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EX-12.01 - EXHIBIT 12.01 - HARTFORD LIFE INSURANCE COc13149exv12w01.htm
EX-32.01 - EXHIBIT 32.01 - HARTFORD LIFE INSURANCE COc13149exv32w01.htm
EX-32.02 - EXHIBIT 32.02 - HARTFORD LIFE INSURANCE COc13149exv32w02.htm
EX-31.02 - EXHIBIT 31.02 - HARTFORD LIFE INSURANCE COc13149exv31w02.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 001-32293
HARTFORD LIFE INSURANCE COMPANY
(Exact name of registrant as specified in its charter)
     
Connecticut   06-0974148
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
200 Hopmeadow Street, Simsbury, Connecticut 06089
(Address of principal executive offices)
(860) 547-5000
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: Floating Rate IncomeNotes(sm) due 2011
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. þ
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. (Check one):
             
Large accelerated filer o   Accelerated filer o   Non Accelerated filer þ   Smaller Reporting Company o
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
The aggregate market value of the shares of Common Stock held by non-affiliates of the registrant as of June 30, 2010 was $0, because all of the outstanding shares of Common Stock were owned by Hartford Life and Accident Insurance Company, a direct wholly owned subsidiary of Hartford Life, Inc.
As of February 18, 2011, there were outstanding 1,000 shares of Common Stock, $5,690 par value per share, of the registrant.
The registrant meets the conditions set forth in General Instruction (I) (1) (a) and (b) of Form 10-K and is therefore filing this Form with the reduced disclosure format.
 
 

 

 


 

HARTFORD LIFE INSURANCE COMPANY
ANNUAL REPORT ON FORM 10-K
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2010
TABLE OF CONTENTS
             
Item   Description   Page  
 
           
 
  Part I        
 
           
  Business *     5  
 
           
  Risk Factors     9  
 
           
  Unresolved Staff Comments     19  
 
           
  Properties *     19  
 
           
  Legal Proceedings     19  
 
           
  (Removed and Reserved)     19  
 
           
 
  Part II        
 
           
  Market for Hartford Life Insurance Company’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities     19  
 
           
  Selected Financial Data     19  
 
           
  Management’s Discussion and Analysis of Financial Condition and Results of Operations *     20  
 
           
  Quantitative and Qualitative Disclosures About Market Risk     52  
 
           
  Financial Statements and Supplementary Data     52  
 
           
  Changes in and Disagreements With Accountants on Accounting and Financial Disclosure     52  
 
           
  Controls and Procedures     52  
 
           
  Other Information     52  
 
           
 
  Part III        
 
           
  Directors, Executive Officers and Corporate Governance of Hartford Life Insurance Company     52  
 
           
  Executive Compensation     52  
 
           
  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters     53  
 
           
  Certain Relationships and Related Transactions, and Director Independence     53  
 
           
  Principal Accounting Fees and Services     53  
 
           
 
  Part IV        
 
           
  Exhibits, Financial Statement Schedules     53  
 
           
 
  Signatures   II-1  
 
           
 
  Exhibits Index   II-2  
 
           
 Exhibit 12.01
 Exhibit 23.01
 Exhibit 31.01
 Exhibit 31.02
 Exhibit 32.01
 Exhibit 32.02
     
*  
Item prepared in accordance with General Instruction I (2) of Form 10-K.

 

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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 Hartford Life Insurance Company 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 reflect 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 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;
 
actions by our competitors, many of which are larger or have greater financial resources than we do;
 
the restrictions, oversight, costs and other consequences of our parent, The Hartford Financial Services Group, Inc. (“The Hartford”), 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 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;
 
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;

 

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the Company’s ability to distribute its products through distribution channels, both current and future;
 
limitations on the ability of the Company’s subsidiaries to declare and pay dividends to the Company;
 
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 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 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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PART I
Item 1.  
BUSINESS
(Dollar amounts in millions, except for per share data, unless otherwise stated)
General
Hartford Life Insurance Company (together with its subsidiaries, “HLIC”, “the Company”, “we” or “our”), is an indirect wholly-owned subsidiary of The Hartford Financial Services Group, Inc. (“The Hartford”), an insurance and financial services company. HLIC is among the largest providers of insurance and investment products in the United States. The Company also assumes fixed annuity products and living and death benefit riders on variable annuities from The Hartford’s Japan operations and also cedes insurance risks to affiliates and third party reinsurance companies. At December 31, 2010, total assets and total stockholder’s equity were $231.8 billion and $8.2 billion, respectively.
Reporting Segments
The Company is organized into four reporting segments: Global Annuity, Life Insurance, Retirement Plans and Mutual Funds. The Company’s Other category includes: assumed and ceded reinsurance of death and living benefits from The Hartford’s Japan operations; its leveraged private placement life insurance (“PPLI”) product line of business; corporate items not directly allocated to any of its reporting segments; certain direct group life and group disability insurance that is ceded to an affiliate; as well as certain fee income and commission expense associated with sales of non-proprietary products by broker-dealer subsidiaries.
For disclosures on revenues, net income and assets for each reporting segment, see Note 2 of the Notes to Consolidated Financial Statements.
The Company provides investment products for over 6 million customers and life insurance products for approximately 695,000 customers.
As part of The Hartford’s strategic decision to focus on its U.S. businesses, the Company suspended all new sales in its 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. Additionally, in the fourth quarter of 2009, the Company completed a strategic review of certain institutional businesses and decided to exit several businesses that were determined to be outside of the Company’s core business model.
Principal Products
Global Annuity offers individual variable, fixed market adjusted (“MVA”), and single premium immediate annuities in the U.S. and administers investments, retirement savings and other insurance and savings products to individuals and groups outside of the U.S, primarily in Europe. The Company will continue to service existing business written with institutional customers in the form of structured settlements, guaranteed investment products and annuities, but has decided to not actively market those types of contracts. Certain guaranteed investment products may be offered on a selective basis.
Life Insurance offers a variety of life insurance products, including variable universal life, universal life, interest sensitive whole life, and term life, as well as variable private placement life insurance (“PPLI”) owned by corporations and high net worth individuals.
Retirement Plans provides retirement products and services to businesses pursuant to Section 401(k) of the Internal Revenue Code of 1986 (“the IRS Code”), as well as, products and services to municipalities and not-for-profit organizations pursuant to Section 457 and 403(b) of the IRS Code.
Mutual Funds offer retail, proprietary, investment-only mutual funds and 529 college savings plans to investors.
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 The Hartford’s 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, through its internal wholesaler HLD, 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.

 

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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.
Reserves
The Company and its insurance subsidiaries establish and carry as liabilities, predominantly, five types of reserves: (1) a liability equal to the balance that accrues to the benefit of the policyholder as of the financial statement date, otherwise known as the account value, (2) a liability for unpaid losses, including those that have been incurred but not yet reported, (3) 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, (4) fair value reserves for living benefits embedded derivative guarantees; and (5) death and living benefit reserves which are computed based on a percentage of revenues less actual claim costs. The liabilities for unpaid losses and future policy benefits are calculated based on actuarially recognized methods using morbidity and mortality tables, which are modified to reflect the Company’s actual experience when appropriate. Liabilities for unpaid losses include estimates of amounts to fully settle known reported claims as well as claims related to insured events that the Company estimates have been incurred but have not yet been reported. Future policy benefit reserves are computed at amounts that, with additions from estimated net premiums to be received and with interest on such reserves compounded annually at certain assumed rates, are expected to be sufficient to meet the Company’s policy obligations at their maturities or in the event of an insured’s disability or death. Other insurance liabilities include those for unearned premiums and benefits in excess of account value. Reserves for assumed reinsurance are computed in a manner that is comparable to direct insurance reserves.
Reinsurance
The Company cedes insurance risk to reinsurance companies. Reinsurance does not relieve the Company of its primary liability and, as such, failure of reinsurers to honor their obligations could result in losses to the Company. The Company evaluates the risk transfer of its reinsurance contracts, the financial condition of its reinsurers and monitors concentrations of credit risk. The Company’s monitoring procedures include careful initial selection of its reinsurers, structuring agreements to provide collateral funds where possible, and regularly monitoring the financial condition and ratings of its reinsurers. Reinsurance accounting is followed for ceded transactions that provide indemnification against loss or liability relating to insurance risk (i.e. risk transfer). The Company cedes certain insurance risks to various affiliate entities to enable the Company to manage capital and risk exposure. For further discussion of reinsurance, see Note 5 and Note 16 of the Notes to Consolidated Financial Statements. If the ceded transactions do not provide risk transfer, the Company accounts for these transactions as financing transactions.
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.

 

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Risk Management
The Company’s risk management function is part of The Hartford’s overall risk management program. The Hartford has an independent enterprise risk management function (“ERM”) whose responsibility it is to provide a comprehensive, in depth, and transparent view of The Hartford’s risk on an aggregated basis and to ensure The Hartford’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 Hartford in achieving its strategic priorities within an agreed upon risk profile by providing a comprehensive view of the risks facing The Hartford, including risk concentrations and correlations; helping management define The Hartford’s risk tolerances through the evaluation of the risk return profile of the business relative to The Hartford’s strategic intent and financial underpinnings; and monitoring and communicating The Hartford’s risk exposures relative to set tolerances and recommending/implementing appropriate mitigation where applicable.
The Hartford maintains an internal Enterprise Risk and Capital Committee (“ERCC”), which includes The Hartford’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 Hartford’s General Counsel. The ERCC, which is chaired by the CEO, meets regularly to manage The Hartford’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 Hartford’s capital structure; and establish The Hartford’s risk management framework, limits, and standards.
The Hartford’s Board of Directors (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 Hartford and its subsidiaries. They review The Hartford’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 Hartford Life Insurance Company. This legislation provides that each insurance company in the system is required to register with the insurance department of its state of domicile and furnish information concerning the operations of companies within the holding company system 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.
The Company and certain of its 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. 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 Company’s subsidiaries operate. 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 Company’s international operations are comprised of insurers licensed in their respective countries.
Failure to comply with federal and state laws and regulations may result in censure, fines, the issuance of cease-and-desist orders or suspension or suspension, termination or limitation of the activities of our operations and/or employees. We cannot predict the impact of these actions on our business, 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.

 

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Item 1A.  
RISK FACTORS
Investing in The Hartford involves risk. In deciding whether to invest in the securities of the Company, 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 Company. This information should be considered carefully together with the other information contained in this report and the other reports and materials filed by the Company with the Securities and Exchange Commission.
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 continue to pressure returns in our investment portfolio and that our hedging costs will remain higher than historical levels. Unless 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. Lower interest rates are also likely to continue to adversely impact our fixed annuity sales and the cost and earnings impact of our guaranteed minimum withdrawal benefit (“GMWB”) hedging program. 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 hedging 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 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 generally accepted accounting principles 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.
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 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 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 reinsured Japan and direct U.K. variable and fixed annuities. 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 reinsured 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 reinsured 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. In comparison, the strengthening of the yen compared with other currencies will substantially increase our gross exposure to pay yen denominated obligations under our reinsurance of Japan variable annuity riders that offer guaranteed benefits, 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, further 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 our products, 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”), and guaranteed minimum death benefit (“GMDB”) 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 and when implied volatility rises. 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.
Accounting standards and statutory capital and reserve requirements for us and our licensed insurance company subsidiaries 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 risk based capital (“RBC”) formulas for life insurance companies. The RBC formula for life insurance 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.
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. 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, The Harford may seek to raise capital through public or private equity or debt financing. If it does not to raise additional capital, either at its discretion or because it is 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 and increase our cost of capital, could 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.
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 could affect our competitive position and reduce future sales of our products.

 

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Our credit ratings also affect our cost of capital. A downgrade or a potential downgrade of our credit ratings could make it more difficult to support business growth and to maintain or improve our financial strength ratings and those of our 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 stockholder’s 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 using components of EGPs. The projection of EGPs 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, 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, 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 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.
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 operations are also exposed to risk of loss from catastrophes associated with pandemics and other events that could significantly increase our mortality, morbidity and longevity 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.
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.
We may experience difficulty in marketing and distributing products through our current and future distribution channels.
We distribute our products through a variety of distribution channels, including brokers, broker-dealers, banks, wholesalers, our own internal sales force and other third-party organizations. 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.

 

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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.
As a savings and loan holding company, our parent, The Hartford, is subject to certain restrictions, oversight and costs that could materially affect our business, results and prospects.
Our parent, The Hartford, is a savings and loan holding company by virtue of its ownership of Federal Trust Bank (“FTB”), a federally chartered, FDIC-insured thrift. As a savings and loan holding company, The Hartford is subject to various restrictions, oversight and costs and other potential consequences that could materially affect our business, results and prospects. For example, The Hartford is subject to regulation, supervision and examination by the OTS, including with respect to required capital, cash flow, organizational structure, risk management and earnings, and to OTS reporting requirements. All of the activities The Hartford and its subsidiaries engage in must be financially-related activities as defined by federal law (which includes insurance activities), and the OTS has enforcement authority over it, 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. The Hartford must also be a source of strength to FTB, which could require it to make further capital contributions. The Hartford will be subject to similar, potentially stricter, requirements when regulatory authority over it transfers to The Federal Reserve (for our parent) and the Office of the Controller of the Currency (“OCC”) (for FTB).
We cannot predict the impact of future regulations, including, but not limited to, the impact on our parent’s required levels of regulatory capital or the cost and complexity of its compliance programs, all of which could have a material adverse impact on our business, results and prospects.
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 our parent is designated as a systemically important institution, it 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.

 

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A number of provisions of the Dodd-Frank Act affect The Hartford solely due to The Hartford’s status as a savings & loan holding company. For example, under the Dodd-Frank Act, the OTS will be dissolved. The Federal Reserve will regulate The Hartford as a holding company, and the OCC will regulate our affiliate thrift subsidiary, Federal Trust Bank. Because of The Hartford’s status as a savings and loan holding company or if it is designated a systemically important institution, the Dodd-Frank Act may also restrict The Hartford an its subsidiaries 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 our parent, control insured depository institutions.
Other provisions in the Dodd-Frank Act that may impact us, irrespective of whether or not our parent is 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 either directly or indirectly, as a result of its impact on The Hartford.
Limits on the ability of our insurance subsidiaries to pay dividends to us could have a material adverse effect on our liquidity.
The Connecticut insurance holding company laws limit the payment of dividends by our Connecticut-domiciled insurers. In addition, under certain circumstances, these laws require notice to and approval by the state insurance commissioner for the declaration or payment of dividends by these subsidiaries.
The insurance holding company laws of the other jurisdictions in which our insurance subsidiaries are deemed commercially domiciled generally contain similar, and in some instances more restrictive, limitations on the payment of dividends. These restrictions and other regulatory requirements affect the ability of our insurance subsidiaries to make dividend payments. Limits on the ability of the insurance subsidiaries to pay dividends could have a material adverse effect on our liquidity, including our ability to pay dividends to our parent.
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 Company is involved in claims litigation arising in the ordinary course of business. 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, 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 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 outcome of litigation filed against the Company. 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.

 

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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.
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.
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 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
The Company has operations located throughout the U.S. and Europe, with its principal executive offices located in Simsbury, Connecticut. The executive offices are owned by our parent company, and facilities located in Windsor, Connecticut and Woodbury, Minnesota are owned by the Company. The Company believes its properties and facilities are suitable and adequate for current operations.
Item 3.  
LEGAL PROCEEDINGS
Litigation
The Company is involved in claims litigation arising in the ordinary course of business, both as a liability insurer defending or providing indemnity for third-party claims brought against insureds and as an insurer defending coverage claims brought against it. The Company accounts for such activity through the establishment of unpaid loss and loss adjustment expense reserves. Management expects that the ultimate liability, if any, with respect to such ordinary-course claims litigation, after consideration of provisions made for potential losses and costs of defense, will not be material to the consolidated financial condition, results of operations or cash flows of the Company.
The Company is also involved in other kinds of legal actions, some of which assert claims for substantial amounts. These actions include, among others, putative state and federal class actions seeking certification of a state or national class. Such putative class actions have alleged, for example, improper sales practices in connection with the sale of life insurance and other investment products; and improper fee arrangements in connection with investment products and structured settlements. The Company also is involved in individual actions in which punitive damages are sought, such as claims alleging bad faith in the handling of insurance claims. Management expects that the ultimate liability, if any, with respect to such lawsuits, after consideration of provisions made for estimated losses, will not be material to the consolidated financial condition of the Company. Nonetheless, given the large or indeterminate amounts sought in certain of these actions, and the inherent unpredictability of litigation, an adverse outcome in certain matters could, from time to time, have a material adverse effect on the Company’s consolidated results of operations or cash flows in particular quarterly or annual periods.
Mutual Fund Fees 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 Litigation — In October 2005, a putative nationwide class action was filed in the United States District Court for the District of Connecticut against the Company and several of its subsidiaries on behalf of persons who had asserted claims against an insured of a Hartford property & casualty insurance company that resulted in a settlement in which some or all of the settlement amount was structured to afford a schedule of future payments of specified amounts funded by an annuity from the 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 $54 in exchange for a full release and dismissal of the litigation. The $54 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.
Item 4.  
(Removed and Reserved)
PART II
Item 5.  
MARKET FOR HARTFORD LIFE INSURANCE COMPANY’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
All of the Company’s outstanding shares are ultimately owned by Hartford Life and Accident Insurance Company, which is ultimately a subsidiary of The Hartford. As of February 18, 2011, the Company had issued and outstanding 1,000 shares of common stock, $5,690 par value per share. There is no established public trading market for the Company’s common stock.
For a discussion regarding the Company’s payment of dividends, and the restrictions related thereto, see the Capital Resources and Liquidity section of the MD&A under “Dividends”.
Item 6.  
SELECTED FINANCIAL DATA
Omitted pursuant to General Instruction I(2)(a) of Form 10-K.

 

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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 Hartford Life Insurance Company and its subsidiaries (“Hartford Life Insurance Company” or the “Company”) as of and for the year ended December 31, 2010 compared with the comparable December 31, 2009 period. Management’s narrative analysis of the results of operations is presented pursuant to General Instruction I(2)(a) of Form 10-K. This discussion should be read in conjunction with the Consolidated Financial Statements and related Notes beginning on page F-1. Certain reclassifications have been made to prior year financial information to conform to the current year presentation.
INDEX
         
Description   Page  
 
       
    21  
 
       
    23  
 
       
    28  
 
       
    30  
 
       
    38  
 
       
    46  
 
       
    52  

 

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CONSOLIDATED RESULTS OF OPERATIONS
Operating Summary
                 
    2010     2009  
Fee income and other
  $ 3,806     $ 3,723  
Earned premiums
    260       377  
Net investment income
               
Securities available-for-sale and other
    2,621       2,505  
Equity securities, trading [1]
    238       343  
 
           
Total net investment income
    2,859       2,848  
Net realized capital gains (losses):
               
Total other-than-impairment (“OTTI”) losses
    (712 )     (1,722 )
OTTI losses recognized to other comprehensive income
    376       530  
 
           
Net OTTI losses recognized in earnings
    (336 )     (1,192 )
Net realized capital gains (losses), excluding net OTTI losses recognized in earnings
    (608 )     316  
 
           
Total net realized capital losses
    (944 )     (876 )
 
           
Total revenues
    5,981       6,072  
Benefits, losses and loss adjustment expenses
    2,948       3,716  
Benefits, losses and loss adjustment expenses — returns credited on International unit — linked bonds and pension products [1]
    238       343  
Insurance operating costs and other expenses
    1,610       1,826  
Amortization of deferred policy acquisition costs and present value of future profits
    215       3,716  
Dividends to policyholders
    21       12  
 
           
Total benefits, claims and expenses
    5,032       9,613  
 
           
Income (loss) from continuing operations before income taxes
    949       (3,541 )
Income tax expense (benefit)
    228       (1,399 )
 
           
Income (loss) from continuing operations
    721       (2,142 )
Income (loss) from discontinued operations, net of tax
    31       (5 )
 
           
Net income (loss)
    752       (2,147 )
Net income (loss) attributable to the noncontrolling interest
    8       10  
 
           
Net income (loss) attributable to Hartford Life Insurance Company
  $ 744     $ (2,157 )
 
           
     
[1]  
Net investment income includes investment income and mark-to-market effects of equity securities, trading, supporting the international variable annuity business, which are classified in net investment income with corresponding amounts credited to policy holders.
Year ended December 31, 2010 compared to the year ended December 31, 2009
The Company’s improvement from a net loss to net income was primarily due to the impact to earnings from the affiliate modco reinsurance agreement, an Unlock benefit in 2010, increases in fee income, and increases in net investment income on securities available-for-sale and other, partially offset by realized losses on the variable annuity hedging program.
The affiliate modco reinsurance agreement improved $2.1 billion from a net loss of $1.6 billion in 2009 to net income of $570 in 2010. The increase is primarily due to an Unlock charge of $1.3 billion at inception in 2009. For further discussion on this affiliate modco reinsurance agreement see Note 16 of the Notes to Consolidated Financial Statements.
The Unlock benefit in 2010 of $149 compared to an Unlock charge of $2.1 billion in 2009. The Unlock benefit in 2010 was primarily due to actual separate account returns being above our aggregated estimated returns and the impacts of assumption updates. The Unlock charge in 2009 was primarily due to the $1.3 billion charge at inception of the affiliate modco reinsurance agreement, as well as 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. See Critical Accounting Estimates within the MD&A for a further discussion on the Unlock.
Fee income and other increased, as a result of an increase in average variable annuity account values and average mutual fund assets as a result of equity market appreciation on a year over year basis largely offsetting net out flows in Global Annuity. Additionally, average mutual fund assets values in Mutual Funds have increased due to increased net flows as investors re-enter the capital markets.
Net investment income on available-for-sale securities and other securities increased primarily due to improved investment performance on limited partnership and other alternative investments, partially offset by lower income on fixed maturities due to lower yields. For additional information on changes in net investment income, see Investment Results within the MD&A.
The variable annuity hedging program net realized capital losses in 2010 were $471 compared to net realized capital gains of $610 in 2009. The losses in 2010 were driven by the macro hedge program of $584, while in 2009, the GMWB derivatives, net realized gains of $1.5 billion drove the gains. For additional information on changes in net realized capital gains and losses, see Investment Results within the MD&A.

 

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Income Taxes
The effective tax rate for 2010 and 2009 was 24% and 39%, respectively. The principal causes of the difference between the effective rate and the U.S. statutory rate of 35% for 2010 and 2009 were the separate account dividends received deduction (“DRD”). This caused a decrease in the tax on the 2010 pre-tax income and an increase in the tax benefit on the 2009 pre-tax loss. The effective tax rate for 2010 also includes the effect of an increase in the valuation allowance on the deferred tax asset. For additional information, see Note 11 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 distributions 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 and $181 related to the separate account DRD in the years ended December 31, 2010 and 2009, respectively. These amounts included benefits (charges) related to prior years’ tax returns of $(3) and $29 in 2010 and 2009, respectively.
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 and $16 related to separate account foreign tax credit in the years ended December 31, 2010 and 2009, respectively. These amounts included benefits (expenses) related to true-ups of prior years’ tax returns of $(4) and $3 in 2010 and 2009, respectively.

 

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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:
 
estimated gross profits used in the valuation and amortization of assets and liabilities associated with variable annuity and other universal life-type contracts;
 
living benefits required to be fair valued (in other policyholder funds and benefits payable);
 
valuation of investments and derivative instruments;
 
evaluation of other-than-temporary impairments on available-for-sale securities and valuation allowances on investments;
 
goodwill impairment;
 
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.
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 Company’s deferred policy acquisition cost (“DAC”) asset, which includes the present value of future profits; sales inducement assets (“SIA”); and unearned revenue reserves (“URR”). See Note 6 of the Notes to Consolidated Financial Statements for additional information on DAC. See Note 9 of the Notes to Consolidated Financial Statements for additional information on SIA. 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 8 of the Notes to Consolidated Financial Statements for additional information on death and other insurance benefit feature reserves.
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 revised 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 a 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 rate of return is 8.3%.

 

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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. In the fourth quarter of 2009, recent market volatility provided the Company additional credible information regarding policyholder behavior, related to living benefit lapses, withdrawal rates and GMDB lapses. This information was incorporated into the Company’s assumptions used in determining estimated gross profits. Upon completion of an 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.
An Unlock revises EGPs, on a quarterly basis, to reflect 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. As of December 31, 2010, the margin between the DAC balance and to the present value of future EGPs was 9% for U.S. individual variable annuities, reflective of the reinsurance of a block of individual variable annuities with an affiliated captive reinsurer. 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.
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.
Effective October 1, 2009, a subsidiary of HLIC, Hartford Life and Annuity Insurance Company (“HLAI”) entered into a reinsurance agreement with an affiliated captive reinsurer, White River Life Reinsurance Company (“the affiliated captive reinsurer” or “WRR”). This agreement provides that HLAI will cede, and WRR will reinsure 100% of the in-force and prospective U.S. variable annuities and the associated GMDB and GMWB riders. This transaction resulted in an Unlock charge of $2.0 billion, pre-tax, and $1.3 billion, after-tax, as the related EGP’s were ceded to the affiliate. See Note 16, Transactions with Affiliates, of the Notes to Consolidated Financial Statements for further information on the transaction.
Unlocks
The after-tax impact on the Company’s assets and liabilities as a result of the Unlocks for the years ended 2010 and 2009 were:
For the year ended December 31, 2010
                                         
                    Death and              
Segment                   Insurance Benefit              
After-tax (Charge) Benefit   DAC     URR     Reserves     SIA     Total  
Global Annuity
  $ 62     $     $ 37     $ 3     $ 102  
Life Insurance
    23       5       1       (1 )     28  
Retirement Plans
    18                         18  
Other
                1             1  
 
                             
Total
  $ 103     $ 5     $ 39     $ 2     $ 149  
 
                             
The most significant contributor to the Unlock benefit recorded during the twelve months ended December 31, 2010 was actual separate account returns being above our aggregated estimated return and the impacts of assumption updates.
For the year ended December 31, 2009
                                         
                    Death and              
Segment                   Insurance Benefit              
After-tax (Charge) Benefit   DAC     URR     Reserves     SIA     Total  
Global Annuity
  $ (1,760 )   $ 84     $ (160 )   $ (188 )   $ (2,024 )
Life Insurance
    (100 )     54       (4 )           (50 )
Retirement Plans
    (55 )                 (1 )     (56 )
Other
                (15 )           (15 )
 
                             
Total
  $ (1,915 )   $ 138     $ (179 )   $ (189 )   $ (2,145 )
 
                             
The most significant contributors to the Unlock amounts were $(1.3) billion related to reinsurance of a block of in-force and prospective U.S. variable annuities and the associated GMDB and GMWB riders with an affiliated captive reinsurer, as well as 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. Also included in the unlock was $(49) related to DAC recoverability impairment associated with the decision to suspend sales in the U.K. variable annuity business.

 

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Living Benefits Required to be Fair Valued (in Other Policyholder Funds and Benefits Payable)
Fair values for direct, assumed and ceded GMWB, GMIB and GMAB contracts are calculated based upon internally developed models because active, observable markets do not exist for those items. The fair value of those 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 Costs; 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 each of these components, as necessary and as reconciled or calibrated to the market information available to the Company, results in an amount that the Company would be required to transfer, or receive, 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 3 of the Notes to Consolidated Financial Statements and for a discussion on the sensitivities of certain living benefits due to capital market factors see Equity Product Risk within Capital Markets Risk Management.
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 3 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 3 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% and 96% of derivatives, respectively, based upon notional values, were priced by valuation models, which utilize independent market data. The remaining derivatives were priced by broker quotations. The derivatives are valued using mid-market level inputs 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.
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 4 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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Goodwill Impairment
Goodwill balances are reviewed for impairment at least annually or more frequently if events occur or circumstances change that would indicate 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 cash flow calculations, price to earnings multiples, the level of The Hartford’s 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 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. The Company’s reporting units, for which goodwill has been allocated, are equivalent to the Company’s operating segments because either there is no discrete financial information available for the separate components of a segment or all of the components of a segment have similar economic characteristics. The variable life, universal life and term life components of Life Insurance 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, with U.S. Individual Annuity within Global Annuity and Individual Life within Life Insurance, the Company has classified those components as reporting units.
As of December 31, 2010 and 2009, the Company had goodwill allocated to the following reporting units:
                 
    December 31, 2010     December 31, 2009  
Individual Life within Life Insurance
  $ 224     $ 224  
Retirement Plans
    87       87  
Mutual Funds
    159       159  
 
           
Total
  $ 470     $ 470  
 
           
The Company completed its annual goodwill assessment for the individual reporting units 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 that 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.
See Note 7 of the Notes to Consolidated Financial Statements for information on the results of goodwill impairment tests performed in 2009.

 

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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 is made at the consolidated level and requires The Hartford’s management to make certain judgments and assumptions. In evaluating the ability to recover deferred tax assets, The Hartford has 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 The Hartford determines 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 Company’s 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. The Hartford’s 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 $139 as of December 31, 2010 and $80 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, The Hartford’s 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 The Hartford’s management as prudent and feasible and will be implemented if necessary to realize the deferred tax asset. Changing economic conditions and market volatility can adversely impact The Hartford’s tax planning strategies and in particular The Hartford’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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INVESTMENT RESULTS
Composition of Invested Assets
                                 
    December 31, 2010     December 31, 2009  
    Amount     Percent     Amount     Percent  
Fixed maturities, AFS, at fair value
  $ 44,834       78.7 %   $ 40,403       75.6 %
Fixed maturities, at fair value using the fair value option
    639       1.1 %            
Equity securities, AFS, at fair value
    340       0.6 %     419       0.8 %
Mortgage loans
    3,244       5.7 %     4,304       8.0 %
Policy loans, at outstanding balance
    2,128       3.7 %     2,120       4.0 %
Limited partnerships and other alternative investments
    838       1.5 %     759       1.4 %
Other investments [1]
    1,461       2.6 %     338       0.6 %
Short-term investments
    3,489       6.1 %     5,128       9.6 %
 
                       
Total investments excluding equity securities, trading
    56,973       100.0 %     53,471       100.0 %
Equity securities, trading, at fair value [2]
    2,279               2,443          
 
                           
Total investments
  $ 59,252             $ 55,914          
 
                           
     
[1]  
Primarily relates to derivative instruments.
 
[2]  
These assets primarily support the European variable annuity business. Changes in these balances are also reflected in the respective liabilities.
Total investments increased 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  
    Amount     Yield [1]     Amount     Yield [1]  
Fixed maturities [2]
  $ 1,977       4.4 %   $ 2,094       4.5 %
Equity securities, AFS
    14       3.7 %     43       8.3 %
Mortgage loans
    199       5.5 %     232       4.9 %
Policy loans
    129       6.1 %     136       6.3 %
Limited partnerships and other alternative investments
    121       16.7 %     (171 )     (18.1 %)
Other [3]
    253               242          
Investment expense
    (72 )             (71 )        
 
                       
Total securities AFS and other
  $ 2,621       4.6 %   $ 2,505       4.2 %
Equity securities, trading
    238               343          
 
                       
Total net investment income (loss), before-tax
  $ 2,859             $ 2,848          
 
                       
     
[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 increased slightly largely due to limited partnerships and other alternative investments, partially offset by lower income on fixed maturity and equity securities, trading. The improved performance of limited partnerships and other alternative investments was primarily within real estate and private equity funds. This was partially offset by lower income on fixed maturities resulting from a decline in average short-term interest rates and lower reinvestment rates. Also included was lower income on equity securities, trading due to a decrease in market performance in the underlying investment funds supporting the European variable annuity product. 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.

 

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Net Realized Capital Gains (Losses)
                 
    For the years ended December 31,  
    2010     2009  
Gross gains on sales
  $ 486     $ 364  
Gross losses on sales
    (336 )     (828 )
Net OTTI losses recognized in earnings
    (336 )     (1,192 )
Valuation allowances on mortgage loans
    (108 )     (292 )
Japanese fixed annuity contract hedges, net [1]
    27       47  
Periodic net coupon settlements on credit derivatives/Japan
    (3 )     (33 )
Fair value measurement transition impact
           
Results of variable annuity hedge program
               
GMWB derivatives, net
    113       1,505  
Macro hedge program
    (584 )     (895 )
 
           
Total results of variable annuity hedge program
    (471 )     610  
GMAB/GMWB/GMIB reinsurance
    (769 )     1,106  
Coinsurance and modified coinsurance reinsurance contracts
    284       (577 )
Other, net [2]
    282       (81 )
 
           
Net realized capital losses, before-tax
  $ (944 )   $ (876 )
 
           
     
[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 structured, government and corporate securities resulting primarily 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.
 
   
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.
 
   
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 3 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.
 
   
Other, net
 
     Other, net gains for the year ended December 31, 2010 was primarily due to gains of $190 on credit derivatives driven by credit spreads tightening and gains of $102 related to Japan variable annuity hedges due to the appreciation of the Japanese yen.
 
   
 
 
     Other, net losses for the year ended December 31, 2009 primarily resulted from net losses of $329 on credit derivatives where the company purchased credit protection due to credit spread tightening. These losses were partially offset by gains of $128 on credit derivatives that assume credit risk due to credit spread tightening, as well as $191 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 accumulated other comprehensive income (“AOCI”).

 

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INVESTMENT CREDIT RISK MANAGEMENT
Investment credit risk is viewed by the Company as the set of credit risks that can impair the value of the investment portfolio. This includes default risk, credit transition risk, systemic credit risk, idiosyncratic risk, and counterparty risk. Default risk is the risk of loss of principal and/or interest income stemming from a debt issuer’s failure to meet their contractual obligations. Credit transition risk is the risk that an investment declines in creditworthiness after purchase. Typically, the decline in creditworthiness is associated with an increase in credit spreads associated with the investment, potentially resulting in increases in other-than —temporary impairments and the increased probability of a realized loss. Counterparty credit risk is the risk that the financial institution, clearing exchange, or other party with whom the Company has entered into a financial contract will default on the obligation and fail to meet their contractual obligations. This is a significant risk in over-the-counter derivatives trading, and futures trading.
The Company has established an enterprise credit policy that views credit risk across the enterprise both at the single obligor level and at the portfolio level across multiple lenses. The portfolio view includes measures of the exposure to loss of statutory surplus, and the exposure to changes in economy. The single obligor measures are also aggregated across the enterprise, and include exposures generated from the investment portfolio, the insurance and reinsurance businesses, and any collateral short-falls. Limits are set prudentially, and size of limit is impacted by an institution’s probability to default.
Counterparty credit risk is mitigated both through the practice of entering into contracts only with highly creditworthy institutions, but also through the practice of holding and posting of collateral, and including collateral short-falls in the exposure calculations. Systemic credit risk is mitigated through the construction of a high-quality, diverse portfolio of investments that are subject to regular underwriting of the risks. Additional limits on investment activity, including setting of policy and defining acceptable risk levels, is subject to regular review and approval by Enterprise Risk Management and senior management.
The Company invests primarily in securities which are rated investment grade and has established exposure limits, diversification standards and review procedures for all credit risks including borrower, issuer and counterparty. Creditworthiness of specific obligors is determined by consideration of external determinants of creditworthiness, typically ratings assigned by nationally recognized ratings agencies and is supplemented by an internal credit evaluation. Obligor, asset sector and industry concentrations are subject to established Company limits and are monitored on a regular basis.
The Company is not exposed to any credit concentration risk of a single issuer greater than 10% of the Company’s stockholders’ equity other than U.S. government and government agencies backed by the full faith and credit of the U.S. government. For further discussion of concentration of credit risk, see the Concentration of Credit Risk Section in Note 4 of the Notes to Consolidated Financial Statements.
Derivative Instruments
In the normal course of business, the Company uses various derivative counterparties in executing its derivative transactions. The use of counterparties creates credit risk that the counterparty may not perform in accordance with the terms of the derivative transaction. The Company has developed a derivative counterparty exposure policy which limits the Company’s exposure to credit risk.
The derivative counterparty exposure policy establishes market-based credit limits, favors long-term financial stability and creditworthiness of the counterparty and typically requires credit enhancement/credit risk reducing agreements. The Company minimizes the credit risk of derivative instruments by entering into transactions with high quality counterparties rated A2/A or better, which are monitored and evaluated by the Company’s risk management team and reviewed by senior management. In addition, the Company monitors counterparty credit exposure on a monthly basis to ensure compliance with Company policies and statutory limitations. The Company also generally requires that derivative contracts, other than exchange traded contracts, certain forward contracts, and certain embedded and reinsurance derivatives, be governed by an International Swaps and Derivatives Association Master Agreement, which is structured by legal entity and by counterparty and permits right of offset.
The Company has developed credit exposure thresholds which are based upon counterparty ratings. Credit exposures are measured using the market value of the derivatives, resulting in amounts owed to the Company by its counterparties or potential payment obligations from the Company to its counterparties. Credit exposures are generally quantified daily based on the prior business day’s market value and collateral is pledged to and held by, or on behalf of, the Company to the extent the current value of derivatives exceeds the contractual thresholds. In accordance with industry standards and the contractual agreements, collateral is typically settled on the next business day. The Company has exposure to credit risk for amounts below the exposure thresholds which are uncollateralized, as well as for market fluctuations that may occur between contractual settlement periods of collateral movements.
The maximum uncollateralized threshold for a derivative counterparty for a single legal entity is $10. The Company currently transacts over-the-counter derivatives in two legal entities and therefore the maximum combined threshold for a single counterparty across all legal entities that use derivatives is $20. In addition, the Company may have exposure to multiple counterparties in a single corporate family due to a common credit support provider. As of December 31, 2010, the maximum combined threshold for all counterparties under a single credit support provider across all legal entities that use derivatives is $40. Based on the contractual terms of the collateral agreements, these thresholds may be immediately reduced due to a downgrade in either party’s credit rating. For further discussion, see the Derivative Commitments Section of Note 9 of the Notes to Consolidated Financial Statements.
For the year ended December 31, 2010, the Company has incurred no losses on derivative instruments due to counterparty default.

 

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In addition to counterparty credit risk, the Company enters into credit default swaps to manage credit exposure. Credit default swaps involve a transfer of credit risk of one or many referenced entities from one party to another in exchange for periodic payments. The party that purchases credit protection will make periodic payments based on an agreed upon rate and notional amount, and for certain transactions there will also be an upfront premium payment. The second party, who assumes credit risk, will typically only make a payment if there is a credit event as defined in the contract and such payment will be typically equal to the notional value of the swap contract less the value of the referenced security issuer’s debt obligation. A credit event is generally defined as default on contractually obligated interest or principal payments or bankruptcy of the referenced entity.
The Company uses credit derivatives to purchase credit protection and assume credit risk with respect to a single entity, referenced index, or asset pool. The Company purchases credit protection through credit default swaps to economically hedge and manage credit risk of certain fixed maturity investments across multiple sectors of the investment portfolio. The Company also enters into credit default swaps that assume credit risk as part of replication transactions. Replication transactions are used as an economical means to synthetically replicate the characteristics and performance of assets that would otherwise be permissible investments under the Company’s investment policies. These swaps reference investment grade single corporate issuers and baskets, which include trades customized diversified portfolios of corporate issuers, which are established within sector concentration limits and may be divided into tranches which possess different credit ratings.
The Company is also exposed to credit spread risk related to security market price and cash flows associated with changes in credit spreads. Credit spread tightening will reduce net investment income associated with new purchases of fixed maturities and increase the fair value of the investment portfolio. Credit spread widening will reduce the fair value of the investment portfolio and will increase net investment income on new purchases. If issuer credit spreads increase significantly or for an extended period of time, it may result in higher impairment losses. For further discussion of sectors most significantly impacted, see the Investment Credit Risk Section of the MD&A. Also, for a discussion of the movement of credit spread impacts on the Company’s statutory financial results as it relates to the accounting and reporting for market value fixed annuities, see the Capital Resources & Liquidity Section of the MD&A.
As of December 31, 2010 and 2009, the notional amount related to credit derivatives that purchase credit protection was $1.7 billion and $1.9 billion, respectively, while the fair value was $(5) and $(34), respectively. As of December 31, 2010 and 2009, the notional amount related to credit derivatives that assume credit risk was $2.0 billion and $902, respectively, while the fair value was $(376) and $(176), respectively. For further information on credit derivatives, see the Capital Markets Risk Management Section of the MD&A and Note 4 of the Notes to Consolidated Financial Statements.
Investments
The following table presents the Company’s fixed maturities, AFS, by credit quality. The ratings referenced below are based on the ratings of a nationally recognized rating organization or, if not rated, assigned based on the Company’s internal analysis of such securities.
Fixed Maturities by Credit Quality
                                                 
   
    December 31, 2010     December 31, 2009  
                    Percent of                     Percent of  
    Amortized             Total Fair     Amortized             Total Fair  
    Cost     Fair Value     Value     Cost     Fair Value     Value  
United States Government/Government agencies
  $ 6,074     $ 6,040       13.5 %   $ 4,707     $ 4,552       11.3 %
AAA
    5,175       5,216       11.6 %     6,564       5,966       14.8 %
AA
    6,560       6,347       14.2 %     6,701       5,867       14.5 %
A
    12,396       12,552       28.1 %     11,957       11,093       27.4 %
BBB
    11,878       12,059       26.8 %     11,269       10,704       26.5 %
BB & below
    3,240       2,620       5.8 %     3,086       2,221       5.5 %
 
                                   
Total fixed maturities
  $ 45,323     $ 44,834       100.0 %   $ 44,284     $ 40,403       100.0 %
 
                                   
The movement in the overall credit quality of the Company’s portfolio was primarily attributable to purchases of U.S. Treasuries and investment grade corporate securities. This was partially offset by rating agency downgrades primarily associated with commercial real estate (“CRE”) collateralized debt obligations (“CDOs”), commercial mortgage-backed securities (“CMBS”) and securities in the financial services sector. Fixed maturities, FVO, are not included in the above table as of December 31, 2010. For further discussion on the election of fair value option, see Note 3 of the Notes to Consolidated Financial Statements.

 

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The following table presents the Company’s AFS securities by type, as well as fixed maturities, FVO.
Securities by Type
                                                                                 
    December 31, 2010     December 31, 2009  
                                    Percent                                     Percent  
    Cost or     Gross     Gross             of Total     Cost or     Gross     Gross             of Total  
    Amortized     Unrealized     Unrealized     Fair     Fair     Amortized     Unrealized     Unrealized     Fair     Fair  
    Cost     Gains     Losses     Value     Value     Cost     Gains     Losses     Value     Value  
Asset-backed securities (“ABS”)
                                                                               
Consumer loans
  $ 1,761     $ 14     $ (199 )   $ 1,576       3.5 %   $ 1,596     $ 13     $ (248 )   $ 1,361       3.4 %
Small business
    369             (125 )     244       0.5 %     418             (185 )     233       0.6 %
Other
    265       15       (32 )     248       0.6 %     330       18       (39 )     309       0.8 %
CDOs
                                                                               
Collateralized loan obligations (“CLOs”)
    1,713             (151 )     1,562       3.5 %     1,997             (208 )     1,789       4.4 %
CREs
    562             (228 )     334       0.7 %     1,157       14       (804 )     367       0.9 %
Other
    3                   3             4       5             9        
CMBS
                                                                               
Agency backed [1]
    295       5       (2 )     298       0.7 %     62       3             65       0.2 %
Bonds
    4,519       91       (383 )     4,227       9.4 %     6,138       33       (1,519 )     4,652       11.5 %
Interest only (“IOs”)
    469       50       (16 )     503       1.1 %     644       40       (36 )     648       1.6 %
Corporate
                                                                               
Basic industry
    2,006       127       (20 )     2,113       4.7 %     1,794       78       (45 )     1,827       4.5 %
Capital goods
    2,095       154       (15 )     2,234       5.0 %     2,078       100       (33 )     2,145       5.3 %
Consumer cyclical
    1,259       79       (8 )     1,330       3.0 %     1,324       53       (33 )     1,344       3.3 %
Consumer non-cyclical
    4,262       316       (25 )     4,553       10.2 %     3,260       205       (15 )     3,450       8.6 %
Energy
    2,421       167       (14 )     2,574       5.7 %     2,239       130       (13 )     2,356       5.8 %
Financial services
    4,999       189       (345 )     4,843       10.8 %     5,054       84       (590 )     4,548       11.3 %
Tech./comm.
    2,844       188       (45 )     2,987       6.7 %     2,671       145       (40 )     2,776       6.9 %
Transportation
    845       56       (9 )     892       2.0 %     544       16       (19 )     541       1.3 %
Utilities
    4,661       259       (40 )     4,880       10.9 %     3,790       161       (52 )     3,899       9.7 %
Other [2]
    542       10       (17 )     509       1.1 %     867       13       (99 )     781       1.9 %
Foreign govt./govt. agencies
    963       48       (9 )     1,002       2.2 %     824       35       (13 )     846       2.1 %
Municipal
    1,149       7       (124 )     1,032       2.3 %     971       3       (194 )     780       1.9 %
Residential mortgage-backed securities (“RMBS”)
                                                                               
Agency
    2,908       78       (16 )     2,970       6.6 %     2,088       63       (5 )     2,146       5.3 %
Non-agency
    64             (2 )     62       0.1 %     125             (14 )     111       0.3 %
Alt-A
    144             (18 )     126       0.3 %     187             (52 )     135       0.3 %
Sub-prime
    1,334       1       (375 )     960       2.1 %     1,565       5       (626 )     944       2.3 %
U.S. Treasuries
    2,871       11       (110 )     2,772       6.3 %     2,557       5       (221 )     2,341       5.8 %
 
                                                           
Fixed maturities, AFS
    45,323       1,865       (2,328 )     44,834       100.0 %     44,284       1,222       (5,103 )     40,403       100.0 %
Equity securities
                                                                               
Financial services
    151             (40 )     111               273       4       (51 )     226          
Other
    169       61       (1 )     229               174       34       (15 )     193          
 
                                                           
Equity securities, AFS
    320       61       (41 )     340               447       38       (66 )     419          
 
                                                           
Total AFS securities
  $ 45,643     $ 1,926     $ (2,369 )   $ 45,174             $ 44,731     $ 1,260     $ (5,169 )   $ 40,822          
 
                                                           
Fixed maturities, FVO
                          $ 639                                     $          
 
                                                           
     
[1]  
Represents securities with pools of loans issued by the Small Business Administration which are backed by the full faith and credit of the U.S. government.
 
[2]  
Gross unrealized gains (losses) exclude the fair value of bifurcated embedded derivative features of certain securities. Subsequent changes in value will be recorded in net realized capital gains (losses).
The Company continues to rebalance its AFS investment portfolio to securities with more favorable risk/return profiles, in particular investment grade corporate securities, while reducing its exposure to real estate related securities. The Company’s AFS net unrealized position improved primarily as a result of improved security valuations largely due to a decline in interest rates and, to a lesser extent, credit spread tightening. Fixed maturities, FVO, represents securities containing an embedded credit derivative for which the Company elected the fair value option. The underlying credit risk of these securities is primarily high quality corporate bonds and CRE CDOs. For further discussion on the election of fair value option, see Note 3 of the Notes to Consolidated Financial Statements. The following sections highlight the Company’s significant investment sectors.

 

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Financial Services
The Company’s exposure to the financial services sector is predominantly through banking institutions. The following table presents the Company’s exposure to the financial services sector included in the Securities by Type table above.
                                                 
    December 31, 2010     December 31, 2009  
    Amortized             Net     Amortized             Net  
    Cost     Fair Value     Unrealized     Cost     Fair Value     Unrealized  
AAA
  $ 157     $ 162     $ 5     $ 151     $ 152     $ 1  
AA
    1,472       1,480       8       1,311       1,273       (38 )
A
    2,496       2,381       (115 )     2,702       2,373       (329 )
BBB
    885       809       (76 )     805       681       (124 )
BB & below
    140       122       (18 )     358       295       (63 )
 
                                   
Total
  $ 5,150     $ 4,954     $ (196 )   $ 5,327     $ 4,774     $ (553 )
 
                                   
The improvement in the net unrealized loss position was attributed to improved security valuations resulting from increasing confidence in this sector. During the second half of 2010, companies within the financial sectors generally continued to stabilize with improved earnings performance, positive credit trends and strengthened capital and liquidity positions. Both the Dodd-Frank Act and clarification around Basel III capital requirements will strengthen capital standards prospectively. Despite these positive impacts, the financial sector remains vulnerable to ongoing stress in the real estate markets including mortgage put-back and foreclosure risks, high unemployment and global economic uncertainty, which could potentially result in declines in the Company’s net unrealized position. In 2011, the Company expects a continuation of stabilizing trends seen in 2010 as the regulatory landscape becomes more visible, credit quality continues on an improving path, although likely at a slower rate, and capital and liquidity management remains conservative.
Commercial Real Estate
During the fourth quarter, the commercial real estate market continued to show signs of improving fundamentals, such as increases in market pricing, tightening credit spreads and more readily available financing. Although delinquencies remain high, they are expected to increase at a slower pace before moving lower in late 2011. The Company continues to reduce its exposure to real estate related securities through sales and maturities.
The following table presents the Company’s exposure to CMBS bonds by current credit quality and vintage year, included in the Securities by Type table above. Credit protection represents the current weighted average percentage of the outstanding capital structure subordinated to the Company’s investment holding that is available to absorb losses before the security incurs the first dollar loss of principal and excludes any equity interest or property value in excess of outstanding debt.
CMBS — Bonds [1]
                                                                                                 
December 31, 2010  
 
    AAA     AA     A     BBB     BB and Below     Total  
    Amortized     Fair     Amortized     Fair     Amortized     Fair     Amortized     Fair     Amortized     Fair     Amortized     Fair  
    Cost     Value     Cost     Value     Cost     Value     Cost     Value     Cost     Value     Cost     Value  
2003 & Prior
  $ 545     $ 558     $ 65     $ 64     $ 33     $ 32     $ 14     $ 13     $ 18     $ 16     $ 675     $ 683  
2004
    287       302       25       24       39       35       27       22       6       5       384       388  
2005
    335       347       48       43       138       115       112       94       74       59       707       658  
2006
    703       728       509       481       183       159       322       266       335       262       2,052       1,896  
2007
    187       196       116       93       45       35       137       104       186       143       671       571  
2008
    30       31                                                       30       31  
 
                                                                       
Total
  $ 2,087     $ 2,162     $ 763     $ 705     $ 438     $ 376     $ 612     $ 499     $ 619     $ 485     $ 4,519     $ 4,227  
 
                                                                       
Credit protection
  29.7%     22.9%     12.3%     14.1%     7.6%     21.8%
                                                                                                 
December 31, 2009  
 
    AAA     AA     A     BBB     BB and Below     Total  
    Amortized     Fair     Amortized     Fair     Amortized     Fair     Amortized     Fair     Amortized     Fair     Amortized     Fair  
    Cost     Value     Cost     Value     Cost     Value     Cost     Value     Cost     Value     Cost     Value  
2003 & Prior
  $ 1,198     $ 1,192     $ 159     $ 120     $ 50     $ 34     $ 14     $ 13     $ 6     $ 4     $ 1,427     $ 1,363  
2004
    342       338       61       39       27       17       15       7                   445       401  
2005
    490       449       199       133       126       72       87       54       61       45       963       753  
2006
    1,293       1,091       374       238       377       167       244       95       199       71       2,487       1,662  
2007
    283       223       36       24       116       42       180       88       201       96       816       473  
 
                                                                       
Total
  $ 3,606     $ 3,293     $ 829     $ 554     $ 696     $ 332     $ 540     $ 257     $ 467     $ 216     $ 6,138     $ 4,652  
 
                                                                       
Credit protection
  27.4%     21.5%     13.3%     11.7%     9.1%     22.2%  
     
[1]  
The vintage year represents the year the pool of loans was originated.

 

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In addition to CMBS bonds, the Company has exposure to commercial mortgage loans as presented in the following table. These loans are collateralized by a variety of commercial properties and are diversified both geographically throughout the United States and by property type. These loans may be either in the form of a whole loan, where the Company is the sole lender, or a loan participation. Loan participations are loans where the Company has purchased or retained a portion of an outstanding loan or package of loans and participates on a pro-rata basis in collecting interest and principal pursuant to the terms of the participation agreement. In general, A-Note participations have senior payment priority, followed by B-Note participations and then mezzanine loan participations. As of December 31, 2010, loans within the Company’s mortgage loan portfolio have had minimal extension or restructurings.
Commercial Mortgage Loans
                                                 
    December 31, 2010     December 31, 2009  
    Amortized     Valuation     Carrying     Amortized     Valuation     Carrying  
    Cost [1]     Allowance     Value     Cost [1]     Allowance     Value  
Agricultural
  $ 182     $ (5 )   $ 177     $ 369     $ (3 )   $ 366  
Whole loans
    2,479       (16 )     2,463       2,505       (26 )     2,479  
A-Note participations
    288             288       326             326  
B-Note participations
    195       (5 )     190       508       (131 )     377  
Mezzanine loans
    162       (36 )     126       856       (100 )     756  
 
                                   
Total
  $ 3,306     $ (62 )   $ 3,244     $ 4,564     $ (260 )   $ 4,304  
 
                                   
     
[1]  
Amortized cost represents carrying value prior to valuation allowances, if any.
Since December 31, 2009, the Company significantly reduced its exposure to B-Note participations and mezzanine loans by $817 primarily through sales. As of December 31, 2010, the Company had mortgage loans held-for-sale with a carrying value and valuation allowance of $64 and $4, respectively.
During 2010, the Company funded $183 of commercial whole loans focusing on loans with strong loan-to-value (“LTV”) ratios and high quality property collateral. At origination, these loans had a weighted average LTV of 60% and a weighted average yield of 4.8%. For a discussion of outstanding mortgage loan commitments, see Off-Balance Sheet Arrangements and Aggregate Contractual Obligations within the Capital Resources and Liquidity section of the MD&A and Note 10 of the Notes to Consolidated Financial Statements.
Limited Partnerships and Other Alternative Investments
The following table presents the Company’s investments in limited partnerships and other alternative investments which include hedge funds, mortgage and real estate funds, mezzanine debt funds, and private equity and other funds. Hedge funds include investments in funds of funds and direct funds. Mortgage and real estate funds consist of investments in funds whose assets consist of mortgage loans, mortgage loan participations, mezzanine loans or other notes which may be below investment grade, as well as equity real estate and real estate joint ventures. Mezzanine debt funds include investments in funds whose assets consist of subordinated debt that often incorporates equity-based options such as warrants and a limited amount of direct equity investments. Private equity and other funds primarily consist of investments in funds whose assets typically consist of a diversified pool of investments in small non-public businesses with high growth potential.
                                 
    December 31, 2010     December 31, 2009  
    Amount     Percent     Amount     Percent  
Hedge funds
  $ 33       4.0 %   $ 105       13.8 %
Mortgage and real estate funds
    161       19.2 %     124       16.4 %
Mezzanine debt funds
    68       8.1 %     66       8.7 %
Private equity and other funds
    576       68.7 %     464       61.1 %
 
                       
Total
  $ 838       100.0 %   $ 759       100.0 %
 
                       
The decline in hedge funds since December 31, 2009 was primarily attributable to redemptions, while private equity and other funds increased primarily due to market value appreciation. The increase in mortgage and real estate funds was mainly attributed to additional funding of existing partnerships.

 

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Available-for-Sale Securities — Unrealized Loss Aging
As part of the Company’s ongoing security monitoring process, the Company has reviewed its AFS securities in an unrealized loss position and concluded that there were no additional impairments as of December 31, 2010 and that these securities are temporarily depressed and are expected to recover in value as the securities approach maturity or as real estate related market spreads return to more normalized levels.
Most of the securities depressed over 20% for greater than nine months are structured securities with exposure to commercial and residential real estate, as well as certain floating rate corporate securities or those securities with greater than 10 years to maturity, concentrated in the financial services sector. Both financial and structured securities have a weighted average current rating of BBB. Current market spreads continue to be significantly wider for structured securities with exposure to commercial and residential real estate, as compared to spreads at the security’s respective purchase date, largely due to the economic and market uncertainties regarding future performance of commercial and residential real estate. The Company reviewed these securities as part of its impairment analysis. The Company’s best estimate of future cash flows utilized in its impairment analysis involves both macroeconomic and security specific assumptions that may differ based on security type, vintage year and property location including, but not limited to, historical and projected default and recovery rates, current and expected future delinquency rates and property value declines. For these securities in an unrealized loss position where a credit impairment has not been recorded, the Company’s best estimate of expected future cash flows are sufficient to recover the amortized cost basis of the security. Furthermore, the Company neither has an intention to sell nor does it expect to be required to sell these securities.
The same market conditions noted above also apply to AFS securities depressed over 50% for greater than twelve months, which consist primarily of structured securities with exposure to commercial and residential real estate. Based upon the Company’s cash flow modeling and current market and collateral performance assumptions, these securities have sufficient credit protection levels to receive contractually obligated principal and interest payments, and accordingly the Company has concluded that no credit impairment exists on these securities. Furthermore, the Company neither has an intention to sell nor does it expect to be required to sell these securities.
For the CRE CDOs and CMBS which are included in the AFS securities depressed over 50% for greater than twelve months, current market pricing reflects market illiquidity and higher risk premiums. The illiquidity and risk premiums are the result of the underlying collateral performance to date and the potential uncertainty in the securities’ future cash flows. Because of the uncertainty surrounding the future performance of commercial real estate, market participants in many cases are requiring substantially greater returns, in comparison to the securities’ stated coupon rate, to assume the associated securities’ credit risk. If the securities’ collateral underperforms macroeconomic and collateral assumptions in the future, loss severities may be significant as a result of the security’s contractual terms. In addition, the majority of these securities have a floating-rate coupon referenced to a market index such as LIBOR. When the reference rate declines, the valuation of the respective security may also decline. LIBOR rates have declined substantially after these CRE CDOs and CMBS were purchased. For further information regarding the Company’s security valuation process, see Note 3 of the Notes to Consolidated Financial Statements. For further information regarding the future collateral cash flows assumptions included in the Company’s impairment analysis, see Other-Than-Temporary Impairments in the Investment Credit Risk section of this MD&A. For further discussion on the Company’s ongoing security monitoring process and the factors considered in determining whether a credit impairment exists, see the Recognition and Presentation of Other-Than-Temporary Impairments section in Note 4 of the Notes to Consolidated Financial Statements.
The following table presents the Company’s unrealized loss aging for AFS securities by length of time the security was in a continuous unrealized loss position.
                                                                 
    December 31, 2010     December 31, 2009  
            Cost or                             Cost or              
            Amortized     Fair     Unrealized             Amortized     Fair     Unrealized  
    Items     Cost     Value     Loss [1]     Items     Cost     Value     Loss  
Three months or less
    200     $ 6,892     $ 6,631     $ (257 )     766     $ 5,878     $ 5,622     $ (256 )
Greater than three to six months
    219       353       335       (17 )     39       161       143       (18 )
Greater than six to nine months
    60       293       269       (24 )     172       1,106       931       (175 )
Greater than nine to twelve months
    82       127       115       (12 )     62       1,501       1,205       (296 )
Greater than twelve months
    1,024       10,769       8,689       (2,059 )     1,434       15,309       10,885       (4,424 )
 
                                               
Total
    1,585     $ 18,434     $ 16,039     $ (2,369 )     2,473     $ 23,955     $ 18,786     $ (5,169 )
 
                                               
     
[1]  
Unrealized losses exclude the fair value of bifurcated embedded derivative features of certain securities. Subsequent changes in value will be recorded in net realized capital gains (losses).

 

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The following tables present the Company’s unrealized loss aging for AFS securities continuously depressed over 20% by length of time (included in the table above).
                                                                 
    December 31, 2010     December 31, 2009  
            Cost or                             Cost or              
            Amortized     Fair     Unrealized             Amortized     Fair     Unrealized  
Consecutive Months   Items     Cost     Value     Loss     Items     Cost     Value     Loss  
Three months or less
    47     $ 433     $ 322     $ (111 )     79     $ 591     $ 395     $ (196 )
Greater than three to six months
    15       126       97       (29 )     16       52       36       (16 )
Greater than six to nine months
    24       155       107       (48 )     99       1,237       844       (393 )
Greater than nine to twelve months
    9       20       16       (4 )     67       1,201       801       (400 )
Greater than twelve months
    342       3,547       2,244       (1,303 )     585       6,235       3,115       (3,120 )
 
                                               
Total
    437     $ 4,281     $ 2,786     $ (1,495 )     846     $ 9,316     $ 5,191     $ (4,125 )
 
                                               
The following tables present the Company’s unrealized loss aging for AFS securities continuously depressed over 50% by length of time (included in the tables above).
                                                                 
    December 31, 2010     December 31, 2009  
            Cost or                             Cost or              
            Amortized     Fair     Unrealized             Amortized     Fair     Unrealized  
Consecutive Months   Items     Cost     Value     Loss     Items     Cost     Value     Loss  
Three months or less
    15     $ 25     $ 11     $ (14 )     42     $ 132     $ 46     $ (86 )
Greater than three to six months
    4       2       1       (1 )     11       5       2       (3 )
Greater than six to nine months
    11       64       28       (36 )     51       175       69       (106 )
Greater than nine to twelve months
                            52       499       173       (326 )
Greater than twelve months
    88       635       233       (402 )     205       2,105       601       (1,504 )
 
                                               
Total
    118     $ 726     $ 273     $ (453 )     361     $ 2,916     $ 891     $ (2,025 )
 
                                               
Other-Than-Temporary Impairments
The following table presents the Company’s impairments recognized in earnings by security type.
                 
    For the years ended December 31,  
    2010     2009  
ABS
  $ 11     $ 50  
CDOs
               
CREs
    135       421  
Other
          23  
CMBS
               
Bonds
    112       140  
IOs
    1       17  
Corporate
    23       176  
Equity
    9       109  
Foreign govt./govt. agencies
           
Municipal
           
RMBS
               
Non-agency
    2       4  
Alt-A
    8       46  
Sub-prime
    35       204  
U.S. Treasuries
          2  
 
           
Total
  $ 336     $ 1,192  
 
           

 

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Year ended December 31, 2010
For the year ended December 31, 2010, impairments recognized in earnings were comprised of credit impairments of $303, impairments on debt securities for which the Company intends to sel1 of $27 and impairments on equity securities of $6.
Credit impairments were primarily concentrated in structured securities associated with commercial and residential real estate which were impaired primarily due to continued property-specific deterioration of the underlying collateral and increased delinquencies. The Company calculated these impairments utilizing both a top down modeling approach and, for certain commercial real estate backed securities, a loan by loan collateral review. The top down modeling approach used discounted cash flow models that considered losses under current and expected future economic conditions. Assumptions used over the current period included macroeconomic factors, such as a high unemployment rate, as well as sector specific factors such as property value declines, commercial real estate delinquency levels and changes in net operating income. Those assumptions included CMBS peak-to-trough property value declines, on average, of 36% and RMBS peak-to-trough property value declines, on average, of 35%. The macroeconomic assumptions considered by the Company did not materially change from the previous several quarters and, as such, the credit impairments recognized for the year ended December 31, 2010 were largely driven by actual or expected collateral deterioration, largely as a result of the Company’s loan-by-loan collateral review.
The loan-by-loan collateral review is performed to estimate potential future losses. This review incorporates assumptions about expected future collateral cash flows, including projected rental rates and occupancy levels that varied based on property type and sub-market. The results of the loan by loan collateral review allowed the Company to estimate the expected timing of a security’s first loss, if any, and the probability and severity of potential ultimate losses. The Company then discounted these anticipated future cash flows at the security’s book yield prior to impairment. The results of cash flow modeling utilized by the Company result in cumulative collateral loss rates that vary by vintage year. For the 2007 vintage year, the Company’s cash flow modeling resulted in cumulative collateral loss rates for CMBS and sub-prime RMBS of approximately 12% and 44%, respectively.
Impairments on securities for which the Company had the intent to sell were primarily on CMBS bonds in order to take advantage of price appreciation. Impairments on equity securities were primarily on below investment grade securities that have been depressed 20% for more than six months.
In addition to the credit impairments recognized in earnings, the Company recognized non-credit impairments in other comprehensive income of $376 for the year ended December 31, 2010, predominantly concentrated in CRE CDOs and RMBS. These non-credit impairments represent the difference between fair value and the Company’s best estimate of expected future cash flows discounted at the security’s effective yield prior to impairment, rather than at current market implied credit spreads. These non-credit impairments primarily represent increases in market liquidity premiums and credit spread widening that occurred after the securities were purchased, as well as a discount for variable-rate coupons which are paying less than at purchase date. In general, larger liquidity premiums and wider credit spreads are the result of deterioration of the underlying collateral performance of the securities, as well as the risk premium required to reflect future uncertainty in the real estate market.
Future impairments may develop as the result of changes in intent to sell of specific securities or if actual results underperform current modeling assumptions, which may be the result of, but are not limited to, macroeconomic factors, and property performance below current expectations. Recent improvements in commercial real estate property valuations will positively impact future loss development, with future impairments driven by idiosyncratic security specific risk.
Year ended December 31, 2009
Impairments recognized in earnings were comprised of credit impairments of $965 primarily concentrated on CRE CDOs, below-prime RMBS and CMBS bonds. Also included were impairments on debt securities for which the Company intended to sell of $127, mainly comprised of corporate financial services securities, as well as impairments on equity securities of $100 related to below investment grade hybrid securities.
Valuation Allowances on Mortgage Loans
The following table presents additions to valuation allowances on mortgage loans.
                 
    For the years ended December 31,  
    2010     2009  
Credit-related concerns
  $ 40     $ 216  
Held for sale
               
Agricultural loans
    7        
B-note participations
    10       36  
Mezzanine loans
    51       40  
 
           
Total
  $ 108     $ 292  
 
           
For the year ended December 31, 2010, additions of $108 primarily related to anticipated, and since executed, B-Note participant and mezzanine loan sales. Also included were additions for expected credit losses due to borrower financial difficulty and/or collateral deterioration. Recent improvements in commercial real estate property valuations will positively impact future loss development, with future impairments driven by idiosyncratic security specific risk.

 

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CAPITAL MARKETS RISK MANAGEMENT
The Company has a disciplined approach to managing risks associated with its capital markets and asset/liability management activities. Investment portfolio management is organized to focus investment management expertise on specific classes of investments. The Company invests in various types of investments, including derivative instruments, in order to meet portfolio objectives. Derivative instruments are utilized in compliance with established Company policy and regulatory requirements and are monitored internally and reviewed by senior management.
The Company utilizes a variety of over-the-counter and exchange traded derivative instruments as a part of its overall risk management strategy, as well as to enter into replication transactions. Derivative instruments are used to manage risk associated with interest rate, equity market, credit spread, issuer default, price, and currency exchange rate risk or volatility. Replication transactions are used as an economical means to synthetically replicate the characteristics and performance of assets that would otherwise be permissible investments under the Company’s investment policies. For further information, see Note 4 of the Notes to Consolidated Financial Statements.
Derivative activities are monitored and evaluated by the Company’s compliance and risk management teams and reviewed by senior management. In addition, the Company monitors counterparty credit exposure on a monthly basis to ensure compliance with Company policies and statutory limitations. The notional amounts of derivative contracts represent the basis upon which pay or receive amounts are calculated and are not reflective of credit risk. For further information on the Company’s use of derivatives, see Note 4 of the Notes to Consolidated Financial Statements.
Market Risk
The Company is exposed to market risk associated with changes in interest rates, credit spreads including issuer defaults, equity prices or market indices, and foreign currency exchange rates. The Company is also exposed to credit and counterparty repayment risk. Derivative instruments are utilized in compliance with established Company policy and regulatory requirements and are monitored internally and reviewed by senior management.
Interest Rate Risk
The Company manages its exposure to interest rate risk by constructing investment portfolios that maintain asset allocation limits and asset/liability duration matching targets which may include the use of derivatives. The Company analyzes interest rate risk using various models including parametric models and cash flow simulation under various market scenarios of the liabilities and their supporting investment portfolios, which may include derivative instruments. Measures the Company uses to quantify its exposure to interest rate risk inherent in its invested assets and interest rate sensitive liabilities include duration, convexity and key rate duration. Duration is the price sensitivity of a financial instrument or series of cash flows to a parallel change in the underlying yield curve used to value the financial instrument or series of cash flows. For example, a duration of 5 means the price of the security will change by approximately 5% for a 100 basis point change in interest rates. Convexity is used to approximate how the duration of a security changes as interest rates change in a parallel manner. Key rate duration analysis measures the price sensitivity of a security or series of cash flows to each point along the yield curve and enables the Company to estimate the price change of a security assuming non-parallel interest rate movements.
To calculate duration, convexity, and key rate durations, projections of asset and liability cash flows are discounted to a present value using interest rate assumptions. These cash flows are then revalued at alternative interest rate levels to determine the percentage change in fair value due to an incremental change in the entire yield curve for duration and convexity, or a particular point on the yield curve for key rate duration. Cash flows from corporate obligations are assumed to be consistent with the contractual payment streams on a yield to worst basis. Yield to worst is a basis that represents the lowest potential yield that can be received without the issuer actually defaulting. The primary assumptions used in calculating cash flow projections include expected asset payment streams taking into account prepayment speeds, issuer call options and contract holder behavior. Mortgage-backed and asset-backed securities are modeled based on estimates of the rate of future prepayments of principal over the remaining life of the securities. These estimates are developed by incorporating collateral surveillance and anticipated future market dynamics. Actual prepayment experience may vary from these estimates.
The Company is also exposed to interest rate risk based upon the discount rate assumption associated with the Parent’s pension and other postretirement benefit obligations. The discount rate assumption is based upon an interest rate yield curve comprised of bonds rated Aa with maturities primarily between zero and thirty years. For further discussion of interest rate risk associated with the benefit obligations, see Note 14 of the Notes to Consolidated Financial Statements.

 

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An increase in interest rates from the current levels is generally a favorable development for the Company. Rate increases are expected to provide additional net investment income, increase sales of fixed rate investment products, reduce the cost of the variable annuity hedging program, limit the potential risk of margin erosion due to minimum guaranteed crediting rates in certain products and, if sustained, could reduce the Company’s prospective pension expense. Conversely, a rise in interest rates will reduce the fair value of the investment portfolio, increase interest expense on the Company’s variable rate debt obligations and, if long-term interest rates rise dramatically within a six to twelve month time period, certain businesses may be exposed to disintermediation risk. Disintermediation risk refers to the risk that policyholders will surrender their contracts in a rising interest rate environment requiring the Company to liquidate assets in an unrealized loss position. In conjunction with the interest rate risk measurement and management techniques, certain fixed income product offerings have market value adjustment provisions at contract surrender. An increase in interest rates may also impact the Company’s tax planning strategies and in particular its ability to utilize tax benefits to offset certain previously recognized realized capital losses.
A decline in interest rates results in certain mortgage-backed securities being more susceptible to paydowns and prepayments. During such periods, the Company generally will not be able to reinvest the proceeds at comparable yields. Lower interest rates will also likely result in lower net investment income, increased hedging cost associated with variable annuities and, if declines are sustained for a long period of time, it may subject the Company to reinvestment risks, higher pension costs expense and possibly reduced profit margins associated with guaranteed crediting rates on certain products. Conversely, the fair value of the investment portfolio will increase when interest rates decline and the Company’s interest expense will be lower on its variable rate debt obligations.
The investments and liabilities primarily associated with interest rate risk are included in the following discussion. Certain product liabilities, including those containing GMWB, GMIB, GMAB, or GMDB, expose the Company to interest rate risk but also have significant equity risk. These liabilities are discussed as part of the Equity Risk section below.
Fixed Maturity Investments
The Company’s investment portfolios primarily consist of investment grade fixed maturity securities. The fair value of these investments was $45.5 billion and $40.4 billion at December 31, 2010 and 2009, respectively. The fair value of these and other invested assets fluctuates depending on the interest rate environment and other general economic conditions. The weighted average duration of the fixed maturity portfolio was approximately 5.7 and 5.2 years as of December 31, 2010 and 2009, respectively.
Liabilities
The Company’s investment contracts and certain insurance product liabilities, other than non-guaranteed separate accounts, include asset accumulation vehicles such as fixed annuities, guaranteed investment contracts, other investment and universal life-type contracts and certain insurance products such as long-term disability.
Asset accumulation vehicles primarily require a fixed rate payment, often for a specified period of time. Product examples include fixed rate annuities with a market value adjustment feature and fixed rate guaranteed investment contracts. The term to maturity of these contracts generally range from less than one year to ten years. In addition, certain products such as universal life contracts and the general account portion of the variable annuity products, credit interest to policyholders subject to market conditions and minimum interest rate guarantees. The term to maturity of the asset portfolio supporting these products may range from short to intermediate.
While interest rate risk associated with many of these products has been reduced through the use of market value adjustment features and surrender charges, the primary risk associated with these products is that the spread between investment return and credited rate may not be sufficient to earn targeted returns.
The Company also manages the risk of certain insurance liabilities similarly to investment type products due to the relative predictability of the aggregate cash flow payment streams. Products in this category may contain significant reliance upon actuarial (including mortality and morbidity) pricing assumptions and do have some element of cash flow uncertainty. Product examples include structured settlement contracts, and on-benefit annuities (i.e., the annuitant is currently receiving benefits thereon). The cash outflows associated with these policy liabilities are not interest rate sensitive but do vary based on the timing and amount of benefit payments. The primary risks associated with these products are that the benefits will exceed expected actuarial pricing and/or that the actual timing of the cash flows will differ from those anticipated, or interest rate levels may deviate from those assumed in product pricing, ultimately resulting in an investment return lower than that assumed in pricing. The average duration of the liability cash flow payments can range from less than one year to in excess of fifteen years.
Derivatives
The Company utilizes a variety of derivative instruments to mitigate interest rate risk. Interest rate swaps are primarily used to convert interest receipts or payments to a fixed or variable rate. The use of such swaps enables the Company to customize contract terms and conditions to customer objectives and satisfies its asset/liability duration matching policy. Interest rate swaps are also used to hedge the variability in the cash flow of a forecasted purchase or sale of fixed rate securities due to changes in interest rates. Forward rate agreements are used to convert interest receipts on floating-rate securities to fixed rates. These derivatives are used to lock in the forward interest rate curve and reduce income volatility that results from changes in interest rates. Interest rate caps, floors, swaptions, and futures may be used to manage portfolio duration.
At December 31, 2010 and 2009, notional amounts pertaining to derivatives utilized to manage interest rate risk totaled $14.2 billion and $16.0 billion, respectively ($13.8 billion and $12.6 billion, respectively, related to investments and $0.4 billion and $3.4 billion, respectively, related to liabilities). The fair value of these derivatives was $(158) and ($47) as of December 31, 2010 and 2009, respectively.

 

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Interest Rate Sensitivity
The before-tax change in the net economic value of investment contracts (e.g., fixed annuity contracts) and certain insurance product liabilities, for which the payment rates are fixed at contract issuance and the investment experience is substantially absorbed by the Company’s operations, along with the corresponding invested assets are included in the following table. Also included in this analysis are the interest rate sensitive derivatives used by the Company to hedge its exposure to interest rate risk in the investment portfolios supporting these contracts. This analysis does not include the assets and corresponding liabilities of certain insurance products such as whole and term life insurance, and certain life contingent annuities. Certain financial instruments, such as limited partnerships and other alternative investments, have been omitted from the analysis due to the fact that the investments are accounted for under the equity method and generally lack sensitivity to interest rate changes. Separate account assets and liabilities, equity securities, trading and the corresponding liabilities associated with the variable annuity products sold in Europe are excluded from the analysis because gains and losses in separate accounts accrue to policyholders. The calculation of the estimated hypothetical change in net economic value below assumes a 100 basis point upward and downward parallel shift in the yield curve.
                                 
    Change in Net Economic Value As of December 31,  
    2010     2009  
Basis point shift
    - 100       + 100       - 100       + 100  
Amount
  $ (184 )   $ 99     $ (11 )   $ (7 )
The fixed liabilities included above represented approximately 58% and 61% of the Company’s general account liabilities as of December 31, 2010 and 2009, respectively. The assets supporting the fixed liabilities are monitored and managed within set duration guidelines, and are evaluated on a daily basis, as well as annually using scenario simulation techniques in compliance with regulatory requirements.
The following table provides an analysis showing the estimated before-tax change in the fair value of the Company’s fixed maturity investments and related derivatives, assuming 100 basis point upward and downward parallel shifts in the yield curve as of December 31, 2010 and 2009. Certain financial instruments, such as limited partnerships and other alternative investments, have been omitted from the analysis due to the fact that the investments are accounted for under the equity method and generally lack sensitivity to interest rate changes.
                                 
    Change in Fair Value As of December 31,  
    2010     2009  
Basis point shift
    - 100       + 100       - 100       + 100  
Amount
  $ 1,406     $ (1,275 )   $ 939     $ (864 )
The selection of the 100 basis point parallel shift in the yield curve was made only as an illustration of the potential hypothetical impact of such an event and should not be construed as a prediction of future market events. Actual results could differ materially from those illustrated above due to the nature of the estimates and assumptions used in the above analysis. The Company’s sensitivity analysis calculation assumes that the composition of invested assets and liabilities remain materially consistent throughout the year and that the current relationship between short-term and long-term interest rates will remain constant over time. As a result, these calculations may not fully capture the impact of portfolio re-allocations, significant product sales or non-parallel changes in interest rates.
Credit Risk
The Company is exposed to credit risk within our investment portfolio and through counterparties. Credit risk relates to the uncertainty of an obligor’s continued ability to make timely payments in accordance with the contractual terms of the instrument or contract. The Company manages credit risk through established investment credit policies which address quality of obligors and counterparties, credit concentration limits, diversification requirements and acceptable risk levels under expected and stressed scenarios. These policies are regularly reviewed and approved by senior management and The Hartford’s Enterprise Risk Management group.
The Company is also exposed to credit spread risk related to security market price and cash flows associated with changes in credit spreads. Credit spread tightening will reduce net investment income associated with new purchases of fixed maturities and increase the fair value of the investment portfolio. Credit spread widening will reduce the fair value of the investment portfolio and will increase net investment income on new purchases. If issuer credit spreads increase significantly or for an extended period of time, it may result in higher impairment losses. For further discussion of sectors most significantly impacted, see the Investment Credit Risk Section of the MD&A. Also, for a discussion of the movement of credit spread impacts on the Company’s statutory financial results as it relates to the accounting and reporting for market value fixed annuities, see the Capital Resources & Liquidity Section of the MD&A.
Equity Risk
The Company does not have significant equity risk exposure from invested assets. The Company’s primary exposure to equity risk relates to the potential for lower earnings associated with certain of its businesses such as variable annuities where fee income is earned based upon the fair value of the assets under management. For further discussion of equity risk, see the Variable Product Equity Risk section below. In addition, the Company offers certain guaranteed benefits, primarily associated with variable annuity products, which increases the Company’s potential benefit exposure as the equity markets decline.

 

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Variable Product Equity Risk
The Company’s equity product risk is managed at the Life Operations level of the Hartford Financial Services Group (“HFSG”). The disclosures in the following equity product risk section are reflective of the risk management program, including reinsurance with third parties and the dynamic and macro derivative hedging programs which are structured at a parent company level. The following disclosures are also reflective of the Company’s reinsurance of the majority of variable annuities with living and death benefit riders to an affiliated captive reinsurer, effective October 1, 2009. See Note 16, Transactions with Affiliates for further information on the reinsurance transaction.
The Company’s operations are significantly influenced by the U.S., Japanese and other global equity markets. Increases or decreases in equity markets impact certain assets and liabilities related to the Company’s variable products and the Company’s earnings derived from those products. These variable products include variable annuities, mutual funds, and variable life insurance.
Generally, declines in equity markets will:
 
reduce the value of assets under management and the amount of fee income generated from those assets;
 
increase the liability for direct GMWB benefits, and reinsured GMWB and GMIB benefits, resulting in realized capital losses;
 
increase the value of derivative assets used to dynamically hedge product guarantees resulting in realized capital gains;
 
increase the costs of the hedging instruments we use in our hedging program;
 
increase the Company’s net amount at risk for GMDB benefits;
 
decrease the Company’s actual gross profits, resulting in increased DAC amortization;
 
increase the amount of required assets to be held for backing variable annuity guarantees to maintain required regulatory reserve levels and targeted risk based capital ratios;
 
adversely affect customer sentiment toward equity-linked products negative, causing a decline in sales, and
 
decrease the Company’s estimated future gross profits See Estimated Gross Profits Used in the Valuation and Amortization of Assets and Liabilities Associated with Variable Annuity and Other Universal Life-Type Contracts within Critical Accounting Estimates for further information.
Generally, increases in equity markets will reduce the value of derivative assets used to provide a macro hedge on statutory surplus, resulting in realized capital losses during periods of market appreciation.
GMWB and Intercompany Reinsurance of GMWB, GMAB, and GMIB
The majority of the Company’s U.S. and U.K. variable annuities include a GMWB rider. In the second quarter of 2009, the Company suspended all product sales in the U.K. The Company’s new U.S. variable annuity product, launched in October 2009, does not offer a GMWB. Declines in the equity markets will increase the Company’s liability for these benefits. The Company reinsures a majority of the GMWB benefits with an affiliated captive reinsurer. A GMWB contract is ‘in the money’ if the contract holder’s guaranteed remaining benefit (“GRB”) becomes greater than the account value. As of December 31, 2010 and December 31, 2009, 44% and 59%, respectively, of all unreinsured U.S GMWB ’in-force’ contracts were ‘in the money’. For U.S. and U.K. GMWB contracts that were ‘in the money’ the Company’s exposure to the GRB, after internal and external reinsurance, as of December 31, 2010 and December 31, 2009, was $1.0 and $0.8 billion, respectively. However, the Company expects to incur these payments in the future only if the policyholder has an ’in the money’ GMWB at their death or their account value is reduced to a specified minimum level, through contractually permitted withdrawals and/or market declines. If the account value is reduced to the specified level, the contract holder will receive an annuity equal to the remaining GRB. For the Company’s “life-time” GMWB products, this annuity can continue beyond the GRB. As the account value fluctuates with equity market returns on a daily basis and the “life-time” GMWB payments can exceed the GRB, the ultimate amount to be paid by the Company, if any, is uncertain and could be significantly more or less than $3.2 billion. For additional information on the Company’s GMWB liability, see Note 3 of the Notes to Consolidated Financial Statements.
The Company enters into various reinsurance agreements to reinsure GMWB and GMIB benefits issued by HLIKK, a Japan affiliate of the Company. In the second quarter of 2009, the Company suspended new product sales in the Company’s Japan affiliate and in the fourth quarter of 2009 the Company reinsured 100% of the assumed benefits to an affiliated captive reinsurer. See Note 16, Transactions with Affiliates, of the Notes to Consolidated Financial Statements for further discussion.

 

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GMDB and Intercompany Reinsurance of GMDB
The majority of the Company’s variable annuity contracts include a GMDB rider. A majority of the Company’s GMDB benefits, both direct and assumed, are reinsured with an affiliated captive reinsurer and an external reinsurer. Declines in the equity market will increase the Company’s liability GMDB riders. The Company’s total gross exposure (i.e. before reinsurance) to U.S. GMDBs as of December 31, 2010 and December 31, 2009 is $10.7 billion and $18.4 billion, respectively. The Company will incur these payments in the future only if the policyholder has an ‘in-the-money’ GMDB at their time of death. As of December 31, 2010 and December 31, 2009, 56% and 73%, respectively, of all unreinsured U.S. GMDB in-force contracts were ‘in the money’. As of December 31, 2010, of the remaining net amount at risk for the GMDB benefit after the Company’s 60% of external reinsurance, 69% is internally reinsured with an affiliated captive reinsurer. As of December 31, 2009, of the remaining net amount at risk for GMDB benefit after the Company’s 53% of external reinsurance, 69% is internally reinsured with an affiliated captive reinsurer. Under certain of these reinsurance agreements, the reinsurers’ exposure is subject to an annual cap. The Company’s net exposure (i.e. after reinsurance) referred to as the retained net amount at risk is $ $1.4 billion and $2.6 billion, as of December 31, 2010 and December 31, 2009. For additional information on the Company’s GMDB liability, see Note 8 of the Notes to Condensed Consolidated Financial Statements.
The Company enters into various reinsurance agreements to reinsure GMDB benefits issued by HLIKK, a Japan affiliate of the Company. In the second quarter of 2009, the Company suspended new product sales in the Company’s Japan affiliate and in the fourth quarter the company reinsured 100% of the assumed benefits to an affiliated captive reinsurer. See Note 16, Transactions with Affiliates for further discussion.
Variable Product Equity Risk Management
Market Risk Exposures
The following table summarizes the broad Variable Annuity Guarantees offered by the Company and the market risks to which the guarantee is most exposed from a U.S. GAAP accounting perspective.
         
Variable Annuity Guarantee [1]   U.S. GAAP Treatment [1]   Market Risk Exposures [1]
U.S. GMDB
  Accumulation of the portion of fees required to cover expected claims, less accumulation of actual claims paid   Equity Market Levels
 
       
Japan GMDB (Assumed)
  Accumulation of the portion of fees required to cover expected claims, less accumulation of actual claims paid   Equity Market Levels/Interest Rates / Foreign Currency
 
       
GMWB
  Fair Value   Equity Market Levels/Implied Volatility/Interest Rates
 
       
For Life Component of GMWB
  Accumulation of the portion of fees required to cover expected claims, less accumulation of actual claims paid   Equity Market Levels
 
       
Japan GMIB (Assumed)
  Fair Value   Equity Market Levels/Interest Rate/Foreign Currency
 
       
Japan GMAB (Assumed)
  Fair Value   Equity Market Levels/Implied Volatility/Interest Rates
     
[1]  
Each of these guarantees and the related U.S. GAAP accounting volatility will also be influenced by actual and estimated policyholder behavior.
Risk Management
The Company carefully analyzes market risk exposures arising from: GMDB, GMIB, GMWB, GMAB; equity market, interest rate risks, implied volatility, foreign currency exchange risk and correlation between these market risk exposures. The Company evaluates these risks both individually and, in the aggregate, to determine the financial risk of its products and to judge their potential impacts on U.S. GAAP earnings and statutory surplus. The Company manages the equity market, interest rate, implied volatility and foreign currency exchange risks embedded in its products through reinsurance, customized derivatives, and dynamic hedging and macro hedging programs. The Company recently launched a new variable annuity product with reduced equity risk and has increased GMWB rider fees on new sales of the Company’s legacy variable annuities and the related in-force policies, as contractually permitted. Depending upon competitors’ reactions with respect to products and related rider charges, the Company’s strategy of reducing product risk and increasing fees has and may continue to result in a decline in market share.

 

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The following table depicts the type of risk management strategy being used by the Company to either partially or fully mitigate market risk exposures displayed above by variable annuity guarantees, as of December 31, 2010:
                 
        Customized   Dynamic   Macro
Variable Annuity Guarantee   Reinsurance [1]   Derivative   Hedging [2]   Hedging [3]
GMDB
  ü           ü
GMDB (Assumed)
  ü           ü
GMWB
  ü   ü   ü   ü
For Life Component of GMWB
  ü           ü
GMIB (Assumed)
  ü           ü
GMAB (Assumed)
  ü           ü
     
[1]  
The Company cedes the GMDB and GMWB including “for life component of GMWB”, written by HLAI, and GMDB, GMIB and GMAB assumed by HLAI from HLIKK, to an affiliated captive reinsurer. See Note 16 Transactions with Affiliates for further discussion.
 
[2]  
Through the third quarter of 2010, the Company continued to maintain a reduced level of dynamic hedge protection on GMWB while placing a greater relative emphasis on the protection of statutory surplus through the inclusion of a macro hedging program. This portion of the GMWB hedge strategy may include derivatives with maturities of up to 10 years. U.S. GAAP fair value volatility will be driven by a reduced level of dynamic hedge protection and macro program positions.
 
[3]  
As described below, the Company’s macro hedging program is not designed to provide protection against any one variable annuity guarantee program, but rather is a broad based hedge designed to provide protection against multiple guarantees and market risks, primarily focused on statutory liability and surplus volatility.
Third Party Reinsurance
The Company uses third-party reinsurance for a portion of U.S. contracts issued with GMWB riders prior to the third quarter of 2003 and GMWB risks associated with a block of business sold between the third quarter of 2003 and the second quarter of 2006. The Company also uses third party reinsurance for a majority of the GMDB issued in the U.S.
Derivative Hedging Strategies
The Company maintains derivative hedging strategies for its product guarantee risk to meet multiple, and in some cases, competing risk management objectives, including providing protection against tail scenario equity market events, providing resources to pay product guarantee claims, and minimizing U.S GAAP earnings volatility, statutory surplus volatility and other economic metrics.
Customized Derivatives
The Company holds customized derivative contracts to provide protection from certain capital market risks for the remaining term of specified blocks of non-reinsured GMWB riders. These customized derivative contracts are based on policyholder behavior assumptions specified at the inception of the derivative contracts. The Company retains the risk for differences between assumed and actual policyholder behavior and between the performance of the actively managed funds underlying the separate accounts and their respective indices.
Dynamic Hedging
The Company’s dynamic hedging program uses derivative instruments to provide protection against the risk associated with the GMWB variable annuity product guarantees including equity market declines, equity implied volatility increases, and declines in interest rates. (See Market Risk on Statutory Capital below.) The Company uses hedging instruments including interest rate futures and swaps, variance swaps, S&P 500, NASDAQ and EAFE index put options and futures contracts. During the first quarter and early in the second quarter of 2010, the Company added additional volatility protection. While the Company actively manages this dynamic hedging program, increased U.S. GAAP earnings volatility may result from factors including, but not limited to, policyholder behavior, capital markets, divergence between the performance of the underlying funds and the hedging indices, changes in hedging positions and the relative emphasis placed on various risk management objectives.
Macro Hedging
The Company’s macro hedging program uses derivative instruments such as options, swaps, futures, and forwards on equities, interest rates, and currencies to partially hedge the statutory tail scenario risk, arising from U.S., U.K. and Japan GMWB, GMDB, GMIB, and GMAB statutory liabilities, on the Company’s statutory surplus and the associated target RBC ratios (see Capital Resources and Liquidity). These macro hedges cover some of the residual risks not otherwise covered by specific dynamic hedging programs. Management assesses this residual risk under various scenarios in designing and executing the macro hedge program. During the year, the Company added more equity macro hedge coverage and added additional currency protection. The macro hedge program will result in additional cost and U.S. GAAP earnings volatility in times of market increases as changes in the value of the macro hedge derivatives, which is designed to reduce statutory reserve and capital volatility, may not be closely aligned to changes in U.S. GAAP liabilities.
Hedging Impact
During the year ended December 31, 2010, U.S. GMWB liabilities, net of the dynamic and macro hedging programs, reported a net realized pre-tax loss of $900 primarily driven by the transfer of the increase of $400 in GMWB liabilities to an affiliated reinsurer, increases in U.S. equity markets of approximately 13%, decrease in volatility of approximately 2%, and increases in interest rates of approximately 60 basis points, partially offset by strengthened Yen of approximately 12% against USD and a strengthened Yen of approximately 19% against the Euro. See Note 16 Transactions with Affiliates for further discussion.

 

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Equity Risk Impact on Statutory Capital and Risked Based Capital
See Statutory Capital under Capital Resources and Liquidity for information on the equity risk impact on statutory results.
Derivative Instruments
The Company utilizes a variety of derivative instruments, including swaps, caps, floors, forwards, futures and options through one of four Company-approved objectives: to hedge risk arising from interest rate, equity market, credit spread including issuer default, price or currency exchange rate risk or volatility; to manage liquidity; to control transaction costs; or to enter into replication transactions.
Downgrades to the credit ratings of the Company’s insurance operating companies may have adverse implications for its use of derivatives including those used to hedge benefit guarantees of variable annuities. In some cases, further downgrades may give derivative counterparties the unilateral contractual right to cancel and settle outstanding derivative trades or require additional collateral to be posted. In addition, further downgrades may result in counterparties becoming unwilling to engage in additional over-the-counter (“OTC”) derivatives or may require collateralization before entering into any new trades. This will restrict the supply of derivative instruments commonly used to hedge variable annuity guarantees, particularly long-dated equity derivatives and interest rate swaps. Under these circumstances, the Company’s operating subsidiaries could conduct hedging activity using a combination of cash and exchange-traded instruments, in addition to using the available OTC derivatives.
Foreign Currency Exchange Risk
The Company’s foreign currency exchange risk is related to non—U.S. dollar denominated investments, which primarily consist of fixed maturity investments, the investment in and net income of U.K. Life operations, and non-U.S. dollar denominated liability contracts, including its GMDB, GMAB, GMWB and GMIB benefits associated with its reinsurance of Japanese variable annuities, and a yen denominated individual fixed annuity product. Also, foreign currency exchange rate risk is inherent when the Japan policyholders’ variable annuity sub-account investments are non-Japanese yen denominated securities while the related GMDB and GMIB guarantees are effectively yen-denominated. A portion of the Company’s foreign currency exposure is mitigated through the use of derivatives.
Fixed Maturity Investments
The risk associated with the non-U.S. dollar denominated fixed maturities relates to potential decreases in value and income resulting from unfavorable changes in foreign exchange rates. The fair value of the non-U.S. dollar denominated fixed maturities, which are primarily denominated in euro, sterling, yen and Canadian dollars, at December 31, 2010 and 2009, were approximately $792 and $549, respectively.
In order to manage its currency exposures, the Company enters into foreign currency swaps and forwards to hedge the variability in cash flows as fair value associated with certain foreign denominated fixed maturities. These foreign currency swap and forward agreements are structured to match the foreign currency cash flows of the hedged foreign denominated securities. At December 31, 2010 and 2009, the derivatives used to hedge currency exchange risk related to non-U.S. dollar denominated fixed maturities had a total notional amount of $266 and $316, respectively, and total fair value of $(8) and $(22), respectively.
Based on the fair values of the Company’s non-U.S. dollar denominated securities and derivative instruments as of December 31, 2010 and 2009, management estimates that a 10% unfavorable change in exchange rates would decrease the fair values by a before-tax total of approximately $26 and $21, respectively. The estimated impact was based upon a 10% change in December 31 spot rates. The selection of the 10% unfavorable change was made only for illustration of the potential hypothetical impact of such an event and should not be construed as a prediction of future market events. Actual results could differ materially from those illustrated above due to the nature of the estimates and assumptions used in the above analysis.

 

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Liabilities
The Company issued non-U.S. dollar denominated funding agreement liability contracts. The Company hedges the foreign currency risk associated with these liability contracts with currency rate swaps. At December 31, 2010 and 2009, the derivatives used to hedge foreign currency exchange risk related to foreign denominated liability contracts had a total notional amount of $771 and $814, respectively, and a total fair value of $(17) and $(2), respectively.
The yen based fixed annuity product was written by HLIKK and ceded to the Company. During 2009, the Company has since suspended new sales of the Japan business. The underlying investment involves investing in U.S. securities markets, which offer favorable credit spreads. The yen denominated fixed annuity product (“yen fixed annuities”) assumed is recorded in the consolidated balance sheets with invested assets denominated in U.S. dollars while policyholder liabilities are denominated in yen and converted to U.S. dollars based upon the December 31, 2010 yen to U.S. dollar spot rate. The difference between U.S. dollar denominated investments and yen denominated liabilities exposes the Company to currency risk. The Company manages this currency risk associated with the yen fixed annuities primarily with pay variable U.S. dollar and receive fixed yen currency swaps. As of December 31, 2010 and 2009, the notional value of the currency swaps was $2.1 billion and $2.3 billion and the fair value was $608 and $316, respectively. Although economically an effective hedge, a divergence between the yen denominated fixed annuity product liability and the currency swaps exists primarily due to the difference in the basis of accounting between the liability and the derivative instruments (i.e. historical cost versus fair value). The yen denominated fixed annuity product liabilities are recorded on a historical cost basis and are only adjusted for changes in foreign spot rates and accrued income. The currency swaps are recorded at fair value incorporating changes in value due to changes in forward foreign exchange rates, interest rates and accrued income. A before-tax net gain of $27 and $47 for the years ended December 31, 2010 and 2009, respectively, which includes the changes in value of the currency swaps, excluding net periodic coupon settlements, and the yen fixed annuity contract remeasurement, was recorded in net realized capital gains and losses.
Prior to 2010, the Company had also issued guaranteed benefits (GMDB and GMIB) that were reinsured from HLIKK to the U.S. insurance subsidiaries. During 2010, the Company entered into foreign currency forward contracts that convert U.S. dollars to yen in order to hedge the foreign currency risk due to U.S. dollar denominated assets backing the yen denominated liabilities. The Company also enters into foreign currency forward contracts that convert euros to yen in order to economically hedge the risk arising when the Japan policyholders’ variable annuity sub-accounts are invested in non-Japanese yen denominated securities while the related GMDB and GMIB guarantees are effectively yen-denominated. As of December 31, 2010 and 2009, the derivatives used to hedge foreign currency risk associated with Japanese variable annuity products had a total notional amount of $1.7 billion and $257, respectively, and a total fair value of $73 and $(8), respectively.

 

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CAPITAL RESOURCES AND LIQUIDITY
Capital resources and liquidity represent the overall strength of Hartford Life Insurance Company and its ability to generate strong cash flows from each of the business segments, borrow funds at competitive rates and raise new capital to meet operating and growth needs over the next twelve months.
Derivative Commitments
Certain of the Company’s derivative agreements contain provisions that are tied to the financial strength ratings of the individual legal entity that entered into the derivative agreement as set by nationally recognized statistical rating agencies. If the legal entity’s financial strength were to fall below certain ratings, the counterparties to the derivative agreements could demand immediate and ongoing full collateralization and in certain instances demand immediate settlement of all outstanding derivative positions traded under each impacted bilateral agreement. The settlement amount is determined by netting the derivative positions transacted under each agreement. If the termination rights were to be exercised by the counterparties, it could impact the legal entity’s ability to conduct hedging activities by increasing the associated costs and decreasing the willingness of counterparties to transact with the legal entity. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that are in a net liability position as of December 31, 2010, is $254. Of this $254, the legal entities have posted collateral of $284 in the normal course of business. Based on derivative market values as of December 31, 2010, a downgrade of one level below the current financial strength ratings by either Moody’s or S&P would not require additional collateral to be posted. These collateral amounts could change as derivative market values change, as a result of changes in our hedging activities or to the extent changes in contractual terms are negotiated. The nature of the collateral that we may be required to post is primarily in the form of U.S. Treasury bills and U.S. Treasury notes.
The table below presents the aggregate notional amount and fair value of derivative relationships that could be subject to immediate termination in the event of further rating agency downgrades.
                 
    As of December 31, 2010  
Ratings levels   Notional Amount     Fair Value  
Either BBB+ or Baa1 [1]
  $ 14,146     $ 348  
     
[1]  
The notional and fair value amounts include a customized GMWB derivative with a notional amount of $5.1 billion and a fair value of $122, for which the Company has a contractual right to make a collateral payment in the amount of approximately $60 to prevent its termination.
Insurance Operations
In the event customers elect to surrender separate account assets, international statutory separate accounts or retail mutual funds, the Company will use the proceeds from the sale of the assets to fund the surrender and the Company’s liquidity position will not be impacted. In many instances the Company will receive a percentage of the surrender amount as compensation for early surrender (surrender charge), increasing the Company’s liquidity position. In addition, a surrender of variable annuity separate account or general account assets (see below) will decrease the Company’s obligation for payments on guaranteed living and death benefits.
As of December 31, 2010, the Company’s cash and short-term investments of $4 billion, included $1.1 of collateral received from, and held on behalf of, derivative counterparties and $260 of collateral pledged to derivative counterparties. The Company also held $2.8 billion of treasury securities, of which $284 had been pledged to derivative counterparties.
Total general account contractholder obligations are supported by $58 billion of cash and total general account invested assets, excluding equity securities, trading, which includes a significant short-term investment position, as depicted below, to meet liquidity needs.
The following table summarizes the Company’s fixed maturities, short-term investments, and cash, as of December 31, 2010:
         
Fixed maturities [1]
  $ 45,473  
Short-term investments
    3,489  
Cash
    531  
Less: Derivative collateral
    (1,639 )
 
     
Total
  $ 47,854  
 
     
     
[1]  
Includes $2.8 billion of U.S. Treasuries.
Capital resources available to fund liquidity, upon contract holder surrender, are a function of the legal entity in which the liquidity requirement resides. Generally, obligations of Global Annuity and Life Insurance obligations will be generally funded by both Hartford Life Insurance Company and Hartford Life and Annuity Insurance Company; obligations of Retirement Plans and institutional investment products will be generally funded by Hartford Life Insurance Company; and obligations of the Company’s international annuity subsidiary and affiliate will be generally funded by the legal entity in the country in which the obligation was generated.

 

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    As of  
    December 31,  
Contractholder Obligations   2010  
Total Contractholder obligations
  $ 217,143  
Less: Separate account assets [1]
    (159,729 )
International statutory separate accounts [1]
    (2,279 )
 
     
General account contractholder obligations
  $ 55,135  
 
     
 
       
Composition of General Account Contractholder Obligations
       
Contracts without a surrender provision and/or fixed payout dates [2]
  $ 21,176  
Fixed MVA annuities [3]
    10,467  
International fixed MVA annuities
    2,723  
Guaranteed investment contracts (“GIC”) [4]
    912  
Other [5]
    19,857  
 
     
General account contractholder obligations
  $ 55,135  
 
     
     
[1]  
In the event customers elect to surrender separate account assets or international statutory separate accounts, the Company will use the proceeds from the sale of the assets to fund the surrender, and the Company’s liquidity position will not be impacted. In many instances the Company will receive a percentage of the surrender amount as compensation for early surrender (surrender charge), increasing the Company’s liquidity position. In addition, a surrender of variable annuity separate account or general account assets (see below) will decrease the Company’s obligation for payments on guaranteed living and death benefits.
 
[2]  
Relates to contracts such as payout annuities or institutional notes, other than guaranteed investment products with an MVA feature (discussed below) or surrenders of term life, group benefit contracts or death and living benefit reserves for which surrenders will have no current effect on the Company’s liquidity requirements.
 
[3]  
Relates to annuities that are held in a statutory separate account, but under U.S. GAAP are recorded in the general account as Fixed MVA annuity contract holders are subject to the Company’s credit risk. In the statutory separate account, the Company is required to maintain invested assets with a fair value equal to the MVA surrender value of the Fixed MVA contract. In the event assets decline in value at a greater rate than the MVA surrender value of the Fixed MVA contract, the Company is required to contribute additional capital to the statutory separate account. the Company will fund these required contributions with operating cash flows or short-term investments. In the event that operating cash flows or short-term investments are not sufficient to fund required contributions, the Company may have to sell other invested assets at a loss, potentially resulting in a decrease in statutory surplus. As the fair value of invested assets in the statutory separate account are generally equal to the MVA surrender value of the Fixed MVA contract, surrender of Fixed MVA annuities will have an insignificant impact on the liquidity requirements of the Company.
 
[4]  
GICs are subject to discontinuance provisions which allow the policyholders to terminate their contracts prior to scheduled maturity at the lesser of the book value or market value. Generally, the market value adjustment reflects changes in interest rates and credit spreads. As a result, the market value adjustment feature in the GIC serves to protect the Company from interest rate risks and limit the Company’s liquidity requirements in the event of a surrender.
 
[5]  
Surrenders of, or policy loans taken from, as applicable, these general account liabilities, which include the general account option for Global Annuity’s individual variable annuities and Life Insurance’s variable life contracts, the general account option for Retirement Plans’ annuities and universal life contracts sold by Life Insurance may be funded through operating cash flows of the Company, available short-term investments, or the Company may be required to sell fixed maturity investments to fund the surrender payment. Sales of fixed maturity investments could result in the recognition of significant realized losses and insufficient proceeds to fully fund the surrender amount. In this circumstance, the Company may need to take other actions, including enforcing certain contract provisions which could restrict surrenders and/or slow or defer payouts.
Consumer Notes
In 2008, the Company made the decision to discontinue future issuances of consumer notes; this decision does not impact consumer notes currently outstanding. A consumer note is an investment product distributed through broker-dealers directly to retail investors as medium-term, publicly traded fixed or floating rate, or a combination of fixed and floating rate, notes. Consumer notes are part of the Company’s spread-based business and proceeds are used to purchase investment products, primarily fixed rate bonds. Proceeds are not used for general operating purposes. Consumer notes maturities may extend up to 30 years and have contractual coupons based upon varying interest rates or indexes (e.g. consumer price index) and may include a call provision that allows the Company to extinguish the notes prior to its scheduled maturity date. Certain Consumer notes may be redeemed by the holder in the event of death. Redemptions are subject to certain limitations, including calendar year aggregate and individual limits. The aggregate limit is equal to the greater of $1 or 1% of the aggregate principal amount of the notes as of the end of the prior year. The individual limit is $250 thousand per individual. Derivative instruments are utilized to hedge the Company’s exposure to market risks in accordance with Company policy.
As of December 31, 2010 and 2009 $382 and $1,136, respectively, of consumer notes were outstanding. As of December 31, 2010, these consumer notes have interest rates ranging from 4% to 6% for fixed notes and, for variable notes, based on December 31, 2010 rates, either consumer price index plus 80 to 260 basis points, or indexed to the S&P 500, Dow Jones Industrials, foreign currency, or the Nikkei 225. The aggregate maturities of Consumer Notes are as follows: $62 in 2011, $155 in 2012, $78 in 2013, $17 in 2014 and $70 thereafter. For 2010, 2009 and 2008, interest credited to holders of consumer notes was $25, $51 and $59, respectively.

 

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Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
The following table identifies the Company’s contractual obligations as of December 31, 2010:
                                         
    Payments due by period  
            Less than     1-3     3-5     More than  
    Total     1 year     years     years     5 years  
Operating Leases [1]
  $ 29     $ 12     $ 14     $ 3     $  
Consumer notes [2]
    419       79       250       50       40  
Other long-term liabilities
    1,511       1,095       274       142        
Life and Annuity obligations [3]
    335,117       23,183       46,203       38,305       227,426  
Purchase Obligations [4]
    1,156       1,102       48       6        
 
                             
Total
  $ 338,232     $ 25,471     $ 46,789     $ 38,506     $ 227,466  
 
                             
     
[1]  
Includes future minimum lease payments on operating lease agreements. See Note 10 of the Notes to Consolidated Financial Statements for additional discussion on lease commitments.
 
[2]  
Consumer notes include principal payments, contractual interest for fixed rate notes and, interest based on current rates for floating rate notes. See Note 12 of the Notes to Consolidated Financial Statements for additional discussion of consumer notes.
 
[3]  
Estimated life and annuity obligations include death claims, other charges associated with policyholder reserves, policy surrenders and policyholder dividends, offset by expected future deposits on in-force contracts. Estimated life and annuity obligations are based on mortality, morbidity and lapse assumptions comparable with the Company’s historical experience, modified for recent observed trends. The Company has also assumed market growth and interest crediting consistent with other assumptions. In contrast to this table, the majority of the Company’s obligations are recorded on the balance sheet at the current account values and do not incorporate an expectation of future market growth, interest crediting, or future deposits. Therefore, the estimated obligations presented in this table significantly exceed the liabilities recorded in reserve for future policy benefits and unpaid loss and loss adjustment expenses, other policyholder funds and benefits payable and separate account liabilities. Due to the significance of the assumptions used, the amounts presented could materially differ from actual results
 
[4]  
Included in purchase obligations is $192 relating to contractual commitments to purchase various goods and services such as maintenance, human resources, information technology, and transportation in the normal course of business. Purchase obligations exclude contracts that are cancelable without penalty or contracts that do not specify minimum levels of goods or services to be purchased.
Dividends
Dividends to the Company from its insurance subsidiaries are restricted, as is the ability of the Company to pay dividends to its parent company. Future dividend decisions will be based on, and affected by, a number of factors, including the operating results and financial requirements of the Company on a stand-alone basis and the impact of regulatory restrictions.
The payment of dividends by Connecticut-domiciled insurers is limited under the insurance holding company laws of Connecticut. These laws require notice to and approval by the state insurance commissioner for the declaration or payment of any dividend, which, together with other dividends or distributions made within the preceding twelve months, exceeds the greater of (i) 10% of the insurer’s policyholder surplus as of December 31 of the preceding year or (ii) net income (or net gain from operations, if such company is a life insurance company) for the twelve-month period ending on the thirty-first day of December last preceding, 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 the Company’s insurance subsidiaries are incorporated (or deemed commercially domiciled) generally contain similar (although in certain instances somewhat more restrictive) limitations on the payment of dividends.
The Company’s subsidiaries are permitted to pay up to a maximum of approximately $815 in dividends in 2011 without prior approval from the applicable insurance commissioner. In 2010, the Company received dividends of $72 from its subsidiaries. With respect to dividends to its parent, the Company’s dividend limitation under the holding company laws of Connecticut is $676 in 2011. However, because the Company’s earned surplus is negative as of December 31, 2010, the Company will not be permitted to pay any dividends to its parent in 2011 without prior approval from the Connecticut Insurance Commissioner. In 2010, the Company did not pay dividends to its parent company.

 

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Cash Flows
                 
    2010     2009  
Net cash provided by operating activities
  $ 1,882     $ 2,522  
Net cash provided by (used for) investing activities
  $ 209     $ (192 )
Net cash used for financing activities
  $ (2,363 )   $ (2,183 )
Cash — End of Year
  $ 531     $ 793  
Year ended December 31, 2010 compared to Year-ended December 31, 2009
Net cash provided by operating activities decreased primarily due to income taxes paid of $354 in 2010, compared to income taxes received of $282 in 2009.
Net cash provided by investing activities in 2010 primarily relates to net proceeds from sales of mortgage loans of $1.1 billion, partially offset by net purchases of available-for-sale securities of $241 and net payments on derivatives of $664. Net cash used for investing activities in 2009 consisted of net outflows of $1.8 billion from changes in payables on securities lending and net payments on derivatives of $520, partially offset by net proceeds from available-for-sale securities of $1.8 billion and net proceeds from sales of mortgage loans of $216.
Net cash used for financing activities in 2010 primarily relates to net outflows on investment and universal life-type contracts of $1.4 billion and repayments of consumer notes of $754. Net cash used for financing activities in 2009 primarily relates net outflows on investment and universal life-type contracts of $3.3 billion and repayments of consumer notes of $74, partially offset by capital contributions of $1.4 billion.
Operating cash flows in both periods have been more than adequate to meet liquidity requirements.
Equity Markets
For a discussion of the potential impact of the equity markets on capital and liquidity, see the Capital Markets Risk Management section under “Market Risk”.
Ratings
Ratings impact the Company’s cost of borrowing and its ability to access financing and are an important factor in establishing competitive position in the insurance and financial services marketplace. There can be no assurance that the Company’s ratings will continue for any given period of time or that they will not be changed. In the event the Company’s ratings are downgraded, the Company’s cost of borrowing and ability to access financing, as well as the level of revenues or the persistency of its business may be adversely impacted.
The following table summarizes Hartford Life Insurance Company’s and it’s wholly-owned subsidiary Hartford Life and Annuity Insurance Company’s financial ratings from the major independent rating organizations as of February 18, 2011:
                                 
Insurance Financial Strength Ratings:   A.M. Best     Fitch     Standard & Poor’s     Moody’s  
Hartford Life Insurance Company
    A       A-       A       A3  
Hartford Life and Annuity Insurance Company
    A       A-       A       A3  
These ratings are not a recommendation to buy or hold any of the Company’s securities and they may be revised or revoked at any time at the sole discretion of the rating organization.
The agencies consider many factors in determining the final rating of an insurance company. One consideration is the relative level of statutory surplus necessary to support the business written. Statutory surplus represents the capital of the insurance company reported in accordance with accounting practices prescribed by the applicable state insurance department.

 

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Statutory Capital
The Company’s stockholder’s equity, as prepared using U.S. GAAP, was $8.2 billion as of December 31, 2010. The Company’s estimated aggregate statutory capital and surplus, as prepared in accordance with the National Association of Insurance Commissioners’ Accounting Practices and Procedures Manual (“U.S. STAT”), was $5.8 billion as of December 31, 2010.
Significant differences between U.S. GAAP stockholder’s equity and aggregate statutory capital and surplus prepared in accordance with U.S. STAT include the following:
 
Costs incurred by the Company to acquire insurance policies are deferred under US GAAP while those costs are expensed immediately under US STAT.
 
Temporary differences between the book and tax basis of an asset or liability which are recorded as deferred tax assets are evaluated for recoverability under US GAAP while those amounts deferred are subject to limitations under US STAT.
 
The assumptions used in the determination of benefit reserves is prescribed under US STAT, while the assumptions used under US GAAP are generally the Company’s best estimates. The methodologies for determining life insurance reserve amounts may also be different. For example, reserving for living benefit reserves under US STAT is generally addressed by the Commissioners’ Annuity Reserving Valuation Methodology and the related Actuarial Guidelines, while under US GAAP, those same living benefits may be considered embedded derivatives and recorded at fair value or they may be considered SOP 03-1 reserves. The sensitivity of these life insurance reserves to changes in equity markets, as applicable, will be different between US GAAP and US STAT.
 
The difference between the amortized cost and fair value of fixed maturity and other investments, net of tax, is recorded as an increase or decrease to the carrying value of the related asset and to equity under US GAAP, while US STAT only records certain securities at fair value, such as equity securities and certain lower rated bonds required by the NAIC to be recorded at the lower of amortized cost or fair value. In the case of the Company’s market value adjusted (MVA) fixed annuity products, invested assets are marked to fair value (including the impact of audit spreads) and liabilities are marked to fair value (but generally excluding the impacts of credit spreads) for statutory purposes only. In the case of the Company’s market value adjusted (MVA) fixed annuity products, invested assets are marked to fair value (but generally actual credit spreads are not fully reflected) for statutory purposes only.
 
US STAT for life insurance companies establishes a formula reserve for realized and unrealized losses due to default and equity risks associated with certain invested assets (the Asset Valuation Reserve), while US GAAP does not. Also, for those realized gains and losses caused by changes in interest rates, US STAT for life insurance companies defers and amortizes the gains and losses, caused by changes in interest rates, into income over the original life to maturity of the asset sold (the Interest Maintenance Reserve) while US GAAP does not.
 
Goodwill arising from the acquisition of a business is tested for recoverability on an annual basis (or more frequently, as necessary) for US GAAP, while under US STAT goodwill is amortized over a period not to exceed 10 years and the amount of goodwill is limited.
In addition, certain assets, including a portion of premiums receivable and fixed assets, are non-admitted (recorded at zero value and charged against surplus) under US STAT. US GAAP generally evaluates assets based on their recoverability.
Risk-based Capital
State insurance regulators and the NAIC have adopted risk-based capital requirements for life insurance companies to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks. The requirements provide a means of measuring the minimum amount of statutory surplus appropriate for an insurance company to support its overall business operations based on its size and risk profile. Under risk-based capital (“RBC”) requirements, a company’s RBC is calculated by applying factors and performing calculations relating to various asset, premium, claim, expense and reserve items. The adequacy of a company’s actual capital is determined by the ratio of a company’s total adjusted capital, as defined by the insurance regulators, to its company action level of RBC (known as the RBC ratio), also as defined by insurance regulators. RBC standards are used by regulators to set in motion appropriate regulatory actions related to insurers that show indications of inadequate conditions. In addition, the rating agencies view RBC ratios along with their proprietary models as factors in making ratings determinations.

 

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Sensitivity
In any particular year, statutory surplus amounts and RBC ratios may increase or decrease depending upon a variety of factors. The amount of change in the statutory surplus or RBC ratios can vary based on individual factors and may be compounded in extreme scenarios or if multiple factors occur at the same time. At times the impact of changes in certain market factors or a combination of multiple factors on RBC ratios can be varied and in some instances counterintuitive. Factors include:
 
In general, as equity market levels decline, our reserves for death and living benefit guarantees associated with variable annuity contracts increases, sometimes at a greater than linear rate, reducing statutory surplus levels. In addition, as equity market levels increase, generally surplus levels will increase. RBC ratios will also tend to increase when equity markets increase. 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 increase resulting in lower RBC ratios.
 
As the value of certain fixed-income and equity securities in our investment portfolio decreases, due in part to credit spread widening, statutory surplus and RBC ratios may decrease.
 
As the value of certain derivative instruments that do not get hedge accounting decreases, statutory surplus and RBC ratios may decrease.
 
Our statutory surplus is also impacted by widening credit spreads as a result of the accounting for the assets and liabilities in our fixed market value adjusted (“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 many capital market scenarios, current crediting rates are highly correlated with market rates implicit in the fair value of statutory separate account assets. As a result, the change in 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, such as we have experienced, 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 the current crediting rates, 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 and can create funding obligations to the statutory separate account.
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. Due to all of these factors, projecting statutory capital and the related projected RBC ratios is complex. In addition, rating agencies may implement changes to their internal models that have the effect of increasing or decreasing the amount of statutory capital we must hold in order to maintain our current ratings.
The Company has reinsured approximately 18% of its risk associated with U.S. GMWB with a third party and 16% of its risk associated with U.S. GMWB with an affiliated captive reinsurer. The Company has also reinsured 60% of its risk associated with the aggregate U.S. GMDB exposure. These reinsurance agreements serve to reduce the Company’s exposure to changes in the statutory reserves and the related capital and RBC ratios associated with changes in the equity markets. The Company also continues to explore other solutions for mitigating the capital market risk effect on surplus, such as internal and external reinsurance solutions, migrating towards a more statutory based hedging program, changes in product design, increasing pricing and expense management.
In addition, in 2010 The Hartford entered into an intercompany liquidity agreement that allows for short-term advances of funds among the HFSG Holding Company and certain Connecticut domiciled insurers, including Hartford Life Insurance Company, of up to $2.0 billion for liquidity and other general corporate purposes. The Connecticut Insurance Department granted approval for these insurance companies to treat receivables from a parent as admitted assets for statutory accounting.
Contingencies
Legal Proceedings — For a discussion regarding contingencies related to the Company’s legal proceedings, please see Item 3, “Legal Proceedings”.
For further information on other contingencies, see Note 10 of Notes to Consolidated Financial Statements.
Legislative Initiatives
Tax proposals and regulatory initiatives which have been or are being considered by Congress and/or the United States Treasury Department could have a material effect on the insurance business. These proposals and initiatives include, or could include, changes pertaining to the income tax treatment of insurance companies and life insurance products and annuities, repeal or reform of the estate tax and comprehensive federal tax reform. The nature and timing of any Congressional or regulatory action with respect to any such efforts is unclear.
Guaranty Fund and Other Insurance-related Assessments
For a discussion regarding Guaranty Fund and Other Insurance-related Assessment, see Note 10 of the Notes to Consolidated Financial Statements.

 

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IMPACT OF NEW ACCOUNTING STANDARDS
For a discussion of accounting standards, see Note 1 of Notes to Consolidated Financial Statements.
Item 7A.  
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is set forth in the Capital Markets Risk Management section of Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and is incorporated herein by reference.
Item 8.  
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Index to Consolidated Financial Statements and Schedules elsewhere herein.
Item 9.  
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Item 9A.  
CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures
The Company’s principal executive officer and its principal financial officer, based on their evaluation of the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) have concluded that the Company’s disclosure controls and procedures are effective for the purposes set forth in the definition thereof in Exchange Act Rule 13a-15(e) as of December 31, 2010.
Management’s annual report on internal control over financial reporting
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting for the Company as defined in Rule 13a-15(f) under the Securities Exchange Act of 1934.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. A company’s internal control over financial reporting includes policies and procedures that (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company’s management assessed its internal controls over financial reporting as of December 31, 2010 in relation to criteria for effective internal control over financial reporting described in “Internal Control — Integrated Framework” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment under those criteria, The Company’s management concluded that its internal control over financial reporting was effective as of December 31, 2010.
This annual report does not include an attestation report of the company’s registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the company’s registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
Changes in internal control over financial reporting
There were no changes in the Company’s internal control over financial reporting that occurred during the Company’s fourth fiscal quarter of 2010 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Item 9B.  
OTHER INFORMATION
None.
PART III
Item 10.  
DIRECTORS, AND EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE OF HARTFORD LIFE INSURANCE COMPANY
Omitted pursuant to General Instruction I(2)(c) of Form 10-K.
Item 11.  
EXECUTIVE COMPENSATION
Omitted pursuant to General Instruction I(2)(c) of Form 10-K.

 

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Item 12.  
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Omitted pursuant to General Instruction I(2)(c) of Form 10-K.
Item 13.  
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
Omitted pursuant to General Instruction I(2)(c) of Form 10-K.
Item 14.  
PRINCIPAL ACCOUNTING FEES AND SERVICES
The following table presents fees for professional services rendered by Deloitte & Touche LLP, the member firms of Deloitte Touche Tohmatsu, and their respective affiliates (collectively, the “Deloitte Entities”) for the audit of the Company’s annual financial statements, audit-related services, tax services and all other services for the years ended December 31, 2010 and 2009.
                 
    Year Ended     Year Ended  
    December 31, 2010     December 31, 2009  
(1) Audit fees
  $ 9,766,032     $ 9,036,682  
(2) Audit-related fees(a)
    707,026       735,674  
(3) Tax fees(b)
    12,200       14,000  
(4) All other fees(c)
    267,081       30,000  
 
           
Total
  $ 10,752,339     $ 9,816,356  
 
           
     
(a)  
Principally consisted of internal control reviews and due diligence and related services.
 
(b)  
Principally consisted of domestic and international tax compliance services and tax examination assistance.
 
(c)  
Fees for the year ended December 31, 2010 consisted primarily of an enterprise risk management project.
The Hartford’s Audit Committee (the “Committee”) concluded that the provision of the non-audit services provided to The Hartford by the Deloitte Entities during 2010 and 2009 was compatible with maintaining the Deloitte Entities’ independence.
The Committee has established policies requiring it’s pre-approval of audit and non-audit services provided by the independent registered public accounting firm. The policies require that the Committee pre-approve specifically described audit, audit-related and tax services, annually. For the annual pre-approval, the Committee approves categories of audit services, audit-related services and tax services, and related fee budgets. For all pre-approvals, the Committee considers whether such services are consistent with the rules of the Securities and Exchange Commission and the Public Company Accounting Oversight Board on auditor independence. The independent registered public accounting firm and management report to the Committee on a timely basis regarding the services rendered by and actual fees paid to the independent registered public accounting firm to ensure that such services are within the limits approved by the Committee. The Committee’s policies require specific pre-approval of all internal control-related services and all other permitted services on an individual project basis. As provided by the Committee’s policies, the Committee has delegated to its Chairman the authority to address any requests for pre-approval of services between Committee meetings, up to a maximum of $100,000. The Chairman must report any pre-approvals to the full Committee at its next scheduled meeting.
PART IV
Item 15.  
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) Documents filed as a part of this report:
(1) Consolidated Financial Statements. See Index to Consolidated Financial Statements and Schedules elsewhere herein.
(2) Consolidated Financial Statement Schedules. See Index to Consolidated Financial Statement and Schedules elsewhere herein.
(3) Exhibits. See Exhibit Index elsewhere herein.

 

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HARTFORD LIFE INSURANCE COMPANY
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
         
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    F-8-64  
 
       
    S-1  
 
       
    S-2  
 
       
    S-4  
 
       
    S-5  

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholder of
Hartford Life Insurance Company
Hartford, Connecticut
We have audited the accompanying consolidated balance sheets of Hartford Life Insurance Company and subsidiaries (the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of operations, changes in equity, and cash flows for each of the three years in the period ended December 31, 2010. Our audits also included the financial statement schedules listed in the Index at Item 15. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedules based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Harford Life Insurance Company and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such consolidated financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
As discussed in Note 1 of the consolidated financial statements, the Company changed its method of accounting and reporting for variable interest entities and embedded credit derivatives as required by accounting guidance adopted in 2010, for other-than-temporary impairments as required by accounting guidance adopted in 2009, and for the fair value measurement of financial instruments as required by accounting guidance adopted in 2008.
DELOITTE & TOUCHE LLP
Hartford, Connecticut
February 25, 2011

 

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HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
Consolidated Statements of Operations
                         
    For the years ended December 31,  
(In millions)   2010     2009     2008  
Revenues
                       
Fee income and other
  $ 3,806     $ 3,723     $ 4,123  
Earned premiums
    260       377       984  
Net investment income (loss)
                       
Securities available-for-sale and other
    2,621       2,505       2,588  
Equity securities held for trading
    238       343       (246 )
Total net investment income (loss)
    2,859       2,848       2,342  
Net realized capital gains (losses):
                       
Total other-than-temporary impairment (“OTTI”) losses
    (712 )     (1,722 )     (1,888 )
OTTI losses recognized to other comprehensive income
    376       530        
 
                 
Net OTTI losses recognized in earnings
    (336 )     (1,192 )     (1,888 )
Net realized capital gains (losses), excluding net OTTI losses recognized in earnings
    (608 )     316       (3,875 )
 
                 
Total net realized capital gains (losses)
    (944 )     (876 )     (5,763 )
 
                 
Total revenues
    5,981       6,072       1,686  
Benefits, losses and expenses
                       
Benefits, loss and loss adjustment expenses
    2,948       3,716       4,048  
Benefits, loss and loss adjustment expenses — returns credited on International unit-linked bonds and pension products
    238       343       (246 )
Insurance operating costs and other expenses
    1,610       1,826       1,911  
Amortization of deferred policy acquisition costs and present value of future profits
    215       3,716       1,610  
Goodwill impairment
                184  
Dividends to policyholders
    21       12       13  
 
                 
Total benefits, losses and expenses
    5,032       9,613       7,520  
 
                 
Income (loss) from continuing operations before income taxes
    949       (3,541 )     (5,834 )
Income tax expense (benefit)
    228       (1,399 )     (2,180 )
 
                 
Income (loss) from continuing operations
    721       (2,142 )     (3,654 )
Income (loss) from discontinued operations, net of tax
    31       (5 )     (5 )
 
                 
Net income (loss)
    752       (2,147 )     (3,659 )
Net income (loss) attributable to the noncontrolling interest
    8       10       (105 )
 
                 
Net income (loss) attributable to Hartford Life Insurance Company
  $ 744     $ (2,157 )   $ (3,554 )
 
                 
See Notes to Consolidated Financial Statements.

 

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HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
Consolidated Balance Sheets
                 
    As of December 31,  
(In millions, except for share data)   2010     2009  
Assets
               
Investments
               
Fixed maturities, available-for-sale, at fair value (amortized cost of $45,323 and $44,284) (includes variable interest entity assets, at fair value, of $406 as of December 31, 2010)
  $ 44,834     $ 40,403  
Fixed maturities, at fair value using the fair value option (includes variable interest entity assets, at fair value, of $323 as of December 31, 2010)
    639        
Equity securities, trading, at fair value (cost of $2,061 and $2,359)
    2,279       2,443  
Equity securities, available for sale, at fair value (cost of $320 and $447)
    340       419  
Policy loans, at outstanding balance
    2,128       2,120  
Mortgage loans (net of allowances for loan losses of $62 and $260)
    3,244       4,304  
Limited partnership and other alternative investments (includes variable interest entity assets of $14 as of December 31, 2010)
    838       759  
Other investments
    1,461       338  
Short-term investments
    3,489       5,128  
 
           
Total investments
    59,252       55,914  
Cash
    531       793  
Premiums receivable and agents’ balances
    67       69  
Reinsurance recoverables
    3,924       3,140  
Deferred income taxes, net
    2,138       3,066  
Deferred policy acquisition costs and present value of future profits
    4,949       5,779  
Goodwill
    470       470  
Other assets
    692       1,709  
Separate account assets
    159,729       150,380  
 
           
Total assets
  $ 231,752     $ 221,320  
 
           
Liabilities
               
Reserve for future policy benefits and unpaid losses and loss adjustment expenses
  $ 11,385     $ 11,318  
Other policyholder funds and benefits payable
    43,395       43,526  
Other policyholder funds and benefits payable — International unit-liked bonds and pension products
    2,252       2,419  
Consumer notes
    382       1,136  
Other liabilities (includes variable interest entity liabilities of $422 as of December 31, 2010)
    6,398       6,245  
Separate account liabilities
    159,729       150,380  
 
           
Total liabilities
    223,541       215,024  
 
           
Commitments and contingent liabilities (Note 10)
               
Stockholder’s Equity
               
Common stock — 1,000 shares authorized, issued and outstanding, par value $5,690
    6       6  
Capital surplus
    8,265       8,457  
Accumulated other comprehensive loss, net of tax
    (372 )     (1,941 )
Retained earnings (deficit)
    312       (287 )
 
           
Total stockholder’s equity
    8,211       6,235  
 
           
Noncontrolling interest
          61  
 
           
Total equity
    8,211       6,296  
 
           
Total liabilities and stockholder’s equity
  $ 231,752     $ 221,320  
 
           
See Notes to Consolidated Financial Statements.

 

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HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
Consolidated Statements of Changes in Equity
                                                                         
                    Accumulated Other Comprehensive                            
                    Income (Loss)                            
                    Net Unrealized     Net (Loss)                                  
                    Capital Gains     Gain On Cash     Foreign                            
                    (Losses)     Flow Hedging     Currency             Total     Non-        
    Common     Capital     On Securities,     Instruments,     Translation     Retained     Stockholder’s     Controlling     Total  
(In millions)   Stock     Surplus     Net of Tax     Net of Tax     Adjs     Earnings (Deficit)     Equity     Interest     Equity  
 
2010
                                                                       
Balance, December 31, 2009
  $ 6     $ 8,457     $ (2,039 )   $ 148     $ (50 )   $ (287 )   $ 6,235     $ 61     $ 6,296  
Comprehensive income
                                                                       
Net income
                                            744       744               744  
Other comprehensive income, net of tax (1)
                                                                       
Net change in unrealized capital gains (losses) on securities (2)
                    1,298                               1,298               1,298  
Net gains on cash flow hedging instruments
                            117                       117               117  
Cumulative translation adjustments
                                    (18 )             (18 )             (18 )
 
                                                                   
Total other comprehensive income
                    1,298       117       (18 )             1,397               1,397  
Total comprehensive income
                    1,298       117       (18 )     744       2,141               2,141  
Capital contribution from parent (3)
            (192 )                                     (192 )             (192 )
Dividends declared
                                            1       1               1  
Cumulative effect of accounting changes, net of tax
                    172                       (146 )     26               26  
 
                                                     
Change in noncontrolling interest ownership
                                                            (69 )     (69 )
 
                                                     
Noncontrolling income
                                                            8       8  
 
                                                     
Balance, December 31, 2010
  $ 6     $ 8,265     $ (569 )   $ 265     $ (68 )   $ 312     $ 8,211     $     $ 8,211  
 
                                                     
 
2009
                                                                       
Balance, December 31, 2008
  $ 6     $ 6,157     $ (4,806 )   $ 440     $ (165 )   $ 1,446     $ 3,078     $ 165     $ 3,243  
Comprehensive income
                                                                       
Net loss
                                            (2,157 )     (2,157 )             (2,157 )
Other comprehensive income, net of tax (1)
                                                                       
Net change in unrealized capital gains (losses) on securities (2)
                    3,229                               3,229               3,229  
Net gains on cash flow hedging instruments
                            (292 )                     (292 )             (292 )
Cumulative translation adjustments
                                    115               115               115  
 
                                                                   
Total other comprehensive income
                                                    3,052               3,052  
 
                                                                   
Total comprehensive income
                                                    895               895  
Capital contribution from parent (3)
            2,300                                       2,300               2,300  
Dividends declared
                                            (38 )     (38 )             (38 )
Cumulative effect of accounting changes, net of tax
                    (462 )                     462                      
 
                                                     
Change in noncontrolling interest ownership
                                                            (114 )     (114 )
 
                                                     
Noncontrolling income (loss)
                                                            10       10  
 
                                                     
Balance, December 31, 2009
  $ 6     $ 8,457     $ (2,039 )   $ 148     $ (50 )   $ (287 )   $ 6,235     $ 61     $ 6,296  
 
                                                     
See Notes to Consolidated Financial Statements.

 

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HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
Consolidated Statements of Changes in Equity (continued)
                                                                         
                    Accumulated Other Comprehensive
Income (Loss)
                           
                    Net Unrealized     Net (Loss)                                  
                    Capital Gains     Gain On Cash     Foreign                            
                    (Losses)     Flow Hedging     Currency             Total     Non-        
    Common     Capital     On Securities,     Instruments,     Translation     Retained     Stockholder’s     Controlling     Total  
    Stock     Surplus     Net of Tax     Net of Tax     Adjs     Earnings     Equity     Interest     Equity  
2008
                                                                       
Balance, December 31, 2007
  $ 6     $ 3,746     $ (318 )   $ (137 )   $ 8     $ 5,315     $ 8,620     $ 255     $ 8,875  
Comprehensive income
                                                                       
Net loss
                                            (3,554 )     (3,554 )             (3,554 )
Other comprehensive income, net of tax (1)
                                                                       
net change in unrealized capital gains (losses) on securities (2)
                    (4,488 )                             (4,488 )             (4,488 )
Net loss on cash flow hedging instruments
                            577                       577               577  
Cumulative translation adjustments
                                    (173 )             (173 )             (173 )
 
                                                                   
Total other comprehensive loss
                                                    (4,084 )             (4,084 )
 
                                                                   
Total comprehensive loss
                                                    (7,638 )             (7,638 )
Capital contribution from parent (3)
            2,411                                       2,411               2,411  
Dividends declared
                                            (313 )     (313 )             (313 )
Cumulative effect of accounting changes, net of tax
                                            (2 )     (2 )             (2 )
 
                                                     
Change in noncontrolling interest ownership
                                                            15       15  
 
                                                     
Noncontrolling income (loss)
                                                            (105 )     (105 )
Balance, December 31, 2008
  $ 6     $ 6,157     $ (4,806 )   $ 440     $ (165 )   $ 1,446     $ 3,078     $ 165     $ 3,243  
 
                                                     
(1)  
Net change in unrealized capital gain on securities is reflected net of tax provision (benefit) and other items of $(699), $(1,739), and $2,416 for the years ended December 31, 2010, 2009 and 2008, respectively. Net (loss) gain on cash flow hedging instruments is net of tax provision (benefit) of $(63), $157 and $(310) for the years ended December 31, 2010, 2009 and 2008, respectively. There is no tax effect on cumulative translation adjustments.
 
(2)  
There were reclassification adjustments for after-tax gains (losses) realized in net income of $(121), $(1,076), and $(1,396) for the years ended December 31, 2010, 2009 and 2008, respectively.
 
(3)  
The Company received $2.1 billion in capital contributions from its parent and returned capital of $700 to its parent. The Company received noncash capital contributions of $887 as a result of valuations associated with the October 1, 2009 reinsurance transaction with an affiliated captive reinsurer. Refer to Note 16 Transactions with Affiliates. The Company received a noncash asset capital contribution of $180 from its parent company during 2008.
See Notes to Consolidated Financial Statements.

 

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HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
Consolidated Statements of Cash Flows
                         
    For the years ended December 31,  
(In millions)   2010     2009     2008  
Operating Activities
                       
Net income(loss)
  $ 752     $ (2,147 )   $ (3,659 )
Adjustments to reconcile net income(loss) to net cash provided by operating activities
                       
Amortization of deferred policy acquisition costs and present value of future profits
    232       3,727       1,620  
Additions to deferred policy acquisition costs and present value of future profits
    (521 )     (674 )     (1,258 )
Change in:
                       
Reserve for future policy benefits, unpaid losses and loss adjustment expenses
    13       574       1,161  
Reinsurance recoverables
    26       66       (29 )
Receivables and other assets
    (112 )     (20 )     66  
Payables and accruals
    295       420       (369 )
Accrued and deferred income taxes
    (90 )     (797 )     (2,166 )
Net realized capital losses
    882       877       5,763  
Net receipts from investment contracts related to policyholder funds — International unit-linked bonds and pension products
    (167 )     804       396  
Net increase in equity securities, trading
    164       (809 )     (386 )
Depreciation and amortization
    207       173       78  
Goodwill impairment
                184  
Other, net
    201       328       (190 )
 
                 
Net cash provided by operating activities
  $ 1,882     $ 2,522     $ 1,211  
 
                 
Investing Activities
                       
Proceeds from the sale/maturity/prepayment of:
                       
Fixed maturities and short-term investments, available for sale
  $ 28,581     $ 37,224     $ 12,104  
Fixed maturities, fair value option
    20              
Equity securities, available-for-sale
    171       162       140  
Mortgage loans
    1,288       413       325  
Partnerships
    151       173       250  
Payments for the purchase of:
                       
Fixed maturities and short-term investments, available for sale
    (28,871 )     (35,519 )     (18,216 )
Fixed maturities, fair value option
    (74 )            
Equity securities, available-for-sale
    (122 )     (61 )     (144 )
Mortgage loans
    (189 )     (197 )     (1,067 )
Partnerships
    (172 )     (121 )     (330 )
Derivatives payments (sales), net
    (644 )     (520 )     1,170  
Proceeds from business sold
    241              
Purchase price of businesses acquired
                (78 )
Change in policy loans, net
    (8 )     34       (139 )
Change in payables for collateral under securities lending, net
    (46 )     (1,805 )     (974 )
Change in all other, net
    (117 )     25       362  
 
                 
Net cash provided by (used for) investing activities
  $ 209     $ (192 )   $ (6,597 )
 
                 
Financing Activities
                       
Deposits and other additions to investment and universal life-type contracts
  $ 15,405     $ 13,398     $ 22,449  
Withdrawals and other deductions from investment and universal life-type contracts
    (25,030 )     (23,487 )     (28,105 )
Net transfers (to)/from separate accounts related to investment and universal life-type contracts
    8,211       6,805       7,074  
Issuance of structured financing
          (189 )     2,001  
Capital contributions (1) (2)
    (195 )     1,397       2,231  
Dividends paid (1)
          (33 )     (299 )
Net Issuances/(Repayments) at maturity or settlement of consumer notes
    (754 )     (74 )     401  
 
                 
Net cash provided by (used for) financing activities
  $ (2,363 )   $ (2,183 )   $ 5,752  
 
                 
Impact of foreign exchange
    10       (15 )     (128 )
Net (decrease) increase in cash
    (262 )     132       238  
 
                 
Cash — beginning of year
    793       661       423  
 
                 
Cash — end of year
  $ 531     $ 793     $ 661  
 
                 
Supplemental Disclosure of Cash Flow Information:
                       
Net Cash Paid (Received) During the Year for:
                       
Income taxes
  $ 354     $ (282 )   $ (183 )
Supplemental schedule of noncash operating and financing activities:
(1)  
The Company made noncash dividends of $5 in 2009 related to the assumed reinsurance agreements with Hartford Life Insurance K.K. The Company made noncash dividends of $54 and received a noncash capital contributions of $180 from its parent company during 2008 related to the assumed reinsurance agreement with Hartford Life Insurance K.K.
 
(2)  
The Company received noncash capital contributions of $887 as a result of valuations associated with an October 1, 2009 reinsurance transaction with an affiliated captive reinsurer. Refer to Note 16 Transactions with Affiliates for further discussion of this transaction.
See Notes to Consolidated Financial Statements.

 

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HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in millions, unless otherwise stated)
1. Basis of Presentation and Accounting Policies
Basis of Presentation
Hartford Life Insurance Company (together with its subsidiaries, “HLIC”, “Company”, “we” or “our”) is a provider of insurance and investment products in the United States of America (“U.S.”) and is an indirect wholly-owned subsidiary of The Hartford Financial Services Group, Inc. (“The Hartford”).
The Consolidated Financial Statements have been prepared on the basis of accounting principles generally accepted in the United States of America (“U.S. GAAP”), which differ materially from the accounting practices prescribed by various insurance regulatory authorities.
Consolidation
The Consolidated Financial Statements include the accounts of Hartford Life Insurance Company, companies in which the Company directly or indirectly has a controlling financial interest and those variable interest entities (“VIEs”) in which the Company is required to consolidate. Entities in which HLIC has significant influence over the operating and financing decisions but are not required to consolidate are reported using the equity method. Material intercompany transactions and balances between HLIC and its subsidiaries have been eliminated. For further information on VIEs, see Note 4.
Use of Estimates
The preparation of financial statements, in conformity with U.S. GAAP, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The most significant estimates include those used in determining estimated gross profits used in the valuation and amortization of assets and liabilities associated with variable annuity and other universal life-type contracts; living benefits required to be fair valued (in other policyholder funds and benefits payable); valuation of investments and derivative instruments; evaluation of other-than-temporary impairments on available-for-sale securities and valuation allowances on investments; goodwill impairment; 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.
Reclassifications
Certain reclassifications have been made to prior year financial year financial information to conform to the current year presentation.

 

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Table of Contents

HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
1. Basis of Presentation and Accounting Policies (continued)
Adoption of New Accounting Standards
Variable Interest Entities
In June 2009, the Financial Accounting Standards Board (“FASB”) updated the guidance which amends the consolidation requirements applicable to variable interest entities (“VIE”). Under this new guidance, an entity would consolidate a VIE when the entity has both (a) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and (b) the obligation to absorb losses of the entity that could potentially be significant to the VIE or the right to receive benefits from the entity that could potentially be significant to the VIE. The FASB also issued an amendment to this guidance in February 2010 which defers application of this guidance to certain entities that apply specialized accounting guidance for investment companies. The Company adopted this guidance on January 1, 2010. As a result of adoption, in addition to those VIEs the Company consolidates under the previous guidance, the Company consolidated a Company sponsored Collateralized Debt Obligation (“CDO”) electing the fair value option, and a Company sponsored Collateralized Loan Obligation, at carrying values carried forward as if the Company had been the primary beneficiary from the date the Company entered into the VIE arrangement. The impact on the Company’s Consolidated Balance Sheet as a result of adopting this guidance was an increase in assets of $432, an increase in liabilities of $406, and an increase in January 1, 2010 retained earnings, net of tax, of $26. The Company has investments in mutual funds, limited partnerships and other alternative investments, including hedge funds, mortgage and real estate funds, mezzanine debt funds, and private equity and other funds which may be VIEs. The accounting for these investments will remain unchanged as they fall within the scope of the deferral of this new consolidation guidance. See Note 4 for further discussion.
Embedded Credit Derivatives
In March 2010, the FASB issued guidance clarifying the scope exception for certain credit derivatives embedded within structured securities which may result in bifurcation of these credit derivatives. Embedded credit derivatives resulting only from subordination of one financial instrument to another continue to qualify for the exemption. As a result, investments with an embedded credit derivative in a form other than the above mentioned subordination may need to be separately accounted for as an embedded credit derivative resulting in recognition of the change in the fair value of the embedded credit derivative in current period earnings. Upon adoption, an entity may elect the fair value option prospectively, with changes in fair value of the investment in its entirety recognized in earnings, rather than bifurcate the embedded credit derivative. The guidance is effective, on a prospective basis only, for fiscal years and interim periods within those fiscal years, beginning on or after June 15, 2010. The Company adopted this guidance on July 1, 2010 and identified securities with an amortized cost and fair value of $753 and $464, respectively, which were impacted by the scope of this standard. Upon adoption, the Company elected the fair value option for securities having an amortized cost and fair value of $429 and $203, respectively. For further discussion of fair value option, see Note 3. For the remainder of securities that were impacted by the scope of this standard, upon adoption, the embedded credit derivatives were bifurcated but are reported with the host instrument in the consolidated balance sheets. As of July 1, 2010, these securities had an amortized cost and fair value of $324 and $261, respectively, with an associated embedded derivative notional value of $325. For further discussion of embedded derivatives, see Note 4. The adoption, on July 1, 2010 resulted in the reclassification of $172, after-tax and after deferred policy acquisition costs (“DAC”), net unrealized losses from accumulated other comprehensive loss to retained earnings, including $188 of unrealized capital losses and $16 of unrealized capital gains.
Future Adoption of New Accounting Standards
Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts
In October 2010, the FASB issued guidance clarifying the definition of acquisition costs that are eligible for deferral. Acquisition costs are to include only those costs that are directly related to the successful acquisition or renewal of insurance contracts; incremental direct costs of contract acquisition that are incurred in transactions with either independent third parties or employees; and advertising costs meeting the capitalization criteria for direct-response advertising.
This guidance will be effective for fiscal years beginning after December 15, 2011, and interim periods within those years. This guidance may be applied prospectively upon the date of adoption, with retrospective application permitted, but not required. Early adoption is permitted.
The Company will adopt this guidance on January 1, 2012. The Company has not yet determined if it will apply the guidance on a prospective or retrospective basis or the effect of the adoption on the Company’s Consolidated Financial Statements. If retrospective application is elected, the adoption could have a material impact on stockholders’ equity. If prospective application is elected, there could be a material impact to the Company’s Consolidated Statement of Operations as non-deferrable acquisition costs will increase while amortization would continue on the existing DAC balance.

 

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Table of Contents

HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
1. Basis of Presentation and Accounting Policies (continued)
Significant Accounting Policies
The Company’s significant accounting policies are described below or are referenced below to the applicable Note where the description is included.
         
Accounting Policy   Note  
Fair Value
    3  
Investments and Derivative Instruments
    4  
Reinsurance
    5  
Deferred Policy Acquisition Costs and Present Value of Future Profits
    6  
Goodwill and Other Intangible Assets
    7  
Separate Accounts
    8  
Sales Inducements
    9  
Commitments and Contingencies
    10  
Income Taxes
    11  
 
     
Revenue Recognition
For investment and universal life-type contracts, the amounts collected from policyholders are considered deposits and are not included in revenue. Fee income for universal life-type contracts consists of policy charges for policy administration, cost of insurance charges and surrender charges assessed against policyholders’ account balances and are recognized in the period in which services are provided. For the Company’s traditional life and group disability products premiums are recognized as revenue when due from policyholders.
Dividends to Policyholders
Policyholder dividends are paid to certain life insurance policyholders. Policies that receive dividends are referred to as participating policies. Such dividends are accrued using an estimate of the amount to be paid based on underlying contractual obligations under policies and applicable state laws.
As of December 31, 2010, 2009, and 2008 3% of the total life insurance policies were participating policies. Dividends to policyholders were $21, $12 and $13 for the years ended December 31, 2010, 2009, and 2008, respectively. There were no additional amounts of income allocated to participating policyholders. If limitations exist on the amount of net income from participating life insurance contracts that may be distributed to stockholder’s, the policyholder’s share of net income on those contracts that cannot be distributed is excluded from stockholder’s equity by a charge to operations and a credit to a liability.
Cash
Cash represents cash on hand and demand deposits with banks or other financial institutions.
Other Policyholder Funds and Benefits Payable
The Company has classified its fixed and variable annuities, 401(k), certain governmental annuities, private placement life insurance (“PPLI”), variable universal life insurance, universal life insurance and interest sensitive whole life insurance as universal life-type contracts. The liability for universal life-type contracts is equal to the balance that accrues to the benefit of the policyholders as of the financial statement date (commonly referred to as the account value), including credited interest, amounts that have been assessed to compensate the Company for services to be performed over future periods, and any amounts previously assessed against policyholders that are refundable on termination of the contract.
The Company has classified its institutional and governmental products, without life contingencies, including funding agreements, certain structured settlements and guaranteed investment contracts, as investment contracts. The liability for investment contracts is equal to the balance that accrues to the benefit of the contract holder as of the financial statement date, which includes the accumulation of deposits plus credited interest, less withdrawals and amounts assessed through the financial statement date. Contract holder funds include funding agreements held by Variable Interest Entities issuing medium-term notes.

 

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Table of Contents

HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
1. Basis of Presentation and Accounting Policies (continued)
Reserve for Future Policy Benefits and Unpaid Losses and Loss Adjustment
Liabilities for the Company’s group life and disability contracts as well its individual term life insurance policies include amounts for unpaid losses and future policy benefits. Liabilities for unpaid losses include estimates of amounts to fully settle known reported claims as well as claims related to insured events that the Company estimates have been incurred but have not yet been reported. Liabilities for future policy benefits are calculated by the net level premium method using interest, withdrawal and mortality assumptions appropriate at the time the policies were issued. The methods used in determining the liability for unpaid losses and future policy benefits are standard actuarial methods recognized by the American Academy of Actuaries. For the tabular reserves, discount rates are based on the Company’s earned investment yield and the morbidity/mortality tables used are standard industry tables modified to reflect the Company’s actual experience when appropriate. In particular, for the Company’s group disability known claim reserves, the morbidity table for the early durations of claim is based exclusively on the Company’s experience, incorporating factors such as gender, elimination period and diagnosis. These reserves are computed such that they are expected to meet the Company’s future policy obligations. Future policy benefits are computed at amounts that, with additions from estimated premiums to be received and with interest on such reserves compounded annually at certain assumed rates, are expected to be sufficient to meet the Company’s policy obligations at their maturities or in the event of an insured’s death. Changes in or deviations from the assumptions used for mortality, morbidity, expected future premiums and interest can significantly affect the Company’s reserve levels and related future operations and, as such, provisions for adverse deviation are built into the long-tailed liability assumptions.
Certain contracts classified as universal life-type may also include additional death or other insurance benefit features, such as guaranteed minimum death benefits offered with variable annuity contracts and no lapse guarantees offered with universal life insurance contracts. An additional liability is established for these benefits by estimating the expected present value of the benefits in excess of the projected account value in proportion to the present value of total expected assessments. Excess benefits are accrued as a liability as actual assessments are recorded. Determination of the expected value of excess benefits and assessments are based on a range of scenarios and assumptions including those related to market rates of return and volatility, contract surrender rates and mortality experience. Revisions to assumptions are made consistent with the Company’s process for a DAC unlock. For further information, see MD&A, Critical Accounting Estimates, Life Deferred Policy Acquisition Costs and Present Value of Future Benefits.
Discontinued Operations
The results of operations of a component of the Company that either has been disposed of or is classified as held-for-sale are reported in discontinued operations if the operations and cash flows of the component have been or will be eliminated from the ongoing operations of the Company as a result of the disposal transaction and the Company will not have any significant continuing involvement in the operations of the component after the disposal transaction.
Foreign Currency Translation
Foreign currency translation gains and losses are reflected in stockholders’ equity as a component of accumulated other comprehensive income. The Company’s foreign subsidiaries’ balance sheet accounts are translated at the exchange rates in effect at each year end and income statement accounts are translated at the average rates of exchange prevailing during the year. The national currencies of the international operations are generally their functional currencies.
Mutual Funds
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. As such, the mutual fund assets and liabilities and related investment returns are not reflected in the Company’s Consolidated Financial Statements since they are not assets, liabilities and operations of the Company.

 

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Table of Contents

HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
2. Segment Information
The Company has four reporting segments: Global Annuity, Life Insurance, Retirement Plans, and Mutual Funds, as well as an Other category, as follows:
Global Annuity
Global Annuity offers variable, fixed market value adjusted (“MVA”) annuities, structured settlements, single premium immediate annuities, longevity assurance to individuals as well as customized investment, insurance, and income solutions to select markets of institutional investors. Products offered to institutional investors (“IIP”) include mutual funds, stable value contracts, institutional annuities (primarily terminal funding cases) and mutual funds owned by institutional investors.
Life Insurance
Life Insurance sells a variety of life insurance products, including variable universal life, universal life, interest sensitive whole life, term life, and variable private placement life insurance (“PPLI”) owned by corporations and high net worth individuals.
Retirement Plans
Retirement Plans provides products and services to corporations pursuant to Section 401(k) and products and services to municipalities and not-for-profit organizations under Section 457 and 403(b) of the Internal Revenue Service Code of 1986 as amended (“the IRS Code”).
Mutual Funds
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 fund supporting the insurance products issued by The Hartford.
Other category
The Company includes in an Other category its leveraged PPLI product line of business, corporate items not directly allocated to any of its reporting segments, intersegment eliminations, direct and assumed guaranteed minimum income benefit (“GMIB”), guaranteed minimum death benefit (“GMDB”), guaranteed minimum accumulation benefit (“GMAB”) and guaranteed minimum withdrawal benefit (“GMWB”) which is subsequently ceded to an affiliated captive reinsurer, and certain group benefit products, including group life and group disability insurance that is directly written by the Company and for which nearly half is ceded to its parent, Hartford Life and Accident Insurance Company (“HLA”).
The accounting policies of the reporting segments are the same as those described in the summary of significant accounting policies in Note 1. The Company evaluates performance of its segments based on revenues, net income and the segment’s return on allocated capital. Each operating segment is allocated corporate surplus as needed to support its business.
The Company charges direct operating expenses to the appropriate segment and allocates the majority of indirect expenses to the segments based on an intercompany expense arrangement. Inter-segment revenues primarily occur between the Company’s Other category and the reporting segments. These amounts primarily include interest income on allocated surplus and interest charges on excess separate account surplus. Consolidated net investment income is unaffected by such transactions.
The following tables represent summarized financial information concerning the Company’s reporting segments.
                 
    As of December 31,  
Assets   2010     2009  
Global Annuity
  $ 122,962     $ 126,326  
Life Insurance
    63,390       54,376  
Retirement Plans
    34,153       28,180  
Mutual Funds
    153       140  
Other
    11,094       12,298  
 
           
Total assets
  $ 231,752     $ 221,320  
 
           

 

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Table of Contents

HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
2. Segment Information (continued)
                         
Revenues by Product Line   For the years ended December 31,  
Revenues   2010     2009     2008  
Earned premiums, fees, and other considerations
                       
Global Annuity
                       
Individual variable annuity
  $ 1,760     $ 1,589     $ 1,981  
Fixed / MVA and other annuity
    18       17       (2 )
IIP
    24       386       929  
 
                 
Total Global Annuity
    1,802       1,992       2,908  
Life Insurance
                       
Variable life
    416       503       374  
Universal life
    367       362       376  
Term life
    36       37       42  
PPLI
    174       115       119  
 
                 
Total Life Insurance
    993       1,017       911  
Retirement Plans
                       
401(k)
    318       286       290  
Government plans
    41       38       48  
 
                 
Total Retirement Plans
    359       324       338  
Mutual Funds
                       
Non-Proprietary
    519       437       553  
Proprietary
    61              
 
                 
Total Mutual Funds
    580       437       553  
Other
    332       330       397  
 
                 
Total premiums, fees, and other considerations
    4,066       4,100       5,107  
 
                 
Net investment income
    2,859       2,848       2,342  
Net realized capital losses
    (944 )     (876 )     (5,763 )
 
                 
Total Revenues
  $ 5,981     $ 6,072     $ 1,686  
 
                 
Net income (loss) attributable to Hartford Life Insurance Company
                       
Global Annuity
  $ 231     $ (2,620 )   $ (1,866 )
Life Insurance
    224       28       (22 )
Retirement Plans
    47       (222 )     (157 )
Mutual Funds
    129       32       37  
Other
    113       625       (1,546 )
 
                 
Total net income (loss)
  $ 744     $ (2,157 )   $ (3,554 )
 
                 
Net investment income (loss)
                       
Global Annuity
  $ 1,808     $ 1,929     $ 1,539  
Life Insurance
    485       317       313  
Retirement Plans
    364       315       342  
Mutual Funds
    (1 )     (16 )     (12 )
Other
    203       303       160  
 
                 
Total net investment income
  $ 2,859     $ 2,848     $ 2,342  
 
                 
Amortization of deferred policy acquisition and present value of future profits
                       
Global Annuity
  $ 15     $ 3,297     $ 1,268  
Life Insurance
    122       315       168  
Retirement Plans
    27       56       91  
Mutual Funds
    51       50       86  
Other
          (2 )     (3 )
 
                 
Total amortization of DAC
  $ 215     $ 3,716     $ 1,610  
 
                 
Income tax expense (benefit)
                       
Global Annuity
  $ 23     $ (1,604 )   $ (1,196 )
Life Insurance
    103       (27 )     (35 )
Retirement Plans
    13       (143 )     (133 )
Mutual Funds
    51       20       22  
Other
    38       355       (838 )
 
                 
Total income tax expense (benefit)
  $ 228     $ (1,399 )   $ (2,180 )
 
                 

 

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Table of Contents

HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Fair Value Measurements
The following financial instruments are carried at fair value in the Company’s Condensed Consolidated Financial Statements: fixed maturity and equity securities, available-for-sale (“AFS”), fixed maturities at fair value using fair value option (“FVO”), equity securities, trading, short-term investments, freestanding and embedded derivatives, separate account assets and certain other liabilities.
The following section applies the fair value hierarchy and disclosure requirements for the Company’s financial instruments that are carried at fair value. The fair value hierarchy prioritizes the inputs in the valuation techniques used to measure fair value into three broad Levels (Level 1, 2, and 3).
     
Level 1
  Observable inputs that reflect quoted prices for identical assets or liabilities in active markets that the Company has the ability to access at the measurement date. Level 1 securities include highly liquid U.S. Treasuries, money market funds, and exchange traded equity and derivative securities.
 
   
Level 2
  Observable inputs, other than quoted prices included in Level 1, for the asset or liability or prices for similar assets and liabilities. Most debt securities and some preferred stocks are model priced by vendors using observable inputs and are classified within Level 2. Also included in the Level 2 category are exchange traded equity securities, derivative instruments that are priced using models with observable market inputs, including interest rate, foreign currency and certain credit default swap contracts and have no significant unobservable market inputs.
 
   
Level 3
  Valuations that are derived from techniques in which one or more of the significant inputs are unobservable (including assumptions about risk). Level 3 securities include less liquid securities such as and/or lower quality asset-backed securities (“ABS”) and commercial mortgage-backed securities (“CMBS”), commercial real estate (“CRE”) CDOs, residential mortgage-backed securities (“RMBS”) primarily below-prime loans, and below investment grade private placement securities. Also included in Level 3 are guaranteed product embedded and reinsurance derivatives and other complex derivatives securities, including customized GMWB hedging derivatives, equity derivatives, longer dated derivatives, swaps with optionality, and certain complex credit derivatives and certain other liabilities. Because Level 3 fair values, by their nature, contain unobservable inputs as there is little or no observable market for these assets and liabilities, considerable judgment is used to determine the Level 3 fair values. Level 3 fair values represent the Company’s best estimate of an amount that could be realized in a current market exchange absent actual market exchanges.
In many situations, inputs used to measure the fair value of an asset or liability position may fall into different levels of the fair value hierarchy. In these situations, the Company will determine the level in which the fair value falls based upon the lowest level input that is significant to the determination of the fair value. Transfers of securities among the levels occur at the beginning of the reporting period. Transfers between Level 1 and Level 2 were not material for the year ended December 31, 2010. In most cases, both observable (e.g., changes in interest rates) and unobservable (e.g., changes in risk assumptions) inputs are used in the determination of fair values that the Company has classified within Level 3. Consequently, these values and the related gains and losses are based upon both observable and unobservable inputs. The Company’s fixed maturities included in Level 3 are classified as such as they are primarily priced by independent brokers and/or within illiquid markets.

 

F-14


Table of Contents

HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Fair Value Measurements (continued)
                                 
    December 31, 2010  
            Quoted Prices              
            in Active     Significant     Significant  
            Markets for     Observable     Unobservable  
            Identical Assets     Inputs     Inputs  
    Total     (Level 1)     (Level 2)     (Level 3)  
Assets accounted for at fair value on a recurring basis
                               
Fixed maturities, AFS
                               
ABS
  $ 2,068     $     $ 1,660     $ 408  
CDOs
    1,899             30       1,869  
CMBS
    5,028             4,536       492  
Corporate
    26,915             25,429       1,486  
Foreign government/government agencies
    1,002             962       40  
States, municipalities and political subdivisions (“Municipal”)
    1,032             774       258  
RMBS
    4,118             3,013       1,105  
U.S. Treasuries
    2,772       248       2,524        
 
                       
Total fixed maturities
    44,834       248       38,928       5,658  
Fixed maturities, FVO
    639             128       511  
Equity securities, trading
    2,279       2,279              
Equity securities, AFS
    340       174       119       47  
Derivative assets
                               
Credit derivatives
    (11 )           (19 )     8  
Equity derivatives
    2                   2  
Foreign exchange derivatives
    857             857        
Interest rate derivatives
    (99 )           (63 )     (36 )
Variable annuity hedging derivatives and macro hedge program
    704       2       33       669  
 
                       
Total derivative assets [1]
    1,453       2       808       643  
Short-term investments
    3,489       204       3,285        
Reinsurance recoverable for U.S. GMWB and Japan GMWB, GMIB, and GMAB
    2,002                   2,002  
Separate account assets [2]
    153,713       116,703       35,763       1,247  
 
                       
Total assets accounted for at fair value on a recurring basis
  $ 208,749       119,610       79,031       10,108  
 
                       
Liabilities accounted for at fair value on a recurring basis
                               
Other policyholder funds and benefits payable
                               
Guaranteed living benefits
  $ (4,258 )   $     $     $ (4,258 )
Equity linked notes
    (9 )                 (9 )
 
                       
Total other policyholder funds and benefits payable
    (4,267 )                 (4,267 )
Derivative liabilities
                               
Credit derivatives
    (401 )           (49 )     (352 )
Equity derivatives
    2                   2  
Foreign exchange derivatives
    (25 )           (25 )      
Interest rate derivatives
    (59 )           (42 )     (17 )
Variable annuity hedging derivatives and macro hedge program
    126       (2 )     (11 )     139  
 
                       
Total derivative liabilities [3]
    (357 )     (2 )     (127 )     (228 )
Other liabilities
    (37 )                 (37 )
Consumer notes [4]
    (5 )                 (5 )
 
                       
Total liabilities accounted for at fair value on a recurring basis
  $ (4,666 )   $ (2 )   $ (127 )   $ (4,537 )
 
                       
[1]  
Includes over-the-counter derivative instruments in a net asset value position which may require the counterparty to pledge collateral to the Company. At December 31, 2010, $962 was the amount of cash collateral liability that was netted against the derivative asset value on the Consolidated Balance Sheet, and is excluded from the table above. For further information on derivative liabilities, see below in this Note 3.
 
[2]  
As of December 31, 2010 excludes approximately $6 billion of investment sales receivable that are not subject to fair value accounting.
 
[3]  
Includes over-the-counter derivative instruments in a net negative market value position (derivative liability). In the Level 3 roll forward table included below in this Note, the derivative asset and liability are referred to as “freestanding derivatives” and are presented on a net basis.
 
[4]  
Represents embedded derivatives associated with non-funding agreement-backed consumer equity-linked notes.

 

F-15


Table of Contents

HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Fair Value Measurements (continued)
                                 
    December 31, 2009  
            Quoted Prices              
            in Active     Significant     Significant  
            Markets for     Observable     Unobservable  
            Identical Assets     Inputs     Inputs  
    Total     (Level 1)     (Level 2)     (Level 3)  
Assets accounted for at fair value on a recurring basis
                               
Fixed maturities, AFS
                               
ABS
  $ 1,903     $     $ 1,406     $ 497  
CDOs
    2,165             56       2,109  
CMBS
    5,365             5,096       269  
Corporate
    23,667             18,428       5,239  
Foreign government/government agencies
    846             766       80  
States, municipalities and political subdivisions (“Municipal”)
    780             562       218  
RMBS
    3,336             2,341       995  
U.S. Treasuries
    2,341       325       2,016        
 
                       
Total fixed maturities, AFS
    40,403       325       30,671       9,407  
Equity securities, trading
    2,443       2,443              
Equity securities, AFS
    419       113       274       32  
Other investments
                               
Variable annuity hedging derivatives and macro hedge program
    212       8       16       188  
Other derivatives [1]
    8             (4 )     12  
 
                       
Total other investments
    220       8       12       200  
Short-term investments
    5,128       3,785       1,343        
Reinsurance recoverable for U.S. GMWB and Japan GMWB, GMIB, and GMAB
    1,108                   1,108  
Separate account assets [3]
    147,418       112,863       33,593       962  
 
                       
Total assets accounted for at fair value on a recurring basis
  $ 197,139     $ 119,537     $ 65,893     $ 11,709  
 
                       
Liabilities accounted for at fair value on a recurring basis
                               
Other policyholder funds and benefits payable
                               
Guaranteed living benefits
  $ (3,439 )   $     $     $ (3,439 )
Institutional notes
    (2 )                 (2 )
Equity linked notes
    (10 )                 (10 )
 
                       
Total other policyholder funds and benefits payable
    (3,451 )                 (3,451 )
Other liabilities [4]
                               
Variable annuity hedging derivatives and macro hedge program
    158       (2 )     (178 )     338  
Other derivative liabilities
    (45 )           125       (170 )
 
                       
Total other liabilities
    113       (2 )     (53 )     168  
Consumer notes [5]
    (5 )                 (5 )
 
                       
Total liabilities accounted for at fair value on a recurring basis
  $ (3,343 )   $ (2 )   $ (53 )   $ (3,288 )
 
                       
[1]  
Includes over-the-counter derivative instruments in a net asset value position which may require the counterparty to pledge collateral to the Company. At December 31, 2009, $104 was the amount of cash collateral liability that was netted against the derivative asset value on the Consolidated Balance Sheet, and is excluded from the table above. See footnote 3 below for derivative liabilities.
 
[2]  
Includes fair value of reinsurance recoverables of approximately $761 related to a transaction entered into on October 1, 2009 with an affiliated captive reinsurer. Please see Note 16 Transactions with Affiliates for more information.
 
[3]  
As of December 31, 2009 excludes approximately $3 billion of investment sales receivable that are not subject to fair value accounting.
 
[4]  
Includes over-the-counter derivative instruments in a net negative market value position (derivative liability). In the Level 3 roll forward table included below in this Note, the derivative asset and liability are referred to as “freestanding derivatives” and are presented on a net basis.
 
[5]  
Represents embedded derivatives associated with non-funding agreement-backed consumer equity-linked notes.
Determination of Fair Values
The valuation methodologies used to determine the fair values of assets and liabilities under the “exit price” notion, reflect market-participant objectives and are based on the application of the fair value hierarchy that prioritizes relevant observable market inputs over unobservable inputs. The Company determines the fair values of certain financial assets and financial liabilities based on quoted market prices where available and where prices represent a reasonable estimate of fair value. The Company also determines fair value based on future cash flows discounted at the appropriate current market rate. Fair values reflect adjustments for counterparty credit quality, the Company’s default spreads, liquidity and, where appropriate, risk margins on unobservable parameters. The following is a discussion of the methodologies used to determine fair values for the financial instruments listed in the above tables.

 

F-16


Table of Contents

HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Fair Value Measurements (continued)
Available-for-Sale Securities, Fixed Maturities, FVO, Equity Securities, Trading, and Short-term Investments
The fair value of AFS securities, fixed maturities, FVO, equity securities, trading, and short-term investments in an active and orderly market (e.g. not distressed or forced liquidation) is determined by management after considering one of three primary sources of information: third party pricing services, independent broker quotations or pricing matrices. Security pricing is applied using a “waterfall” approach whereby publicly available prices are first sought from third party pricing services, the remaining unpriced securities are submitted to independent brokers for prices, or lastly, securities are priced using a pricing matrix. Based on the typical trading volumes and the lack of quoted market prices for fixed maturities, third party pricing services will normally derive the security prices from recent reported trades for identical or similar securities making adjustments through the reporting date based upon available market observable information as outlined above. If there are no recently reported trades, the third party pricing services and independent brokers may use matrix or model processes to develop a security price where future cash flow expectations are developed based upon collateral performance and discounted at an estimated market rate. Included in the pricing of ABS and RMBS are estimates of the rate of future prepayments of principal over the remaining life of the securities. Such estimates are derived based on the characteristics of the underlying structure and prepayment speeds previously experienced at the interest rate levels projected for the underlying collateral. Actual prepayment experience may vary from these estimates.
Prices from third-party pricing services are often unavailable for securities that are rarely traded or are traded only in privately negotiated transactions. As a result, certain securities are priced via independent broker quotations which utilize inputs that may be difficult to corroborate with observable market based data. Additionally, the majority of these independent broker quotations are non-binding.
A pricing matrix is used to price private placement securities for which the Company is unable to obtain either a price from a third-party pricing service by discounting the expected future cash flows from the security by a developed market discount rate utilizing current credit spreads. Credit spreads are developed each month using market based data for public securities adjusted for credit spread differentials between public and private securities which are obtained from a survey of multiple private placement brokers. The appropriate credit spreads determined through this survey approach are based upon the issuer’s financial strength and term to maturity, utilizing an independent public security index and trade information and adjusting for the non-public nature of the securities. For the quarter ended September 30, 2010, the Company compared the results of the private placement pricing model to actual trades, as well as to third party broker quotes and determined that the pricing model results were consistent with market observable data for investment grade private placement securities. As a result, the Company reclassified investment grade private placement securities from Level 3 to Level 2. Below investment grade private placement securities remain classified as Level 3.
The Company performs a monthly analysis of the prices and credit spreads received from third parties to ensure that the prices represent a reasonable estimate of the fair value. As a part of this analysis, the Company considers trading volume and other factors to determine whether the decline in market activity is significant when compared to normal activity in an active market, and if so, whether transactions may not be orderly considering the weight of available evidence. If the available evidence indicates that pricing is based upon transactions that are stale or not orderly, the Company places little, if any, weight on the transaction price and will estimate fair value utilizing an internal pricing model. This process involves quantitative and qualitative analysis and is overseen by investment and accounting professionals. Examples of procedures performed include, but are not limited to, initial and on-going review of third party pricing services’ methodologies, review of pricing statistics and trends, back testing recent trades, and monitoring of trading volumes, new issuance activity and other market activities. In addition, the Company ensures that prices received from independent brokers represent a reasonable estimate of fair value through the use of internal and external cash flow models developed based on spreads, and when available, market indices. As a result of this analysis, if the Company determines that there is a more appropriate fair value based upon the available market data, the price received from the third party is adjusted accordingly. The Company’s internal pricing model utilizes the Company’s best estimate of expected future cash flows discounted at a rate of return that a market participant would require. The significant inputs to the model include, but are not limited to, current market inputs, such as credit loss assumptions, estimated prepayment speeds and market risk premiums.
The Company has analyzed the third-party pricing services’ valuation methodologies and related inputs, and has also evaluated the various types of securities in its investment portfolio to determine an appropriate fair value hierarchy level based upon trading activity and the observability of market inputs. Most prices provided by third party pricing services are classified into Level 2 because the inputs used in pricing the securities are market observable. Due to a general lack of transparency in the process that brokers use to develop prices, most valuations that are based on brokers’ prices are classified as Level 3. Some valuations may be classified as Level 2 if the price can be corroborated with observable market data.

 

F-17


Table of Contents

HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Fair Value Measurements (continued)
Derivative Instruments, including embedded derivatives within investments
Derivative instruments are fair valued using pricing valuation models; that utilize independent market data inputs, quoted market prices for exchange-traded derivatives, or independent broker quotations. Excluding embedded and reinsurance related derivatives, as of December 31, 2010 and 2009, 97% and 96%, respectively, of derivatives, based upon notional values, were priced by valuation models or quoted market prices. The remaining derivatives were priced by broker quotations. The Company performs a monthly analysis on derivative valuations which includes both quantitative and qualitative analysis. Examples of procedures performed include, but are not limited to, review of pricing statistics and trends, back testing recent trades, analyzing the impacts of changes in the market environment, and review of changes in market value for each derivative including those derivatives priced by brokers.
The Company utilizes derivative instruments to manage the risk associated with certain assets and liabilities. However, the derivative instrument may not be classified with the same fair value hierarchy level as the associated assets and liabilities. Therefore the realized and unrealized gains and losses on derivatives reported in Level 3 may not reflect the offsetting impact of the realized and unrealized gains and losses of the associated assets and liabilities.
Valuation Techniques and Inputs for Investments
Generally, the Company determines the estimated fair value of its AFS securities, fixed maturities, FVO, equity securities, trading, and short-term investments using the market approach. The income approach is used for securities priced using a pricing matrix, as well as for derivative instruments. For Level 1 investments, which are comprised of on-the-run U.S. Treasuries, exchange-traded equity securities, short-term investments, and exchange traded futures and option contracts, valuations are based on observable inputs that reflect quoted prices for identical assets in active markets that the Company has the ability to access at the measurement date.
For most of the Company’s debt securities, the following inputs are typically used in the Company’s pricing methods: reported trades, benchmark yields, bids and/or estimated cash flows. For securities except U.S. Treasuries, inputs also include issuer spreads, which may consider credit default swaps. Derivative instruments are valued using mid-market inputs that are predominantly observable in the market.
A description of additional inputs used in the Company’s Level 2 and Level 3 measurements is listed below:
     
Level 2
  The fair values of most of the Company’s Level 2 investments are determined by management after considering prices received from third party pricing services. These investments include most fixed maturities and preferred stocks, including those reported in separate account assets.
   
ABS, CDOs, CMBS and RMBS — Primary inputs also include monthly payment information, collateral performance, which varies by vintage year and includes delinquency rates, collateral valuation loss severity rates, collateral refinancing assumptions, credit default swap indices and, for ABS and RMBS, estimated prepayment rates.
   
Corporates — Primary inputs also include observations of credit default swap curves related to the issuer.
   
Foreign government/government agencies - Primary inputs also include observations of credit default swap curves related to the issuer and political events in emerging markets.
   
Municipals — Primary inputs also include Municipal Securities Rulemaking Board reported trades and material event notices, and issuer financial statements.
   
Short-term investments — Primary inputs also include material event notices and new issue money market rates.
   
Equity securities, trading — Consist of investments in mutual funds. Primary inputs include net asset values obtained from third party pricing services.
   
Credit derivatives — Significant inputs primarily include the swap yield curve and credit curves.
   
Foreign exchange derivatives — Significant inputs primarily include the swap yield curve, currency spot and forward rates, and cross currency basis curves.
   
Interest rate derivatives — Significant input is primarily the swap yield curve.

 

F-18


Table of Contents

HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Fair Value Measurements (continued)
     
Level 3
  Most of the Company’s securities classified as Level 3 are valued based on brokers’ prices. Certain long-dated securities are priced based on third party pricing services, including municipal securities and foreign government/government agencies, as well as bank loans and below investment grade private placement securities. Primary inputs for these long-dated securities are consistent with the typical inputs used in Level 1 and Level 2 measurements noted above, but include benchmark interest rate or credit spread assumptions that are not observable in the marketplace. Also included in Level 3 are certain derivative instruments that either have significant unobservable inputs or are valued based on broker quotations. Significant inputs for these derivative contracts primarily include the typical inputs used in the Level 1 and Level 2 measurements noted above, but also may include the following:
   
Credit derivatives — Significant unobservable inputs may include credit correlation and swap yield curve and credit curve extrapolation beyond observable limits.
   
Equity derivatives — Significant unobservable inputs may include equity volatility.
   
Interest rate contracts — Significant unobservable inputs may include swap yield curve extrapolation beyond observable limits and interest rate volatility.
Product Derivatives
The Company currently offers certain variable annuity products with a guaranteed minimum withdrawal benefit (“GMWB”) rider in the U.S., and formerly offered GMWBs in the U.K. The Company has also assumed, through reinsurance, from HLIKK GMIB, GMWB and GMAB. As of October 1, 2009 the Company has subsequently ceded the GMWB and assumed reinsurance from HLIKK to an affiliated captive reinsurer. The GMWB represents an embedded derivative in the variable annuity contract. When it is determined that (1) the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, and (2) a separate instrument with the same terms would qualify as a derivative instrument, the embedded derivative is bifurcated from the host for measurement purposes. The embedded derivative, which is reported with the host instrument in theConsolidated Balance Sheets, is carried at fair value with changes in fair value reported in net realized capital gains and losses. The Company’s GMWB liability is carried at fair value and reported in other policyholder funds.
In valuing the embedded derivative, the Company attributes to the derivative a portion of the fees collected from the contract holder equal to the present value of future GMWB claims (the “Attributed Fees”). All changes in the fair value of the embedded derivative are recorded in net realized capital gains and losses. The excess of fees collected from the contract holder over the Attributed Fees are associated with the host variable annuity contract reported in fee income.
The reinsurance assumed on the HLIKK GMIB, GMWB, and GMAB and ceded to an affiliated captive reinsurer meet the characteristics of a free-standing derivative instrument. As a result, the derivative asset or liability is recorded at fair value with changes in the fair value reported in net realized capital gains and losses.
U.S. GMWB Ceded Reinsurance Derivative
The fair value of the U.S. GMWB reinsurance derivative is calculated as an aggregation of the components described in the Living Benefits Required to be Fair Valued discussion below and is modeled using significant unobservable policyholder behavior inputs, identical to those used in calculating the underlying liability, such as lapses, fund selection, resets and withdrawal utilization and risk margins.
During 2009, the Company entered into a reinsurance arrangement with an affiliated captive reinsurer to transfer a portion of its risk of loss associated with direct US GMWB and assumed HLIKK GMIB, GMWB, and GMAB. This arrangement is recognized as a derivative and carried at fair value in reinsurance recoverables. Changes in the fair value of the reinsurance agreement are reported in net realized capital gains and losses. Please see Note 16 for more information on this transaction.
Adoption of Fair Value Accounting
The impact on January 1, 2008 of adopting fair value measurement guidance for guaranteed benefits and the related reinsurance was a reduction to net income of $311, after the effects of DAC amortization and income taxes.
The adoption of fair value accounting resulted in lower variable annuity fee income for new business issued as Attributed Fees increased consistent with incorporating additional risk margins and other indicia of “exit value” in the valuation of the embedded derivative. The level of Attributed Fees for new business each quarter also depends on the level of equity index volatility, as well as other factors, including interest rates. As equity index volatility increased, interest rates have declined and fees ascribed to new business cohorts issued have risen to levels above the rider fee for most products. The extent of any excess of Attributed Fee over rider fee will vary by product.

 

F-19


Table of Contents

HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Fair Value Measurements (continued)
Separate Account Assets
Separate account assets are primarily invested in mutual funds but also have investments in fixed maturity and equity securities. The separate account investments are valued in the same manner, and using the same pricing sources and inputs, as the fixed maturity, equity security, and short-term investments of the Company.
Living Benefits Required to be Fair Valued (in Other Policyholder Funds and Benefits Payable)
Fair values for GMWB and guaranteed minimum accumulation benefit (“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 Costs calculated based on actuarial and capital market assumptions related to projected cash flows over the lives of the contracts; Credit Standing Adjustment; and Margins representing an amount that market participants would require for the risk that the Company’s assumptions about policyholder behavior could differ from actual experience. 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. Each component described below is unobservable in the marketplace and requires subjectivity by the Company in determining their value.
Best Estimate Claims Costs
The Best Estimate Claims Costs is calculated based on actuarial and capital market assumptions related to projected cash flows, including the present value of benefits and related contract charges, over the lives of the contracts, incorporating expectations concerning policyholder behavior such as lapses, fund selection, resets and withdrawal utilization (for the customized derivatives, policyholder behavior is prescribed in the derivative contract). Because of the dynamic and complex nature of these cash flows, best estimate assumptions and a Monte Carlo stochastic process involving the generation of thousands of scenarios that assume risk neutral returns consistent with swap rates and a blend of observable implied index volatility levels were used. Estimating these cash flows involves numerous estimates and subjective judgments including those regarding expected markets rates of return, market volatility, correlations of market index returns to funds, fund performance, discount rates and various actuarial assumptions for policyholder behavior which emerge over time.
At each valuation date, the Company assumes expected returns based on:
 
risk-free rates as represented by the Eurodollar futures, LIBOR deposits and swap rates to derive forward curve rates;
 
market implied volatility assumptions for each underlying index based primarily on a blend of observed market “implied volatility” data;
 
correlations of historical returns across underlying well known market indices based on actual observed returns over the ten years preceding the valuation date; and
 
three years of history for fund regression.
As many guaranteed benefit obligations are relatively new in the marketplace, actual policyholder behavior experience is limited. As a result, estimates of future policyholder behavior are subjective and based on analogous internal and external data. As markets change, mature and evolve and actual policyholder behavior emerges, management continually evaluates the appropriateness of its assumptions for this component of the fair value model.
On a daily basis, the Company updates capital market assumptions used in the GMWB liability model such as interest rates and equity indices. On a weekly basis, the blend of implied equity index volatilities are updated. The Company continually monitors various aspects of policyholder behavior and may modify certain of its assumptions, including living benefit lapses and withdrawal rates, if credible emerging data indicates that changes are warranted. At a minimum, all policyholder behavior assumptions are reviewed and updated, as appropriate, in conjunction with the completion of the Company’s comprehensive study to refine its estimate of future gross profits during the third quarter of each year.

 

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Table of Contents

HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Fair Value Measurements (continued)
Credit Standing Adjustment
This assumption makes an adjustment that market participants would make, in determining fair value, to reflect the risk that guaranteed benefit obligations or the GMWB reinsurance recoverables will not be fulfilled (“nonperformance risk”). As a result of sustained volatility in the Company’s credit default spreads, during 2009 the Company changed its estimate of the Credit Standing Adjustment to incorporate a blend of observable Company and reinsurer credit default spreads from capital markets, adjusted for market recoverability. Prior to the first quarter of 2009, the Company calculated the Credit Standing Adjustment by using default rates published by rating agencies, adjusted for market recoverability. For the year ended December 30, 2010, 2009 and 2008, the credit standing adjustment assumption, net of reinsurance and exclusive of the impact of the credit standing adjustment on other market sensitivities, resulted in pre-tax realized gains (losses) of $(8), $(263) and $10, respectively.
Margins
The behavior risk margin adds a margin that market participants would require for the risk that the Company’s assumptions about policyholder behavior could differ from actual experience. The behavior risk margin is calculated by taking the difference between adverse policyholder behavior assumptions and best estimate assumptions.
Assumption updates, including policyholder behavior assumptions, affected best estimates and margins for a total pre-tax realized gains (losses) of approximately $45, $231, and $470 for the year ended December, 31, 2010, 2009 and 2008, respectively.
In addition to the non-market-based updates described above, the Company recognized non-market-based updates driven by the relative outperformance (underperformance) of the underlying actively managed funds as compared to their respective indices resulting in before-tax realized gains/(losses) of approximately $31, $481 and $(355) for the year ended December 31, 2010, 2009 and 2008, respectively.
Assets and Liabilities Measured at Fair Value on a Recurring Basis Using Significant Unobservable Inputs (Level 3)
The tables below provide a fair value roll forward for the twelve months ending December 31, 2010, 2009 and 2008, for the financial instruments classified as Level 3.

 

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Table of Contents

HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. Fair Value Measurements (continued)
Roll-forward of Financial Instruments Measured at Fair Value on a Recurring Basis Using Significant Unobservable Inputs (Level 3) for the twelve months from January 1, 2010 to December 31, 2010
                                                                 
            Total                                     Changes in unrealized  
            realized/unrealized                                     gains (losses) included  
            gains (losses)                                     in net income related to  
    Fair value     included in:     Purchases,                     Fair value     financial instruments  
    as of     Net             issuances,     Transfers     Transfers     as of     still held at  
    January 1,     income             and     in to     out of     December 31,     December 31,  
Asset (Liability)   2010     [1] [2] [8]     OCI [3]     Settlements     Level 3 [4]     Level 3 [4]     2010     2010 [2]  
Assets
                                                               
Fixed maturities, AFS
                                                               
ABS
  $ 497     $ (16 )   $ 71     $ (59 )   $ 40     $ (125 )   $ 408     $ (6 )
CDO
    2,109       (124 )     467       (187 )     42       (438 )     1,869       (130 )
CMBS
    269       (98 )     327       (157 )     267       (116 )     492       (58 )
Corporate
    5,239       (10 )     193       (66 )     800       (4,670 )     1,486       (20 )
Foreign govt./govt. agencies
    80             1       (8 )           (33 )     40        
Municipal
    218       1       24       19             (4 )     258        
RMBS
    995       (38 )     228       (129 )     102       (53 )     1,105       (35 )
 
Total fixed maturities, AFS
    9,407       (285 )     1,311       (587 )     1,251       (5,439 )     5,658       (249 )
Fixed maturities, FVO
          74             (10 )     447             511       71  
Equity securities, AFS
    32       (3 )     7       11                   47       (3 )
Derivatives
                                                               
Credit derivatives
    (161 )     104             3       (290 )           (344 )     103  
Equity derivatives
    (2 )     6                               4       6  
Interest rate derivatives
    5       (3 )           (44 )           (11 )     (53 )     (23 )
Variable annuity hedging derivatives and macro hedge program
    526       (415 )           701             (4 )     808       (382 )
 
Total derivatives [5]
    368       (308 )           660       (290 )     (15 )     415       (296 )
Reinsurance recoverable for U.S. GMWB and Japan GMWB, GMIB, and GMAB [1], [7], [9]
    1,108       182       260       452                   2,002       182  
Separate accounts [6]
    962       142             314       14       (185 )     1,247       20  
 
Liabilities
                                                               
Other policyholder funds and benefits payable [1]
                                                               
Guaranteed living benefits [8]
  $ (3,439 )   $ (259 )   $ (307 )   $ (253 )   $       $       $ (4,258 )   $ (259 )
Institutional notes
    (2 )     2                                     2  
Equity linked notes
    (10 )                 1                   (9 )      
 
Total other policyholder funds and benefits payable [1]
    (3,451 )     (257 )     (307 )     (252 )