accounting Estimates section of MD&A.

 

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Definitions of Non-GAAP and other measures and ratios
Account Value
Account value includes policyholders’ balances for investment contracts and reserves for future policy benefits for insurance contracts. Account value is a measure used by the Company because a significant portion of the Company’s fee income is based upon the level of account value. These revenues increase or decrease with a rise or fall in the amount of account value whether caused by changes in the market or through net flows.
After-tax Margin
After-tax margin, excluding realized gains (losses) and DAC Unlock, is a non-GAAP financial measure that the Company uses to evaluate, and believes is an important measure of, certain of the segment’s operating performance. After-tax margin is the most directly comparable U.S. GAAP measure. The Hartford believes that the measure after-tax margin, excluding realized gains (losses) and DAC Unlock, provides investors with a valuable measure of the performance of certain of the Company’s on-going businesses because it reveals trends in those businesses that may be obscured by the effect of realized gains (losses) or quarterly 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 Hartford believes, however, that some realized capital gains and losses are integrally related to our insurance operations, so after-tax margin, excluding realized gains (losses) and DAC Unlock, should include net realized gains and losses on net periodic settlements on credit derivatives. 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 Company’s new best estimates of future gross profits, the result and its impact on the DAC amortization ratio is meaningful; however, it does distort the trend of after-tax margin. After-tax margin, excluding realized gains (losses) and DAC Unlock, should not be considered as a substitute for 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 after-tax margin, excluding realized gains (losses) and DAC Unlock, and after-tax margin when reviewing the Company’s performance. After Tax Margin is calculated by dividing the earnings measures described above by Total Revenues adjusted for the measures described above. For additional information regarding the DAC Unlock, see Critical Accounting Estimates within the MD&A.
Assets Under Administration
Assets under administration (“AUA”) represents the client asset base of the Company’s recordkeeping business for which revenues are predominately based on the number of plan participants. Unlike assets under management, increases or decreases in AUA do not have a direct corresponding increase or decrease to the Company’s revenues, and therefore are not included in assets under management.
Assets Under Management
Assets under management (“AUM”) include account values and mutual fund assets. AUM is a measure used by the Company because a significant portion of the Company’s revenues are based upon asset values. These revenues increase or decrease with a rise or fall in the amount of account value whether caused by changes in the market or through net flows.
Catastrophe ratio
The catastrophe ratio (a component of the loss and loss adjustment expense ratio) represents the ratio of catastrophe losses incurred in the current calendar year (net of reinsurance) to earned premiums and includes catastrophe losses incurred for both the current and prior accident years. A catastrophe is an event that causes $25 or more in industry insured property losses and affects a significant number of property and casualty policyholders and insurers. The catastrophe ratio includes the effect of catastrophe losses, but does not include the effect of reinstatement premiums.
Combined ratio
The combined ratio is the sum of the loss and loss adjustment expense ratio, the expense ratio and the policyholder dividend ratio. This ratio is a relative measurement that describes the related cost of losses and expenses for every $100 of earned premiums. A combined ratio below 100.0 demonstrates underwriting profit; a combined ratio above 100.0 demonstrates underwriting losses.
Combined ratio before catastrophes and prior accident year development
The combined ratio before catastrophes and prior accident year development represents the combined ratio for the current accident year, excluding the impact of catastrophes. The Company believes this ratio is an important measure of the trend in profitability since it removes the impact of volatile and unpredictable catastrophe losses and prior accident year reserve development.
Current accident year loss and loss adjustment expense ratio before catastrophes
The current accident year loss and loss adjustment expense ratio before catastrophes is a measure of the cost of non-catastrophe claims incurred in the current accident year divided by earned premiums. Management believes that the current accident year loss and loss adjustment expense ratio before catastrophes is a performance measure that is useful to investors as it removes the impact of volatile and unpredictable catastrophe losses and prior accident year reserve development.

 

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DAC amortization ratio
DAC amortization ratio, excluding realized gains (losses) and DAC Unlock, is a non-GAAP financial measure that the Company uses to evaluate, and believes is an important measure of, certain of the segment’s operating performance. DAC amortization ratio is the most directly comparable U.S. GAAP measure. The Hartford believes that the measure DAC amortization ratio, excluding realized gains (losses) and DAC Unlock, provides investors with a valuable measure of the performance of certain of the Company’s on-going businesses because it reveals trends in our businesses that may be obscured by the effect of realized gains (losses) or quarterly 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 Hartford believes, however, that some realized capital gains and losses are integrally related to our insurance operations, so 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 realized capital gains and losses and DAC Unlock, however 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 Company’s new best estimates of future gross profits, the result and its impact on the DAC amortization ratio is meaningful; however, it does distort the trend of DAC amortization ratio. DAC amortization ratio, excluding realized gains (losses) and DAC Unlock, should not be considered as a substitute for DAC amortization ratio 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, excluding realized gains (losses) and DAC Unlock, and DAC amortization ratio when reviewing the Company’s performance. For additional information regarding the DAC Unlock, see Critical Accounting Estimates within the MD&A.
Expense ratio
The expense ratio for the underwriting segments of Property & Casualty Commercial and Consumer Markets is the ratio of underwriting expenses, excluding bad debt expense, to earned premiums. Underwriting expenses include the amortization of deferred policy acquisition costs and insurance operating costs and expenses. Deferred policy acquisition costs include commissions, taxes, licenses and fees and other underwriting expenses and are amortized over the policy term.
The expense ratio for the remaining segments is expressed as a ratio of insurance operating costs and expenses to a revenue measure, depending on the type of business. This calculation excludes the amortization of deferred policy acquisition costs, which is calculated as a separate ratio, and is discussed below.
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.
Loss and loss adjustment expense ratio
The loss and loss adjustment expense ratio is a measure of the cost of claims incurred in the calendar year divided by earned premium and includes losses incurred for both the current and prior accident years, as well as the costs of mortality and morbidity and other contractholder benefits to policyholders. Since Group Benefits occasionally buys a block of claims for a stated premium amount, the Company excludes this buyout from the loss ratio used for evaluating the underwriting results of the business as buyouts may distort the loss ratio. Among other factors, the loss and loss adjustment expense ratio needed for the Company to achieve its targeted return on equity fluctuates from year to year based on changes in the expected investment yield over the claim settlement period, the timing of expected claim settlements and the targeted returns set by management based on the competitive environment.
The loss and loss adjustment expense ratio is affected by claim frequency and claim severity, particularly for shorter-tail property lines of business, where the emergence of claim frequency and severity is credible and likely indicative of ultimate losses. Claim frequency represents the percentage change in the average number of reported claims per unit of exposure in the current accident year compared to that of the previous accident year. Claim severity represents the percentage change in the estimated average cost per claim in the current accident year compared to that of the previous accident year. As one of the factors used to determine pricing, the Company’s practice is to first make an overall assumption about claim frequency and severity for a given line of business and then, as part of the ratemaking process, adjust the assumption as appropriate for the particular state, product or coverage.
Loss ratio, excluding buyouts
The loss ratio is utilized for the Group Benefits segment and is expressed as a ratio of benefits, losses and loss adjustment expenses to premiums and other considerations, excluding buyout premiums. Buyout premiums represent takeover of open claim liabilities and other non-recurring premium amounts.

 

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Mutual Fund Assets
Mutual fund assets include retail, investment-only and college savings plan assets under Section 529 of the Code, collectively referred to as non-proprietary, and proprietary mutual funds. Non-proprietary mutual fund assets are owned by the shareholders of those funds and not by the Company. Proprietary mutual funds include mutual funds sponsored by the Company which are owned by the separate accounts of the Company to support insurance and investment products sold by the Company. The non-proprietary mutual fund assets are not reflected in the Company’s consolidated financial statements. Mutual fund assets are a measure used by the Company because a significant portion of the Company’s revenues are based upon asset values. These revenues increase or decrease with a rise or fall in the amount of account value whether caused by changes in the market or through net flows.
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 realized capital gains and losses, including those related to the Company’s GMWB product and related reinsurance and hedging programs), and the related crediting rates on average general account assets under management. The net investment spreads 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. The volatile nature of net investment spread is driven primarily by earnings on limited partnership and other alternative investments and prepayment premiums on securities. Investment earnings can also be influenced by factors such as changes in interest rates, credit spreads and decisions to hold higher levels of short-term investments. Net investment spread is calculated by dividing net investment earnings by average reserves using a 13-point average, less interest credited divided by average account value using a 13-point average.
New business written premium
New business written premium represents the amount of premiums charged for policies issues to customers who were not insured with the Company in the previous policy term. New business written premium plus renewal policy written premium equals total written premium.
Policies in force
Policies in force represent the number of policies with coverage in effect as of the end of the period. The number of policies in force is a growth measure used for Consumer Markets and standard commercial lines within Property & Casualty Commercial and is affected by both new business growth and premium renewal retention.
Policy count retention
Policy count retention represents the ratio of the number of policies renewed during the period divided by the number of policies from the previous policy term period. The number of policies available to renew from the previous policy term represents the number of policies written in the previous policy term net of any cancellations of those policies. Policy count retention is affected by a number of factors, including the percentage of renewal policy quotes accepted and decisions by the Company to non-renew policies because of specific policy underwriting concerns or because of a decision to reduce premium writings in certain classes of business or states. Policy count retention is also affected by advertising and rate actions taken by competitors.
Policyholder dividend ratio
The policyholder dividend ratio is the ratio of policyholder dividends to earned premium.
Prior accident year loss and loss adjustment expense ratio
The prior year loss and loss adjustment expense ratio represents the increase (decrease) in the estimated cost of settling catastrophe and non-catastrophe claims incurred in prior accident years as recorded in the current calendar year divided by earned premiums.
Reinstatement premiums
Reinstatement premium represents additional ceded premium paid for the reinstatement of the amount of reinsurance coverage that was reduced as a result of a reinsurance loss payment.
Renewal earned pricing increase (decrease)
Written premiums are earned over the policy term, which is six months for certain personal lines auto business and 12 months for substantially all of the remainder of the Company’s business. Because the Company earns premiums over the 6 to 12 month term of the policies, renewal earned pricing increases (decreases) lag renewal written pricing increases (decreases) by 6 to 12 months.

 

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Renewal written pricing increase (decrease)
Renewal written pricing increase (decrease) represents the combined effect of rate changes, amount of insurance and individual risk pricing decisions per unit of exposure since the prior year. The rate component represents the average change in rate filings during the period and the amount of insurance represents the value of the rating base, such as model year/vehicle symbol for auto, building replacement costs for property and wage inflation for workers’ compensation. The renewal written price increase (decrease) does not include other factors that affect average premium per unit of exposure such as changes in the mix of business by state, territory, class plan and tier of risk. A number of factors affect renewal written pricing increases (decreases) including expected loss costs as projected by the Company’s pricing actuaries, rate filings approved by state regulators, risk selection decisions made by the Company’s underwriters and marketplace competition. Renewal written pricing changes reflect the property and casualty insurance market cycle. Prices tend to increase for a particular line of business when insurance carriers have incurred significant losses in that line of business in the recent past or the industry as a whole commits less of its capital to writing exposures in that line of business. Prices tend to decrease when recent loss experience has been favorable or when competition among insurance carriers increases.
Return on Assets (“ROA”)
ROA, excluding realized gains (losses) and DAC Unlock, is a non-GAAP financial measure that the Company uses to evaluate, and believes is an important measure of, certain of the segment’s operating performance. ROA is the most directly comparable U.S. GAAP measure. The Hartford believes that the measure ROA, excluding realized gains (losses) and DAC Unlock, provides investors with a valuable measure of the performance of certain of the Company’s on-going businesses because it reveals trends in our businesses that may be obscured by the effect of realized gains (losses) or quarterly 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, this 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 Hartford believes, however, that some realized capital gains and losses are integrally related to our insurance operations, so ROA, excluding the realized gains (losses) and DAC Unlock, 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 Company’s new best estimates of future gross profits, the result and its impact on the DAC amortization ratio is meaningful; however, it does distort the trend of ROA. ROA, excluding realized gains (losses) and DAC Unlock, should not be considered as a substitute for ROA and does not reflect the overall profitability of our businesses. Therefore, the Company believes it is important for investors to evaluate both ROA, excluding realized gains (losses) and DAC Unlock, and ROA when reviewing the Company’s performance. ROA is calculated by dividing the earnings measures described above by a two-point average AUM.
Underwriting results
Underwriting results is a before-tax measure that represents earned premiums less incurred losses, loss adjustment expenses, underwriting expenses and policyholder dividends. The Hartford believes that underwriting results provides investors with a valuable measure of before-tax profitability derived from underwriting activities, which are managed separately from the Company’s investing activities. The underwriting segments of Property & Casualty Commercial and Consumer Markets are evaluated by management primarily based upon underwriting results. A reconciliation of underwriting results to net income for Property & Casualty Commercial and Consumer Markets is set forth in their respective discussions herein.
Written and earned premiums
Written premium is a statutory accounting financial measure which represents the amount of premiums charged for policies issued, net of reinsurance, during a fiscal period. Earned premium is a U.S. GAAP and statutory measure. Premiums are considered earned and are included in the financial results on a pro rata basis over the policy period. Management believes that written premium is a performance measure that is useful to investors as it reflects current trends in the Company’s sale of property and casualty insurance products. Written and earned premium are recorded net of ceded reinsurance premium.
Traditional life insurance type products, such as those sold by Group Benefits, collect premiums from policyholders in exchange for financial protection for the policyholder from a specified insurable loss, such as death or disability. These premiums together with net investment income earned from the overall investment strategy are used to pay the contractual obligations under these insurance contracts. Two major factors, new sales and persistency, impact premium growth. Sales can increase or decrease in a given year based on a number of factors, including but not limited to, customer demand for the Company’s product offerings, pricing competition, distribution channels and the Company’s reputation and ratings. Persistency refers to the percentage of policies remaining in-force from year-to-year.

 

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KEY PERFORMANCE MEASURES AND RATIOS
The Hartford considers several measures and ratios to be the key performance indicators for its businesses. The following discussions include the more significant ratios and measures of profitability for the years ended December 31, 2010, 2009 and 2008. Management believes that these ratios and measures are useful in understanding the underlying trends in The Hartford’s businesses. However, these key performance indicators should only be used in conjunction with, and not in lieu of, the results presented in the segment discussions that follow in this MD&A. These ratios and measures may not be comparable to other performance measures used by the Company’s competitors.
Combined ratio before catastrophes and prior year development
Combined ratio before catastrophes and prior accident year development is a key indicator of overall profitability for the property and casualty underwriting segments of Property & Casualty Commercial and Consumer Markets since it removes the impact of volatile and unpredictable catastrophe losses and prior accident year reserve development.
                         
Property & Casualty Commercial   2010     2009     2008  
Combined ratio
    89.7       85.9       89.4  
Catastrophe ratio
    2.7       0.9       4.0  
Non-catastrophe prior year development
    (6.3 )     (6.3 )     (4.2 )
 
                 
Combined ratio before catastrophes and prior year development
    93.4       91.2       89.6  
 
                 
Consumer Markets
                       
Combined ratio
    99.0       97.2       92.9  
Catastrophe ratio
    7.8       5.9       6.7  
Non-catastrophe prior year development
    (2.4 )     (1.0 )     (1.5 )
 
                 
Combined ratio before catastrophes and prior year development
    93.6       92.3       87.7  
 
                 
Year ended December 31, 2010 compared to the year ended December 31, 2009
 
Property & Casualty Commercial’s combined ratio before catastrophes and prior year development increased primarily due to higher severity on package business and workers’ compensation, as well as an increased ratio for specialty casualty, and to a lesser extent an increase in the expense ratio due to increased expenses for taxes, licenses and fees.
 
 
Consumer Markets combined ratio before catastrophes and prior year development increased primarily due to an increase in the current accident year loss and loss adjustment expense ratio before catastrophes for auto of 1.3 points due to higher auto physical damage emerged frequency and higher expected auto liability loss costs relative to average premium. The current accident year loss and loss adjustment expense ratio before catastrophes for home increased 0.7 points primarily due to an increase in loss adjustment expenses, partially offset by the effect of earned pricing increases.
Year ended December 31, 2009 compared to the year ended December 31, 2008
 
Property & Casualty Commercial’s combined ratio before catastrophes and prior year development for the year increased, primarily due a decrease in earned premium and an increase in the current accident year loss and loss adjustment expense ratio before catastrophes. The increase in the current accident year loss and loss adjustment expense ratio before catastrophes was primarily due to a higher loss and loss adjustment expense ratio on workers’ compensation, package business and general liability, partially offset by lower non-catastrophe losses on property and marine business driven by favorable claim frequency and severity.
 
 
Consumer Markets combined ratio before catastrophes and prior year development for the year increased, primarily due to an increase in the current accident year loss and loss adjustment expense ratio before catastrophes for both auto and home. The increase for auto was due to an increase in expected liability loss costs, an increase in physical damage frequency and a decline in average premium. The increase for home was driven by increasing severity and frequency, offset by a decline in average premium.

 

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Return on Assets
Return on assets is a key indicator of overall profitability for the Global Annuity, Retirement Plans and Mutual Funds reporting segments as a significant portion of their earnings is based on average assets under management.
                         
Ratios   2010     2009     2008  
 
Global Annuity [1]
                       
ROA
  26.1  bps   (75.0 ) bps   (132.9 ) bps
Effect of net realized losses, net of tax and DAC on ROA
  (19.0 ) bps   (53.3 ) bps   (106.3 ) bps
Effect of DAC Unlock on ROA
  4.9  bps   (47.0 ) bps   (49.1 ) bps
 
                 
ROA, excluding realized losses and DAC Unlock
  40.2  bps   25.3  bps   22.5  bps
 
                 
 
                       
Retirement Plans [1]
                       
ROA
  9.7  bps   (54.8 ) bps   (47.9 ) bps
Effect of net realized losses, net of tax and DAC on ROA
  (4.8 ) bps   (46.4 ) bps   (51.3 ) bps
Effect of DAC Unlock on ROA
  5.4  bps   (11.4 ) bps   (14.6 ) bps
 
                 
ROA, excluding realized losses and DAC Unlock
  9.1  bps   3.0  bps   18.0  bps
 
                 
 
                       
Mutual Funds [1]
                       
ROA
  13.6  bps   8.8  bps   8.8  bps
Effect of net realized gains (losses), net of tax and DAC on ROA
  4.3  bps    bps   (0.2 ) bps
Effect of DAC Unlock on ROA
   bps    bps   (0.3 ) bps
 
                 
ROA, excluding realized gains and DAC Unlock
  9.3  bps   8.8  bps   9.3  bps
 
                 
     
[1]  
Proprietary mutual funds, Investment-Only mutual funds, Canadian mutual funds, and 529 college savings plans effective January 1, 2010, are reported in the mutual fund business mix in 2010. Prior to 2010, proprietary mutual fund assets were included in Global Annuity, Retirement Plans, and Mutual Funds, as those same assets generate earnings for each of these segments.
Year ended December 31, 2010 compared to year ended December 31, 2009
 
Global Annuity’s ROA, excluding realized losses and DAC Unlock, increased primarily due to improved net investment income on limited partnerships and other alternative investments, a lower DAC amortization rate, improved operating expenses associated with the restructuring of the international annuity operations and the absence of 3 Win charges recognized in the first quarter of 2009 of $40, after-tax.
 
 
Retirement Plans’ ROA, excluding realized losses and DAC Unlock, increased primarily due to improved performance on limited partnerships and other alternative investments in 2010, and was driven by improvement in the equity markets, which led to increased account values and increased deposit activity.
 
 
Mutual Funds’ ROA, excluding realized gains, increase was primarily driven by improvement in the equity markets, which enabled this business to partially return to scale, and the impact of lower operating expenses, partially offset by the addition of proprietary mutual fund assets to this line of business, which has a lower ROA level than the non-proprietary business.
Year ended December 31, 2009 compared to year ended December 31, 2008
 
Global Annuity’s ROA, excluding realized losses and DAC Unlock, increased primarily due to the impact of the write off of goodwill in 2008 of $274, after-tax, partially offset by higher DAC amortization and lower investment spread in 2009. In addition, Global Annuity’s ROA, excluding realized losses and DAC Unlock, for the year ended December 31, 2009 improved due to lower 3 Win related charges in 2009 versus 2008 of $40 and $152, after-tax, respectively.
 
 
Retirement Plans’ ROA, excluding realized losses and DAC Unlock, decreased primarily due to lower returns on fixed maturities and a full year of activity from the business acquired in 2008, which had produced a lower ROA.
 
 
Mutual Funds’ ROA, excluding realized losses, decreased primarily due to lower account values, despite improvements in the equity markets in 2009, account values did not return to 2008 levels.

 

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After-tax margin
After-tax margin is a key indicator of overall profitability for the Life Insurance and Group Benefits reporting segments as a significant portion of their earnings are a result of the net margin from losses incurred on earned premiums, fees and other considerations.
                         
    2010     2009     2008  
Life Insurance
                       
After-tax margin
    16.6 %     3.1 %     (1.8 %)
Effect of net realized gains (losses), net of tax and DAC on after-tax margin
    0.9 %     (6.0 %)     (13.0 %)
Effect of DAC Unlock on after-tax margin
    1.4 %     (4.3 %)     (2.6 %)
 
                 
After-tax margin, excluding realized gains (losses) and DAC Unlock
    14.3 %     13.4 %     13.8 %
 
                 
 
                       
Group Benefits
                       
After-tax margin (excluding buyouts)
    3.9 %     4.2 %     (0.1 %)
Effect of net realized gains (losses), net of tax on after-tax margin
    0.5 %     (1.5 %)     (7.3 %)
 
                 
After-tax margin (excluding buyouts), excluding realized gains (losses)
    3.4 %     5.7 %     7.2 %
 
                 
Year ended December 31, 2010 compared to year ended December 31, 2009
 
Life Insurance’s after-tax margin, excluding realized gains (losses) and DAC Unlock, increase was primarily due to lower DAC amortization, favorable operating expenses and investment margin, partially offset by higher mortality.
 
 
Group Benefits’ after-tax margin (excluding buyouts), excluding realized gains (losses), decrease was primarily due to a higher loss ratio from unfavorable morbidity driven by lower claim terminations on disability business.
Year ended December 31, 2009 compared to year ended December 31, 2008
 
Life Insurance’s after-tax margin, excluding realized gains (losses) and DAC Unlock, decrease was primarily due to a higher DAC amortization, partially offset by a lower effective rate and lower operating expenses.
 
 
Group Benefits after-tax margin (excluding buyouts), excluding realized gains (losses), decrease was primarily due to the unfavorable loss ratio that resulted from unfavorable morbidity experience, which was primarily due to unfavorable reserve development from the 2008 incurral loss year and higher new incurred long-term disability claims in 2009.

 

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Investment Results
Composition of Invested Assets
                                 
    December 31, 2010     December 31, 2009  
    Amount     Percent     Amount     Percent  
Fixed maturities, AFS, at fair value
  $ 77,820       79.2 %   $ 71,153       76.3 %
Fixed maturities, at fair value using the fair value option
    649       0.7 %            
Equity securities, AFS, at fair value
    973       1.0 %     1,221       1.3 %
Mortgage loans
    4,489       4.6 %     5,938       6.4 %
Policy loans, at outstanding balance
    2,181       2.2 %     2,174       2.3 %
Limited partnerships and other alternative investments
    1,918       2.0 %     1,790       1.9 %
Other investments [1]
    1,617       1.6 %     602       0.7 %
Short-term investments
    8,528       8.7 %     10,357       11.1 %
 
                       
Total investments excluding equity securities, trading
    98,175       100.0 %     93,235       100.0 %
Equity securities, trading, at fair value [2]
    32,820               32,321          
 
                           
Total investments
  $ 130,995             $ 125,556          
 
                           
     
[1]  
Primarily relates to derivative instruments.
 
[2]  
These assets primarily support the Global Annuity-International variable annuity business. Changes in these balances are also reflected in the respective liabilities.
Total investments increased since December 31, 2009 primarily due to increases in fixed maturities, AFS, and other investments, partially offset by declines in short-term investments and mortgage loans. The increase in fixed maturities, AFS, was largely the result of improved security valuations as a result of a decline in interest rates and, to a lesser extent, credit spread tightening, as well as the reallocation of short-term investment and mortgage loan proceeds. The increase in other investments primarily related to increases in value related to derivatives. The decline in mortgage loans was primarily related to sales of B-Note and mezzanine exposures.
Net Investment Income (Loss)
                                                 
    For the years ended December 31,  
    2010     2009     2008  
    Amount     Yield [1]     Amount     Yield [1]     Amount     Yield [1]  
Fixed maturities [2]
  $ 3,490       4.3 %   $ 3,618       4.5 %   $ 4,310       5.2 %
Equity securities, AFS
    53       4.8 %     93       6.5 %     167       6.9 %
Mortgage loans
    283       5.7 %     316       5.0 %     333       5.6 %
Policy loans
    132       6.1 %     139       6.3 %     139       6.5 %
Limited partnerships and other alternative investments
    216       12.6 %     (341 )     (15.6 %)     (445 )     (16.3 %)
Other [3]
    333               318               (72 )        
Investment expense
    (115 )             (112 )             (97 )        
 
                                   
Total securities AFS and other
  $ 4,392       4.5 %   $ 4,031       4.1 %   $ 4,335       4.6 %
Equity securities, trading
    (774 )             3,188               (10,340 )        
 
                                         
Total net investment income (loss), before-tax
  $ 3,618             $ 7,219             $ (6,005 )        
 
                                         
     
[1]  
Yields calculated using annualized investment income before investment expenses divided by the monthly average invested assets at cost, amortized cost, or adjusted carrying value, as applicable, excluding securities lending collateral and consolidated variable interest entity noncontrolling interests. Included in the fixed maturity yield is Other, which primarily relates to derivatives (see footnote [3] below). Included in the total net investment income yield is investment expense.
 
[2]  
Includes net investment income on short-term investments.
 
[3]  
Includes income from derivatives that qualify for hedge accounting and hedge fixed maturities.
Year ended December 31, 2010 compared to the year ended December 31, 2009
Total net investment income decreased largely due to equity securities, trading, resulting primarily from declines in market performance of the underlying investment funds supporting the Japanese variable annuity product. Total net investment income, excluding equity securities, trading, increased primarily due to improved performance of limited partnerships and other alternative investments primarily within real estate and private equity funds, partially offset by lower income on fixed maturities resulting from a decline in average short-term interest rates and lower reinvestment rates. The Company’s expectation, based on the current interest rate and credit environment, is that upcoming maturities will be reinvested at a similar rate. Therefore, the Company expects the 2011 portfolio yield, excluding limited partnership investments, to be relatively consistent with the 2010 portfolio yield excluding limited partnerships.
Year ended December 31, 2009 compared to the year ended December 31, 2008
Total net investment income increased primarily due to equity securities, trading, resulting from improved market performance of the underlying investment funds supporting the Japanese variable annuity product. Total net investment income, excluding equity securities, trading, decreased primarily due to lower income on fixed maturities resulting from a decline in average rates and fixed maturity investments, as well as an increased average asset base of securities with greater market liquidity. The decrease was partially offset by an increase in other income from interest rate swaps hedging variable rate bonds due to a decrease in LIBOR. Also offsetting were decreased losses on limited partnerships and other alternative investments, primarily within hedge funds.

 

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Net Realized Capital Gains (Losses)
                         
    For the years ended December 31,  
    2010     2009     2008  
Gross gains on sales
  $ 836     $ 1,056     $ 607  
Gross losses on sales
    (522 )     (1,397 )     (856 )
Net OTTI losses recognized in earnings
    (434 )     (1,508 )     (3,964 )
Valuation allowances on mortgage loans
    (157 )     (403 )     (26 )
Japanese fixed annuity contract hedges, net [1]
    27       47       64  
Periodic net coupon settlements on credit derivatives/Japan
    (17 )     (49 )     (33 )
Fair value measurement transition impact
                (650 )
Results of variable annuity hedge program
                       
GMWB derivatives, net
    111       1,526       (713 )
Macro hedge program
    (562 )     (895 )     74  
 
                 
Total results of variable annuity hedge program
    (451 )     631       (639 )
Other, net [2]
    164       (387 )     (421 )
 
                 
Net realized capital losses, before-tax
  $ (554 )   $ (2,010 )   $ (5,918 )
 
                 
     
[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]  
Primarily consists of losses on Japan 3Win related foreign currency swaps, changes in fair value on non-qualifying derivatives and fixed maturities, FVO, and other investment gains and losses.
Details on the Company’s net realized capital gains and losses are as follows:
         
Gross gains and losses on sales
    Gross gains and losses on sales for the year ended December 31, 2010 were predominantly from sales of investment grade corporate securities in order to take advantage of attractive market opportunities, as well as, sales of U.S. Treasuries related to tactical repositioning of the portfolio.
 
       
 
    Gross gains and losses on sales for the year ended December 31, 2009 were predominantly within corporate, government and structured securities. Also included were gains of $360 related to the sale of Verisk/ISO securities. Gross gains and losses on sales primarily resulted from efforts to reduce portfolio risk through sales of subordinated financials and real estate related securities and from sales of U.S. Treasuries to manage liquidity.
 
       
 
    Gross gains and losses on sales for the year ended December 31, 2008 primarily resulted from the decision to reallocate the portfolio to securities with more favorable risk/return profiles. Also included was a gain of $141 from the sale of a synthetic CDO.
 
       
Net OTTI losses
    For further information, see Other-Than-Temporary Impairments within the Investment Credit Risk section of the MD&A.
 
       
Valuation allowances on mortgage
loans
    For further information, see Valuation Allowances on Mortgage Loans within the Investment Credit Risk section of the MD&A.

 

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Variable annuity hedge program
    For the year ended December 31, 2010, the gain on GMWB derivatives, net, was primarily due to liability model assumption updates of $159 and lower implied market volatility of $118, and outperformance of the underlying actively managed funds as compared to their respective indices of $104, partially offset by losses due to a general decrease in long-term rates of $(158) and rising equity markets of $(90). The net loss on the macro hedge program was primarily the result of a higher equity market valuation and the impact of trading activity.
 
       
 
    For the year ended December 31, 2009, the gain on GMWB derivatives, net, was primarily due to liability model assumption updates related to favorable policyholder experience of $566, the relative outperformance of the underlying actively managed funds as compared to their respective indices of $550, and the impact of the Company’s own credit standing of $154. Additional net gains of $56 resulted from lower implied market volatility and a general increase in long-term interest rates, partially offset by rising equity markets. Increasing equity markets resulted in a loss of $895 related to the Company’s macro hedge program. Total gains related to GMWB hedging in 2009 were $1.5 billion. For further information, see Note 4a of the Notes to Consolidated Financial Statements. In addition, see the Company’s variable annuity hedging program sensitivity disclosures within Capital Markets Risk Management section of the MD&A.
 
       
 
    For the year ended December 31, 2008, the loss on GMWB derivatives, net, was primarily due to losses of $904 related to market-base hedge ineffectiveness due to extremely volatile capital markets and $355 related to the relative outperformance of the underlying actively managed funds as compared to their respective indices, partially offset by gains of $470 in the fourth quarter related to liability model assumption updates for lapse rates.
 
       
Other, net
    Other, net gains for the year ended December 31, 2010 was primarily due to gains of $217 on credit derivatives driven by credit spreads tightening, gains of $102 related to Japan variable annuity hedges due to the appreciation of the Japanese yen, gains of $62 related to the sale of Hartford Investments Canada Corporation mutual fund business and gains of $59 on interest rate derivatives used to manage portfolio duration driven by a decline in long-term interest rates, partially offset by losses of $(326) on transactional foreign currency re-valuation due to an increase in value of the Japanese yen versus the U.S. dollar associated with the internal reinsurance of the Japan variable annuity business, which is offset in AOCI.
 
       
 
    Other, net losses for the year ended December 31, 2009 primarily resulted in net losses of $463 on credit derivatives where the Company purchased credit protection due to credit spread tightening and approximately $300 from contingent obligations associated with the Allianz transaction. These losses were partially offset by gains of $155 on credit derivatives that assume credit risk due to credit spread tightening, as well as $140 from a change in spot rates related to transactional foreign currency predominately on the internal reinsurance of the Japan variable annuity business, which is offset in AOCI.
 
       
 
    Other, net losses for the year ended December 31, 2008 were primarily due to net losses of $291 related to transactional foreign currency losses predominately on the internal reinsurance of the Japan variable annuity business, which is offset in AOCI, resulting from appreciation of the yen, as well as credit derivative losses of $312 due to significant credit spread widening. Also included were derivative related losses of $46 due to counterparty default related to the bankruptcy of Lehman Brothers Holdings Inc.

 

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PROPERTY & CASUALTY COMMERCIAL
                         
Underwriting Summary   2010     2009     2008  
Written premiums
  $ 5,796     $ 5,715     $ 6,291  
Change in unearned premium reserve
    52       (188 )     (104 )
 
                 
Earned premiums
    5,744       5,903       6,395  
Losses and loss adjustment expenses
                       
Current accident year before catastrophes
    3,579       3,582       3,835  
Current accident year catastrophes
    152       78       285  
Prior accident years
    (361 )     (394 )     (298 )
 
                 
Total losses and loss adjustment expenses
    3,370       3,266       3,822  
Amortization of deferred policy acquisition costs
    1,353       1,393       1,461  
Insurance operating costs and expenses
    431       409       434  
 
                 
Underwriting results
    590       835       678  
 
                 
Net servicing income
          9       13  
Net investment income
    939       759       803  
Net realized capital gains (losses)
    5       (213 )     (1,277 )
Other expenses
    (127 )     (132 )     (119 )
 
                 
Income before income taxes
    1,407       1,258       98  
Income tax expense (benefit)
    412       359       (35 )
 
                 
Net income
  $ 995     $ 899     $ 133  
 
                 
 
   
Premium Measures   2010     2009     2008  
New business premium
  $ 1,122     $ 1,101     $ 1,089  
Standard commercial lines policy count retention
    84 %     81 %     82 %
Standard commercial lines renewal written pricing increase (decrease)
    1 %     (1 %)     (4 %)
Standard commercial lines renewal earned pricing increase (decrease)
          (2 %)     (3 %)
Standard commercial lines policies in-force as of end of period
    1,211,047       1,159,759       1,138,483  
 
                 
 
   
Ratios   2010     2009     2008  
Loss and loss adjustment expense ratio
                       
Current accident year before catastrophes
    62.3       60.7       60.0  
Current accident year catastrophes
    2.7       1.3       4.5  
Prior accident years
    (6.3 )     (6.7 )     (4.7 )
 
                 
Total loss and loss adjustment expense ratio
    58.7       55.3       59.8  
Expense ratio
    31.0       30.4       28.9  
Policyholder dividend ratio
    0.1       0.2       0.7  
 
                 
Combined ratio
    89.7       85.9       89.4  
 
                 
Catastrophe ratio
                       
Current accident year
    2.7       1.3       4.5  
Prior accident years
          (0.4 )     (0.4 )
 
                 
Total catastrophe ratio
    2.7       0.9       4.0  
 
                 
Combined ratio before catastrophes
    87.1       84.9       85.4  
Combined ratio before catastrophes and prior accident year development
    93.4       91.2       89.6  
 
                 
Other revenues [1]
  $ 308     $ 334     $ 363  
 
                 
     
[1]  
Represents servicing revenues.

 

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Year ended December 31, 2010 compared to the year ended December 31, 2009
Net income increased in 2010, as compared to the prior year, driven by improvements in net realized capital gains (losses) and higher net investment income, despite a decrease in underwriting results. The primary causes of the decrease in underwriting results were lower earned premiums and higher current accident year catastrophe losses.
Earned premiums decreased across most product lines, with the exception of workers compensation and specialty casualty. The effects of the economic downturn have contributed to the decrease in earned premiums during 2010. Although earned premiums declined, several key measures have shown improvement. New business written premium increased, driven by increases in specialty casualty and package business, partially offset by decreases in general liability, professional liability and marine. In addition, for standard commercial lines, policy count retention has increased in all lines of business, due in part by an improvement in mid-term cancellations in 2010. Renewal earned pricing was flat for standard commercial lines, as an increase in package business and property was offset by a decrease in all other lines. The earned pricing changes were primarily a reflection of written pricing changes over the last year. Renewal written pricing increased for standard commercial lines driven by increases in property and workers compensation, partially offset by decreases in all other lines. Lastly, the number of policies-in-force increased, primarily due to the increase in policy count retention. The growth in policies in-force does not correspond directly with the change in earned premiums due to the effect of changes in earned pricing and changes in the average premium per policy.
Current accident year losses and loss adjustment expenses before catastrophes decreased slightly, due to the decrease in earned premiums, which was mostly offset by an increase in the current accident year loss and loss adjustment expense ratio before catastrophes. The ratio increased, primarily due to higher severity on package business and workers’ compensation, as well as an increased ratio for specialty casualty.
Current accident year catastrophe losses in 2010 were higher than in 2009 primarily due to more severe windstorm events, particularly from hail in the West, Midwest, plains states and the Southeast, and from winter storms in the Mid-Atlantic and Northeast. Losses in 2009 were primarily incurred from ice storms, windstorms and tornadoes across many states.
Net favorable prior accident year reserve development, in both periods, included reserve releases in the following: general liability, professional liability, workers’ compensation, auto liability and uncollectible reinsurance. Reserve development in 2010 also included a release in package business, while reserve development in 2009 also included strengthening in both package business and fidelity and surety. For a discussion on prior accident year reserve development, see the Property and Casualty Insurance Product Reserves, Net of Reinsurance section within Critical Accounting Estimates.
Insurance operating costs and expenses increased in 2010, driven by an increase in taxes, licenses and fees of $19, which included a $5 increase in reserve strengthening for other state funds and taxes and a $7 reduction in TWIA assessments recognized in 2009 related to hurricane Ike. Also contributing to the increase were higher IT costs. The increased expenses were partially offset by a decrease of $5 in dividends payable primarily for workers’ compensation policyholders, and lower compensation-related costs. Amortization of deferred policy acquisition costs decreased, largely due to the decrease in earned premiums.
Net realized capital gains (losses) improved as compared to the prior year, as did net investment income. The improvements in net realized capital gains (loss) were primarily driven by lower impairments in 2010 compared to 2009 and realized gains on derivatives in 2010 compared to losses in 2009. Net investment income increased in 2010, primarily as a result of improvements in limited partnerships and other alternative investments, partially offset by lower returns on taxable fixed maturities due to declining interest rates. For additional information, see the Investment Results section within Key Performance Measures and Ratios.
The effective tax rate, in both periods, differs from the U.S. Federal statutory rate primarily due to permanent differences related to investments in tax exempt securities. For further discussion, see Income Taxes within Note 13 of the Notes to Consolidated Financial Statements.

 

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Year ended December 31, 2009 compared to the year ended December 31, 2008
Net income increased significantly in 2009, compared to 2008, driven by an increase in underwriting results coupled with improvements in net realized capital losses. Underwriting results increased primarily due to lower losses and loss adjustment expenses for the current accident year before catastrophes, lower current accident year catastrophe losses, and more favorable prior accident year development, partially offset by decreases in earned premiums.
Earned premiums decreased in 2009, in nearly all lines of businesses. The decrease was primarily due to lower earned audit premium on workers’ compensation business and the effect of non-renewals outpacing new business over the last two years for package business and commercial auto. Property earned premiums decreased, primarily due to the sale of the Company’s core excess and surplus lines property business. For additional information on this sale, see Note 20 of the Notes to Consolidated Financial Statements.
New business written premium increased, primarily driven by the increase in workers’ compensation and package business, partially offset by a decrease in new business for professional liability, marine, general liability and commercial auto. Despite continued pricing competition, the Company has increased new business for workers’ compensation by targeting business in selected industries and regions of the country where attractive new business opportunities remain. For standard commercial lines, earned pricing decreased, primarily driven by decreases in workers’ compensation, commercial auto, general liability, property and marine, partially offset by an increase in package business. The earned pricing changes were primarily a reflection of written pricing changes over the last two years. A number of carriers have continued to compete aggressively on price, particularly on larger accounts. In addition to the effect of written pricing decreases in workers’ compensation, average premium per policy has declined due to a reduction in the payrolls of workers’ compensation insureds and the effect of declining endorsements.
Also, for standard commercial lines, policy count retention decreased slightly as the effects of the downturn in the economy caused business closures and increased shopping of policies by businesses seeking lower premiums. The number of policies in-force increased in 2009, as the growth in policies in-force does not correspond directly with the change in earned premiums due to the effect of changes in earned pricing and changes in the average premium per policy.
Current accident year losses and loss adjustment expenses before catastrophes decreased, primarily due to a decrease in earned premium, partially offset by a slight increase in the current accident year loss and loss adjustment expense ratio before catastrophes. The increase in the ratio was primarily due to a higher loss and loss adjustment expense ratio on workers’ compensation, package business and general liability, partially offset by lower non-catastrophe losses on property and marine business, driven by favorable claim frequency and severity. The higher loss and loss adjustment expense ratio on workers’ compensation and general liability business was primarily due to the effects of renewal earned pricing decreases in excess of loss cost change.
Current accident year catastrophe losses decreased as losses in 2008 from hurricane Ike and tornadoes and thunderstorms in the South and Midwest were higher than losses in 2009. Losses in 2009 were primarily incurred from ice storms, windstorms, and tornadoes across Colorado, the Midwest and Southeast.
Net favorable prior accident year reserve development, in both periods, included reserve releases in the following: workers’ compensation, general liability, including umbrella and high hazard liability, professional liability and auto liability. Reserve development in 2009 also included strengthening in both package business and fidelity and surety, and releases in uncollectible reinsurance and catastrophes, while reserve development in 2008 also included strengthening in general liability, including product liability and national accounts. For a discussion on prior accident year reserve development, see the Property and Casualty Insurance Product Reserves, Net of Reinsurance section within Critical Accounting Estimates.
Insurance operating costs and expenses decreased primarily due to a $37 decrease in the estimated amount of dividends payable to certain workers’ compensation policyholders and a decrease in TWIA assessments of $17, partially offset by increase in taxes, license and fees of $23 and higher compensation-related costs. The increase in taxes, license and fees included, a $6 increase in the assessment for a second injury fund and $9 reserve strengthening for other state funds and taxes. Amortization of deferred policy acquisition costs decreased largely due to the decrease in earned premiums.
Net realized capital gains (losses) improved significantly in 2009. The improvements were driven primarily by lower impairments in 2009 compared to 2008. Net investment income decreased in 2009, primarily due to lower income on fixed maturities resulting from a decline in average rates, partially offset by decreased losses on limited partnerships and other alternative investments. For additional information, see the Investment Results section within Key Performance Measures and Ratios.
The effective tax rate, in both periods, differs from the U.S. Federal statutory rate. In 2009, this is primarily due to permanent differences related to investments in tax exempt securities. In 2008, there was a net income tax benefit despite having pre-tax income due to an income tax benefit on realized capital losses that was greater than the income tax expense on all other components of pre-tax income. For further discussion, see Income Taxes within Note 13 of the Notes to Consolidated Financial Statements.

 

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GROUP BENEFITS
                         
Operating Summary   2010     2009     2008  
Premiums and other considerations
  $ 4,278     $ 4,350     $ 4,391  
Net investment income
    429       403       419  
Net realized capital gains (losses)
    46       (124 )     (540 )
 
                 
Total revenues
    4,753       4,629       4,270  
 
                 
Benefits, losses and loss adjustment expenses
    3,331       3,196       3,144  
Amortization of deferred policy acquisition costs
    61       61       57  
Insurance operating costs and other expenses
    1,111       1,120       1,128  
 
                 
Total benefits, losses and expenses
    4,503       4,377       4,329  
 
                 
Income (loss) before income taxes
    250       252       (59 )
Income tax expense (benefit)
    65       59       (53 )
 
                 
Net income (loss)
  $ 185     $ 193     $ (6 )
 
                 
                         
Premiums and other considerations   2010     2009     2008  
Fully insured — ongoing premiums
  $ 4,166     $ 4,309     $ 4,355  
Buyout premiums
    58             1  
Other
    54       41       35  
 
                 
Total premiums and other considerations
  $ 4,278     $ 4,350     $ 4,391  
 
                 
 
                       
Fully insured ongoing sales, excluding buyouts
  $ 583     $ 741     $ 820  
 
                 
 
                       
Ratios, excluding buyouts
                       
Loss ratio
    77.6 %     73.5 %     71.6 %
Loss ratio, excluding financial institutions
    82.8 %     77.8 %     76.3 %
Expense ratio
    27.8 %     27.1 %     27.0 %
Expense ratio, excluding financial institutions
    23.3 %     22.6 %     22.4 %
Group Benefits has a block of financial institution business that is experience rated. This business comprised approximately 9% to 10% of the segment’s 2010, 2009 and 2008 premiums and other considerations (excluding buyouts). With respect to the segment’s net income (loss), excluding net realized capital gains (losses), the financial institution business comprised 6% for 2010, and on average, 2% to 4% for 2009 and 2008, excluding the commission accrual adjustment in 2009 discussed below.
Year ended December 31, 2010 compared to the year ended December 31, 2009
Net income decreased as compared to prior year, as a decrease in premiums and other considerations and higher claim costs offset the improvements in net realized capital gains (losses) and net investment income. Premiums and other considerations decreased due to a 3% decline in fully insured ongoing premiums which was driven by lower sales due to the competitive marketplace, and the pace of the economic recovery. The loss ratio, excluding buyouts, increased compared to the prior year, particularly in group disability, primarily due to unfavorable morbidity experience from higher incidence and lower claim terminations.
The favorable change to net realized capital gains in 2010, from net realized capital losses in 2009, was due to impairments on investment securities recorded in 2009. For further discussion on impairments, see Other-Than-Temporary Impairments within the Investment Credit Risk section of the MD&A. Net investment income increased as a result of higher weighted average portfolio yields primarily due to improved performance on limited partnerships and other alternative investments.
The effective tax rate, in both periods, differs from the U.S. Federal statutory rate primarily due to permanent differences related to investments in tax exempt securities. For further discussion, see Income Taxes within Note 13 of the Notes to Consolidated Financial Statements.
Year ended December 31, 2009 compared to the year ended December 31, 2008
The change to net income in 2009, from a net loss in 2008, was primarily due to lower net realized capital losses in 2009, partially offset by higher claim costs, and decreases in premiums and other considerations and net investment income.
The lower net realized capital losses were primarily driven by fewer impairments in 2009 compared to 2008. For further discussion on impairments, see Other-Than-Temporary Impairments within the Investment Credit Risk section of the MD&A.
The segment’s loss ratio increased primarily due to unfavorable morbidity experience, which was primarily due to unfavorable reserve development from the 2008 incurral loss year and higher new incurred long term disability claims in 2009. In addition, premiums and other considerations decreased primarily due to reductions in covered lives within our customer base, and to a lesser extent, lower sales. Fully insured ongoing sales, excluding buyouts, were lower as compared to the prior year due to the competitive marketplace and the economic environment. Net investment income decreased primarily as a result of lower yields on fixed maturity investments.
The effective tax rate, in both periods, differs from the U.S. Federal statutory rate primarily due to permanent differences related to investments in tax exempt securities. For further discussion, see Income Taxes within Note 13 of the Notes to Consolidated Financial Statements.

 

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CONSUMER MARKETS
                         
Operating Summary   2010     2009     2008  
Written premiums
  $ 3,886     $ 3,995     $ 3,933  
Change in unearned premium reserve
    (61 )     36       (2 )
 
                 
Earned premiums
    3,947       3,959       3,935  
Losses and loss adjustment expenses
                       
Current accident year before catastrophes
    2,737       2,707       2,552  
Current accident year catastrophes
    300       228       258  
Prior accident years
    (86 )     (33 )     (52 )
 
                 
Total losses and loss adjustment expenses
    2,951       2,902       2,758  
Amortization of deferred policy acquisition costs
    667       674       633  
Insurance operating costs and expenses
    290       273       266  
 
                 
Underwriting results
    39       110       278  
Net servicing income
    35       29       26  
Net investment income
    187       178       207  
Net realized capital gains (losses)
          (52 )     (319 )
Other expenses
    (66 )     (77 )     (63 )
 
                 
Income before income taxes
    195       188       129  
Income tax expense
    52       48       27  
 
                 
Net income
  $ 143     $ 140     $ 102  
 
                 
                         
    2010     2009     2008  
Written Premiums
                       
Product Line
                       
Automobile
  $ 2,745     $ 2,877     $ 2,837  
Homeowners
    1,141       1,118       1,096  
 
                 
Total
  $ 3,886     $ 3,995     $ 3,933  
 
                 
 
                       
Earned Premiums
                       
Product Line
                       
Automobile
  $ 2,806     $ 2,857     $ 2,833  
Homeowners
    1,141       1,102       1,102  
 
                 
Total
  $ 3,947     $ 3,959     $ 3,935  
 
                 
                         
Premium Measures   2010     2009     2008  
Policies in force at year end
                       
Automobile
    2,226,351       2,395,421       2,323,882  
Homeowners
    1,426,107       1,488,408       1,455,954  
 
                 
Total policies in force at year end
    3,652,458       3,883,829       3,779,836  
 
                 
New business premium
                       
Automobile
  $ 311     $ 455     $ 364  
Homeowners
  $ 106     $ 149     $ 106  
Policy count retention
                       
Automobile
    83 %     86 %     86 %
Homeowners
    85 %     86 %     87 %
Renewal written pricing increase
                       
Automobile
    6 %     3 %     4 %
Homeowners
    10 %     5 %     6 %
Renewal earned pricing increase
                       
Automobile
    5 %     4 %     4 %
Homeowners
    7 %     6 %     5 %

 

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Ratios and Supplemental Data   2010     2009     2008  
Loss and loss adjustment expense ratio
                       
Current accident year before catastrophes
    69.4       68.4       64.8  
Current accident year catastrophes
    7.6       5.8       6.5  
Prior accident years
    (2.2 )     (0.8 )     (1.3 )
 
                 
Total loss and loss adjustment expense ratio
    74.8       73.3       70.1  
Expense ratio
    24.2       23.9       22.8  
 
                 
Combined ratio
    99.0       97.2       92.9  
 
                 
Catastrophe ratio
                       
Current accident year
    7.6       5.8       6.5  
Prior accident years
    0.3       0.1       0.2  
 
                 
Total catastrophe ratio
    7.8       5.9       6.7  
 
                 
Combined ratio before catastrophes
    91.2       91.3       86.2  
Combined ratio before catastrophes and prior accident year development
    93.6       92.3       87.7  
 
                 
Other revenues [1]
  $ 172     $ 154     $ 135  
 
                 
     
[1]  
Represents servicing revenues.
                         
Product Combined Ratios   2010     2009     2008  
Automobile
    97.1       96.9       91.1  
Homeowners
    104.0       98.2       97.6  
 
                 
Total
    99.0       97.2       92.9  
 
                 
Year ended December 31, 2010 compared to the year ended December 31, 2009
Net income increased slightly in 2010, as compared to the prior year, despite a decrease in underwriting results. The primary causes of the decrease in underwriting results were higher current accident year losses and loss adjustment expenses, including catastrophes, partially offset by more favorable prior accident year reserve development. The lower underwriting results were offset by improvements in net realized capital gains (losses) and higher net investment income.
Earned premiums decreased in 2010, as lower earned premiums in auto were partially offset by an increase in homeowners’. Auto earned premiums were down reflecting a decrease in new business written premium and policy count retention since the fourth quarter of 2009 and a decrease in average renewal earned premium per policy. Homeowners’ earned premiums grew primarily due to the effect of increases in earned pricing, partially offset by a decrease in new business written premium and policy count retention.
Auto and home new business written premium decreased primarily due to the effect of written pricing increases and underwriting actions that lowered the policy issue rate. Also contributing to the decrease in new business were fewer responses from direct marketing on AARP business and fewer quotes from independent agents driven by increased competition. Partially offsetting the decrease in auto new business was the effect of an increase in policies sold to AARP members through agents. Partially offsetting the decrease in home new business was an increase in the cross-sale of homeowners’ insurance to insureds that have auto policies.
The change in auto renewal earned pricing was due to rate increases and the effect of policyholders purchasing newer vehicle models in place of older models. Despite auto renewal earned pricing increasing, average renewal earned premium per policy for auto declined due to a shift to more preferred market segments and a greater concentration of business in states and territories with lower average premium. Homeowners’ renewal earned pricing increased due to rate increases and increased coverage amounts reflecting higher rebuilding costs. For both auto and home, the Company has increased rates in certain states for certain classes of business to maintain profitability in the face of rising loss costs.
Policy count retention for auto and home decreased primarily driven by the effect of renewal written pricing increases and underwriting actions to improve profitability. The decrease in the policy count retention for homeowners was partially offset by the effect of the Company’s non-renewal of Florida homeowners’ agency business in 2009. Compared to 2009, the number of policies in-force as of 2010 decreased for both auto and home, driven by the decreases in policy retention and new business.
Current accident year losses and loss adjustment expenses before catastrophes increased primarily due to an increase in the current accident year loss and loss adjustment expense ratio before catastrophes for auto of 1.3 points due to higher auto physical damage emerged frequency and higher expected auto liability loss costs relative to average premium. The current accident year loss and loss adjustment expense ratio before catastrophes for home increased 0.7 points primarily due to an increase in loss adjustment expenses, partially offset by the effect of earned pricing increases.
Current accident year catastrophes were higher in 2010 than in 2009 primarily due to a severe wind and hail storm event in Arizona during the fourth quarter of 2010. Losses in 2010 were also incurred from tornadoes, thunderstorms and hail events in the Midwest, plains states and the Southeast, as well as from winter storms in the Mid-Atlantic and Northeast. Catastrophe losses in 2009 were primarily incurred from windstorms in Texas and the Midwest as well as the two large Colorado hail and windstorm events.
Net favorable reserve development was higher in 2010 due to more favorable development of auto liability reserves. Net favorable reserve development in both 2010 and 2009 included a release of personal auto liability reserves, partially offset by a strengthening of reserves for non-catastrophe homeowners’ claims. For additional information on prior accident year reserve development, see the Property and Casualty Insurance Product Reserves, Net of Reinsurance section within Critical Accounting Estimates.

 

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The expense ratio increased due largely to an $8 increase in legal settlement costs in 2010 and higher amortization of acquisition costs on AARP business, partially offset by lower direct marketing spend for consumer direct business. Also contributing to the increase in the expense ratio was a $7 reduction of TWIA hurricane assessments in 2009 largely offset by an $8 increase in reserves for other state funds and taxes in 2009.
Net realized capital gains (losses) improved, as compared to prior year. The improvements were primarily driven by lower impairments in 2010 compared to 2009, and realized gains on derivatives in 2010 compared to losses in 2009. Net investment income increased, primarily as a result of increased income from limited partnerships and other alternative investments, partially offset by lower returns on taxable fixed maturities due to declining interest rates. For additional information, see the Investment Results section within Key Performance Measures and Ratios.
The effective tax rate, in both periods, differs from the U.S. Federal statutory rate primarily due to permanent differences related to investments in tax exempt securities. For further discussion, see Income Taxes within Note 13 of the Notes to Consolidated Financial Statements.
Year ended December 31, 2009 compared to the year ended December 31, 2008
Net income increased as a result of lower net realized capital losses, partially offset by a decrease in underwriting results and lower net investment income.
Earned premiums grew in 2009, as a result of an increase in auto, while homeowners remained flat. The increase in auto earned premiums was primarily due to the effect of an increase in new business, largely offset by a decrease in average renewal premium per policy. Homeowners’ earned premiums were flat as the effect of an increase in new business was largely offset by a decrease in policy count retention.
Auto and homeowners’ new business written premium increased in 2009 primarily due to increased direct marketing spend, increased agency appointments, higher auto policy conversion rates and cross-selling homeowners’ insurance to insureds that have auto policies. This increase in new business helped drive an increase in the number of policies in-force in both auto and homeowners.
Policy count retention for auto remained flat in 2009, primarily due to stable renewal written pricing increases and policy retention initiatives. Policy count retention for homeowners decreased slightly in 2009, primarily due to the Company’s decision to stop renewing Florida homeowners’ policies written through independent agents.
The increases in renewal earned pricing during 2009 were primarily a reflection of written pricing in the second half of 2008 and first half of 2009. Renewal written pricing in 2009 increased in auto due to rate increases and the effect of policyholders purchasing newer vehicle models in place of older models. Homeowners’ renewal written pricing increased due to rate increases and increased coverage amounts reflecting higher rebuilding costs. For both auto and home, the Company has increased rates in certain states for certain classes of business to maintain profitability in the face of rising loss costs. While the Company recognized higher renewal earned pricing in 2009, driven by higher rates and an increase in the amount of insurance per exposure unit, average renewal premium per policy decreased for auto and was flat for home. For both auto and home, average renewal premium was impacted by a shift to more preferred market segment business and growth in states and territories with lower average premium. In addition, average renewal premium was affected by the impact of the economic downturn on consumer behavior. Among other actions, in 2009 insureds reduced their premiums by raising deductibles, reducing limits, dropping coverage and reducing mileage.
Current accident year losses and loss adjustment expenses before catastrophes increased, primarily due to an increase in the current accident year loss and loss adjustment expense ratio before catastrophes, driven by a 3.3 point increase for auto and a 4.2 point increase for home. The increase for auto was due to an increase in expected liability loss costs, an increase in physical damage frequency and a decline in average premium. After a historically low claim frequency in 2008, auto claim frequency increased in 2009, mostly in bodily injury coverage, driven by an increase in miles driven. The increase for home was driven by increasing frequency and severity coupled with a decline in average premium.
Current accident year catastrophes decreased by $30 as catastrophe losses in 2008, driven by losses from hurricane Ike and from wind and thunderstorms, were higher than catastrophe losses in 2009, driven by losses from hail and windstorms in Colorado, the Midwest and the Southeast.
Net favorable reserve development was lower in 2009 than in 2008. Net favorable reserve development in 2009 included a release of personal auto liability reserves, partially offset by a strengthening of reserves for homeowners’ claims. Net favorable reserve development in 2008 included a release of personal auto liability reserves. For additional information on prior accident year reserve development, see the Property and Casualty Insurance Product Reserves, Net of Reinsurance section within Critical Accounting Estimates.
The expense ratio increased due largely to higher amortization of deferred acquisition costs and an increase in other non-deferrable costs, partially offset by a decrease in TWIA assessments of $17. Also contributing to the increase in the expense ratio was an $8 increase in reserves for other state funds and taxes in 2009. Amortization of acquisition costs increased due to an increase in direct marketing costs.
Net realized capital gains (losses) improved significantly in 2009. The improvements were primarily driven by lower impairments in 2009 compared to 2008. Net investment income decreased in 2009, primarily as a result of lower returns on taxable fixed maturities due to declining interest rates. For additional information, see the Investment Results section within Key Performance Measures and Ratios.
The effective tax rate, in both periods, differs from the U.S. Federal statutory rate. In 2009, this is primarily due to permanent differences related to investments in tax exempt securities. In 2008, there was an income tax benefit on realized capital losses that partially offset the income tax expense on all other components of pre-tax income. For further discussion, see Income Taxes within Note 13 of the Notes to Consolidated Financial Statements.

 

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GLOBAL ANNUITY