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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Quarterly Period Ended March 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ____________ to ______________
Commission file number 0-19277
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 13-3317783
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
HARTFORD PLAZA, HARTFORD, CONNECTICUT 06115-1900
(Address of principal executive offices)
(860) 547-5000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No[ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [X] No[ ]
As of April 30, 2003, there were outstanding 255,626,654 shares of Common Stock,
$0.01 par value per share, of the registrant.
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INDEX
PAGE
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Independent Accountants' Review Report 3
PART I. FINANCIAL INFORMATION
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ITEM 1. FINANCIAL STATEMENTS 4
Condensed Consolidated Statements of Operations - First Quarter Ended
March 31, 2003 and 2002 4
Condensed Consolidated Balance Sheets - March 31, 2003 and December
31, 2002 5
Condensed Consolidated Statements of Changes in Stockholders' Equity -
First Quarter Ended March 31, 2003 and 2002 6
Condensed Consolidated Statements of Comprehensive Income (Loss) -
First Quarter Ended March 31, 2003 and 2002 6
Condensed Consolidated Statements of Cash Flows - First Quarter Ended
March 31,2003 and 2002 7
Notes to Condensed Consolidated Financial Statements 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS 20
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 51
ITEM 4. CONTROLS AND PROCEDURES 51
PART II. OTHER INFORMATION
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ITEM 1. LEGAL PROCEEDINGS 51
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 52
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 53
Signature 54
Certifications 55
Exhibits 57
- 2 -
INDEPENDENT ACCOUNTANTS' REVIEW REPORT
To the Board of Directors and Stockholders
The Hartford Financial Services Group, Inc.
Hartford, Connecticut
We have reviewed the accompanying condensed consolidated balance sheet of The
Hartford Financial Services Group, Inc. and subsidiaries (the "Company") as of
March 31, 2003, and the related condensed consolidated statements of operations,
changes in stockholders' equity, comprehensive income (loss) and cash flows for
the first quarters ended March 31, 2003 and 2002. These financial statements are
the responsibility of the Company's management.
We conducted our review in accordance with standards established by the American
Institute of Certified Public Accountants. A review of interim financial
information consists principally of applying analytical procedures to financial
data and of making inquiries of persons responsible for financial and accounting
matters. It is substantially less in scope than an audit conducted in accordance
with auditing standards generally accepted in the United States of America, the
objective of which is the expression of an opinion regarding the financial
statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our review, we are not aware of any material modifications that should
be made to such condensed consolidated financial statements for them to be in
conformity with accounting principles generally accepted in the United States of
America.
We have previously audited, in accordance with auditing standards generally
accepted in the United States of America, the consolidated balance sheet of the
Company as of December 31, 2002, and the related consolidated statements of
income, changes in stockholders' equity, comprehensive income and cash flows for
the year then ended (not presented herein); and in our report dated February 19,
2003, which includes an explanatory paragraph relating to the Company's change
in its method of accounting for goodwill and indefinite-lived intangible assets
in 2002, we expressed an unqualified opinion on those consolidated financial
statements. In our opinion, the information set forth in the accompanying
condensed consolidated balance sheet as of December 31, 2002 is fairly stated,
in all material respects, in relation to the consolidated balance sheet from
which it has been derived.
DELOITTE & TOUCHE LLP
Hartford, Connecticut
May 12, 2003
- 3 -
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
FIRST QUARTER ENDED
MARCH 31,
------------------------------
(IN MILLIONS, EXCEPT FOR PER SHARE DATA) 2003 2002
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(Unaudited)
REVENUES
Earned premiums $ 2,849 $ 2,586
Fee income 617 662
Net investment income 796 706
Other revenue 122 113
Net realized capital losses (53) (7)
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TOTAL REVENUES 4,331 4,060
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BENEFITS, CLAIMS AND EXPENSES
Benefits, claims and claim adjustment expenses 5,245 2,416
Amortization of deferred policy acquisition costs and present value
of future profits 564 555
Insurance operating costs and expenses 567 534
Other expenses 180 187
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TOTAL BENEFITS, CLAIMS AND EXPENSES 6,556 3,692
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INCOME (LOSS) BEFORE INCOME TAXES (2,225) 368
Income tax expense (benefit) (830) 76
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NET INCOME (LOSS) $ (1,395) $ 292
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BASIC EARNINGS (LOSS) PER SHARE $ (5.46) $ 1.19
DILUTED EARNINGS (LOSS) PER SHARE [1] $ (5.46) $ 1.17
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Weighted average common shares outstanding 255.4 246.1
Weighted average common shares outstanding and dilutive potential
common shares [1] 255.4 249.7
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Cash dividends declared per share $ 0.27 $ 0.26
==================================================================================================================================
[1] As a result of the net loss for the quarter ended March 31, 2003,
Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings
Per Share", requires the Company to use basic weighted average shares
outstanding in the calculation of first quarter 2003 diluted earnings per
share, as the inclusion of options of 0.7 would have been antidilutive to
the earnings per share calculation. In the absence of the net loss,
weighted average common shares outstanding and dilutive potential common
shares would have totaled 256.1.
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
- 4 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
MARCH 31, DECEMBER 31,
(IN MILLIONS, EXCEPT FOR SHARE DATA) 2003 2002
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(Unaudited)
ASSETS
Investments
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Fixed maturities, available for sale, at fair value (amortized cost of $49,196 and $46,241) $ 52,126 $ 48,889
Equity securities, available for sale, at fair value (cost of $594 and $937) 619 917
Policy loans, at outstanding balance 2,876 2,934
Other investments 1,707 1,790
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Total investments 57,328 54,530
Cash and cash equivalents 655 377
Premiums receivable and agents' balances 2,712 2,611
Reinsurance recoverables 6,500 5,027
Deferred policy acquisition costs and present value of future profits 6,899 6,689
Deferred income tax 1,274 545
Goodwill 1,721 1,721
Other assets 3,500 3,397
Separate account assets 108,068 107,078
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TOTAL ASSETS $ 188,657 $ 181,975
============================================================================================================================
LIABILITIES
Reserve for future policy benefits and unpaid claims and claim adjustment expenses
Property and casualty $ 21,212 $ 17,091
Life 8,721 8,567
Other policyholder funds and benefits payable 25,251 23,956
Unearned premiums 4,291 3,989
Short-term debt 315 315
Long-term debt 2,596 2,596
Company obligated mandatorily redeemable preferred securities of subsidiary trusts holding
solely junior subordinated debentures 1,469 1,468
Other liabilities 7,292 6,181
Separate account liabilities 108,068 107,078
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TOTAL LIABILITIES 179,215 171,241
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COMMITMENTS AND CONTINGENCIES (NOTE 5)
STOCKHOLDERS' EQUITY
Common stock - 750,000,000 shares authorized, 258,386,920 and 258,184,483 shares issued,
$0.01 par value 3 3
Additional paid-in capital 2,793 2,784
Retained earnings 5,426 6,890
Treasury stock, at cost - 2,945,592 and 2,943,565 shares (37) (37)
Accumulated other comprehensive income 1,257 1,094
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TOTAL STOCKHOLDERS' EQUITY 9,442 10,734
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TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 188,657 $ 181,975
============================================================================================================================
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
- 5 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FIRST QUARTER ENDED
MARCH 31,
-----------------------------------------
(IN MILLIONS, EXCEPT FOR SHARE DATA) 2003 2002
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COMMON STOCK/ADDITIONAL PAID-IN CAPITAL (Unaudited)
Balance at beginning of period $ 2,787 $ 2,364
Issuance of shares under incentive and stock purchase plans 8 44
Tax benefit on employee stock options and awards 1 10
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Balance at end of period 2,796 2,418
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RETAINED EARNINGS
Balance at beginning of period 6,890 6,152
Net income (loss) (1,395) 292
Dividends declared on common stock (69) (64)
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Balance at end of period 5,426 6,380
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TREASURY STOCK, AT COST
Balance at beginning of period (37) (37)
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Balance at end of period (37) (37)
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ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Balance at beginning of period 1,094 534
Change in unrealized gain (loss) on securities, net of tax 177 (235)
Change in net loss on cash flow hedging instruments, net of tax (23) (17)
Foreign currency translation adjustments 9 (4)
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Total other comprehensive income (loss) 163 (256)
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Balance at end of period 1,257 278
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TOTAL STOCKHOLDERS' EQUITY 9,442 9,039
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OUTSTANDING SHARES (IN THOUSANDS)
Balance at beginning of period 255,241 245,536
Issuance of shares under incentive and stock purchase plans 200 1,188
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Balance at end of period 255,441 246,724
===================================================================================================================================
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
FIRST QUARTER ENDED
MARCH 31,
-----------------------------------------
(IN MILLIONS) 2003 2002
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COMPREHENSIVE INCOME (LOSS) (Unaudited)
Net income (loss) $ (1,395) $ 292
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OTHER COMPREHENSIVE INCOME (LOSS)
Change in unrealized gain (loss) on securities, net of tax 177 (235)
Change in net loss on cash-flow hedging instruments, net of tax (23) (17)
Foreign currency translation adjustments 9 (4)
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Total other comprehensive income (loss) 163 (256)
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TOTAL COMPREHENSIVE INCOME (LOSS) $ (1,232) $ 36
===================================================================================================================================
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
- 6 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
FIRST QUARTER ENDED
MARCH 31,
----------------------------------
(IN MILLIONS) 2003 2002
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(Unaudited)
OPERATING ACTIVITIES
Net income (loss) $ (1,395) $ 292
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Amortization of deferred policy acquisition costs 564 555
Additions to deferred policy acquisition costs (807) (716)
Change in:
Liabilities for future policy benefits and unpaid claims and claim adjustment expenses
and unearned premiums 4,576 440
Reinsurance recoverables (1,459) 45
Receivables (95) (174)
Payables and accruals (34) (165)
Accrued and deferred income taxes (839) 96
Net realized capital (gains) losses 53 7
Depreciation and amortization 72 13
Other, net 31 (6)
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NET CASH PROVIDED BY OPERATING ACTIVITIES 667 387
================================================================================================================================
INVESTING ACTIVITIES
Purchase of investments (5,859) (3,760)
Sale of investments 3,364 2,604
Maturity of investments 931 412
Additions to property, plant and equipment (43) (31)
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NET CASH USED FOR INVESTING ACTIVITIES (1,607) (775)
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FINANCING ACTIVITIES
Short-term debt, net -- 16
Net proceeds from investment and universal life-type contracts charged against
policyholder accounts 1,279 389
Dividends paid (69) (64)
Proceeds from issuance of shares under incentive and stock purchase plans 6 45
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NET CASH PROVIDED BY FINANCING ACTIVITIES 1,216 386
================================================================================================================================
Foreign exchange rate effect on cash and cash equivalents 2 --
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Net increase (decrease) in cash and cash equivalents 278 (2)
Cash and cash equivalents - beginning of period 377 353
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CASH AND CASH EQUIVALENTS - END OF PERIOD $ 655 $ 351
================================================================================================================================
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
------------------------------------------------
NET CASH PAID (RECEIVED) DURING THE PERIOD FOR:
Income taxes $ (45) $ --
Interest $ 48 $ 29
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
- 7 -
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in millions except per share data
unless otherwise stated)
(unaudited)
NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES
(A) BASIS OF PRESENTATION
The Hartford Financial Services Group, Inc. and its consolidated subsidiaries
("The Hartford" or the "Company") provide investment products and life and
property and casualty insurance to both individual and business customers in the
United States and internationally.
The condensed consolidated financial statements have been prepared on the basis
of accounting principles generally accepted in the United States of America,
which differ materially from the accounting prescribed by various insurance
regulatory authorities. Less than majority-owned subsidiaries in which The
Hartford has at least a 20% interest are reported on the equity basis. All
intercompany transactions and balances between The Hartford, its subsidiaries
and affiliates have been eliminated.
The accompanying condensed consolidated financial statements and the condensed
notes as of March 31, 2003, and for the first quarters ended March 31, 2003 and
2002 are unaudited. These financial statements reflect all adjustments
(consisting only of normal accruals) which are, in the opinion of management,
necessary for the fair presentation of the financial position, results of
operations, and cash flows for the interim periods. These financial statements
and condensed notes should be read in conjunction with the consolidated
financial statements and notes thereto included in The Hartford's 2002 Form 10-K
Annual Report. The results of operations for the interim periods should not be
considered indicative of results to be expected for the full year.
(B) RECLASSIFICATIONS
Certain reclassifications have been made to prior year financial information to
conform to the current year classifications.
(C) USE OF ESTIMATES
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States of America, requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
The most significant estimates include those used in determining reserves;
deferred policy acquisition costs; valuation of investments and derivative
instruments; pension and other postretirement benefits; and contingencies.
(D) SIGNIFICANT ACCOUNTING POLICIES
For a description of accounting policies, see Note 1 of Notes to Consolidated
Financial Statements included in The Hartford's 2002 Form 10-K Annual Report.
(E) ADOPTION OF NEW ACCOUNTING STANDARDS
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46")
which requires an enterprise to assess if consolidation of an entity is
appropriate based upon its variable economic interests in a variable interest
entity ("VIE"). The initial determination of whether an entity is a VIE shall be
made on the date at which an enterprise becomes involved with the entity. A VIE
is an entity in which the equity investors do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial
support from other parties. An enterprise shall consolidate a VIE if it has a
variable interest that will absorb a majority of the VIEs expected losses if
they occur, receive a majority of the entity's expected residual returns if they
occur or both. FIN 46 is effective for new VIEs established or purchased
subsequent to January 31, 2003. For VIEs entered into prior to February 1, 2003,
FIN 46 is effective for interim periods beginning after June 15, 2003. During
the quarter ended March 31, 2003, the Company did not enter into or establish
any VIEs that would require consolidation under FIN 46.
The Hartford invests in a variety of investment structures that require analysis
under FIN 46, including asset-backed securities, partnerships and certain trust
securities and is currently assessing the impact of adopting FIN 46. Based upon
a preliminary review, the adoption of FIN 46 is not expected to have a material
impact on the Company's financial condition or results of operations as there
were no material VIEs identified which would require consolidation. FIN 46
further requires the disclosure of certain information related to VIEs in which
the Company holds a significant variable interest. The Company does not believe
that it owns any such interests that require disclosure at this time.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others" ("FIN 45" or "the Interpretation"). FIN 45 requires
certain guarantees to be recorded at fair value and also requires a guarantor to
make new disclosures, even when the likelihood of making payments under the
guarantee is remote. In general, the Interpretation applies to contracts or
indemnification agreements that contingently require the guarantor to make
payments to the guaranteed party based on changes in an underlying that is
related to an asset, liability or an equity security of the guaranteed party.
The recognition provisions of FIN 45 are effective on a prospective basis for
guarantees issued or modified after December 31, 2002. The disclosure
requirements are effective for financial statements of interim and annual
periods ending after December 15, 2002. (For further discussion, see Note 1(h),
"Other Investment and Risk Management Activities-Specific Strategies", of Notes
to Consolidated Financial Statements included in The Hartford's 2002 Form 10-K
Annual Report.) Adoption of this statement did not have a material impact on the
Company's consolidated financial condition or results of operations.
- 8 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
NOTE 1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES (CONTINUED)
(E) ADOPTION OF NEW ACCOUNTING STANDARDS (CONTINUED)
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities", which addresses financial accounting and
reporting for costs associated with exit or disposal activities and nullifies
Emerging Issues Task Force ("EITF") Issue No. 94-3, "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)" ("Issue 94-3"). The
principal difference between SFAS No. 146 and Issue 94-3 is that SFAS No. 146
requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred, rather than at the date
of an entity's commitment to an exit plan. SFAS No. 146 is effective for exit or
disposal activities after December 31, 2002. Adoption of SFAS No. 146 will
result in a change in the timing of when a liability is recognized if the
Company has restructuring activities after December 31, 2002. Adoption of this
statement did not have a material impact on the Company's consolidated financial
condition or results of operations.
(F) FUTURE ADOPTION OF NEW ACCOUNTING STANDARDS
In April 2003, the FASB issued guidance in Statement 133 Implementation Issue
No. B36, "Embedded Derivatives: Bifurcation of a Debt Instrument That
Incorporates Both Interest Rate Risk and Credit Risk Exposures That Are
Unrelated or Only Partially Related to the Creditworthiness of the Issuer of
That Instrument", ("DIG B36") that addresses the instances in which bifurcation
of an instrument into a debt host contract and an embedded credit derivative is
required. Specifically, one of the examples is related to the bifurcation of an
embedded derivative within a reinsurer's receivable and ceding company's payable
which arises from a modified coinsurance arrangement. DIG B36 indicates that
bifurcation is necessary in a modified coinsurance arrangement because the yield
on the receivable and payable is based on a specified proportion of the ceding
company's return on either its general account assets or a specified block of
those assets, rather than the overall creditworthiness of the ceding company.
The Company believes that the majority of its modified coinsurance and funds
withheld agreements are out of the scope of DIG B36. While the Company believes
there will be no material effect on its results of operations or financial
condition due to the implementation of this guidance, it is currently evaluating
those potential impacts. The guidance is effective for quarterly periods
beginning after September 15, 2003.
DIG B36 is also applicable to corporate issued debt securities that incorporate
credit risk exposures that are unrelated or only partially related to the
creditworthiness of the obligor. The Company is currently evaluating the impact
of DIG B36 on such corporate issued debt securities. The Company does not
believe the adoption of DIG B36 will have a material effect on the Company's
consolidated financial condition or results of operations.
(G) EXPENSING STOCK OPTIONS
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an Amendment to FASB No. 123", which
provides three optional transition methods for entities that decide to
voluntarily adopt the fair value recognition principles of SFAS No. 123,
"Accounting for Stock Issued to Employees", and modifies the disclosure
requirements of SFAS No. 123. In January 2003, the Company adopted the fair
value recognition provisions of accounting for employee stock compensation and
used the prospective transition method. Under the prospective method,
stock-based compensation expense is recognized for awards granted or modified
after the beginning of the fiscal year in which the change is made. The Company
will expense all stock-based compensation awards granted after January 1, 2003.
The fair value of stock-based awards granted during the quarter ended March 31,
2003 was $29, after-tax. The fair value of these awards will be recognized over
the awards' vesting period, generally 3 years. The expense associated with these
awards for the first quarter ending March 31, 2003, was $1, after-tax.
All stock-based awards granted or modified prior to January 1, 2003, will
continue to be valued using the intrinsic value-based provisions set forth in
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock-Issued
to Employees". Under the intrinsic value method, compensation expense is
determined on the measurement date, which is the first date on which both the
number of shares the employee is entitled to receive and the exercise price are
known. Compensation expense, if any, is measured based on the award's intrinsic
value, which is the excess of the market price of the stock over the exercise
price on the measurement date. For the first quarters ended March 31, 2003 and
2002, after-tax compensation expense related to the Company's stock-based
compensation plans, including the expense associated with the transition to SFAS
No. 123 and non-option plans, was $1. The expense, including non-option plans,
related to stock-based employee compensation included in the determination of
net income for the first quarter ended March 31, 2003 is less than that which
would have been recognized if the fair value method had been applied to all
awards since the effective date of SFAS No. 123. (For further discussion of the
Company's stock compensation plans, see Note 11 of Notes to Consolidated
Financial Statements included in The Hartford's 2002 Form 10-K Annual Report.)
The following table illustrates the effect on net income (loss) and earnings
(loss) per share as if the fair value method had been applied to all outstanding
and unvested awards in each period.
- 9 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
(G) EXPENSING STOCK OPTIONS (CONTINUED)
FIRST QUARTER ENDED
MARCH 31,
------------------------
2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
(Unaudited)
Net income (loss), as reported $ (1,395) $ 292
Add: Stock-based employee compensation expense included in reported net
income (loss) , net of related tax effects [1] 1 1
Deduct: Total stock-based employee compensation expense determined under
the fair value method for all awards, net of related tax effects (9) (9)
- ------------------------------------------------------------------------------------------------------------------------------------
Pro forma net income (loss) [2] $ (1,403) $ 284
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) per share:
Basic - as reported $ (5.46) $ 1.19
Basic - pro forma [2] $ (5.49) $ 1.15
Diluted - as reported [3] $ (5.46) $ 1.17
Diluted - pro forma [2] [3] $ (5.49) $ 1.14
====================================================================================================================================
[1] Excludes the impact of non-option plans of $1 for the first quarters ended
March 31, 2003 and 2002.
[2] The pro forma disclosures are not representative of the effects on net
income (loss) and earnings (loss) per share in future periods.
[3] As a result of the net loss in the quarter ended March 31, 2003, SFAS No.
128 requires the Company to use basic weighted average shares outstanding
in the calculation of first quarter 2003 diluted earnings per share, as
the inclusion of options of 0.7 would have been antidilutive to the
earnings per share calculation. In the absence of the net loss, weighted
average common shares outstanding and dilutive potential common shares
would have totaled 256.1.
NOTE 2. GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets", and accordingly ceased all amortization of goodwill.
The following table shows the Company's acquired intangible assets that continue
to be subject to amortization and aggregate amortization expense. Except for
goodwill, the Company has no intangible assets with indefinite useful lives.
AS OF MARCH 31, 2003
-----------------------------
GROSS ACCUMULATED
CARRYING NET
AMORTIZED INTANGIBLE ASSETS AMOUNT AMORTIZATION
- ------------------------------------------------------------------
Present value of future profits $ 1,406 $ 298
Renewal rights 46 29
Other 9 --
- ------------------------------------------------------------------
Total $ 1,461 $ 327
==================================================================
Net amortization expense for the quarter ended March 31, 2003 was $25.
Estimated future net amortization expense for the succeeding five years is as
follows:
FOR THE YEAR ENDED DECEMBER 31,
- ------------------------------------------------------------------
2003 $ 123
2004 $ 117
2005 $ 106
2006 $ 95
2007 $ 80
==================================================================
The carrying amount of goodwill as of March 31, 2003 and December 31, 2002,
respectively, is shown below.
MARCH 31, DECEMBER 31,
2003 2002
- ------------------------------------------------------------------
Life $ 796 $ 796
Property & Casualty 153 153
Corporate 772 772
- ------------------------------------------------------------------
Total $ 1,721 $ 1,721
==================================================================
NOTE 3. DERIVATIVES AND HEDGING ACTIVITIES
The Company utilizes a variety of derivative instruments, including swaps, caps,
floors, forwards and exchange traded futures and options, through one of four
Company-approved objectives: to hedge risk arising from interest rate, price or
currency exchange rate volatility; to manage liquidity; to control transaction
costs; or to enter into income enhancement and replication transactions.
All of the Company's derivative transactions are permitted uses of derivatives
under the derivatives use plan filed and/or approved, as applicable, by the
State of Connecticut and State of New York insurance departments. The Company
does not make a market or trade in these instruments for the express purpose of
earning short-term trading profits.
For a detailed discussion of the Company's use of derivative instruments, see
Note 1(h) of Notes to Consolidated Financial Statements included in The
Hartford's 2002 Form 10-K Annual Report.
As of March 31, 2003 and December 31, 2002, the Company carried $297 and $299,
respectively, of derivative assets in other investments and $204 and $208,
respectively, of derivative liabilities in other liabilities. In addition, the
Company recognized embedded derivative liabilities related to guaranteed minimum
withdrawal benefits ("GMWB") on certain of its variable annuity
- 10 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
NOTE 3. DERIVATIVES AND HEDGING ACTIVITIES (CONTINUED)
contracts of $95 and $48 at March 31, 2003 and December 31, 2002, respectively,
in other policyholder funds. Offsetting reinsurance arrangements recognized as
derivative assets at March 31, 2003 and December 31, 2002 were $95 and $48,
respectively, and were included in reinsurance recoverables.
Cash-Flow Hedges
For the quarters ended March 31, 2003 and 2002, the Company's gross gains and
losses representing the total ineffectiveness of all cash-flow hedges were
immaterial, with the net impact reported as net realized capital gains and
losses.
Gains and losses on derivative contracts that are reclassified from accumulated
other comprehensive income ("AOCI") to current period earnings are included in
the line item in the statement of income in which the hedged item is recorded.
As of March 31, 2003 and 2002, the after-tax deferred net gains on derivative
instruments accumulated in AOCI that are expected to be reclassified to earnings
during the next twelve months are $12 and $3, respectively. This expectation is
based on the anticipated interest payments on hedged investments in fixed
maturity securities that will occur over the next twelve months, at which time
the Company will recognize the deferred net gains and losses as an adjustment to
interest income over the term of the investment cash flows. The maximum term
over which the Company is hedging its exposure to the variability of future cash
flows (for all forecasted transactions, excluding interest payments on
variable-rate debt) is twelve months. As of March 31, 2003 and December 31,
2002, the Company held derivative notional value related to strategies
categorized as cash-flow hedges of $3.1 billion and $3.2 billion, respectively.
For the quarters ended March 31, 2003 and 2002, the net reclassifications from
AOCI to earnings resulting from the discontinuance of cash-flow hedges were
immaterial.
Fair-Value Hedges
For the quarters ended March 31, 2003 and 2002, the Company's gross gains and
losses representing the total ineffectiveness of all fair-value hedges were
immaterial, with the net impact reported as net realized capital gains and
losses. All components of each derivative's gain or loss are included in the
assessment of hedge effectiveness. As of March 31, 2003 and December 31, 2002,
the Company held $786 and $800, respectively, in derivative notional value
related to strategies categorized as fair-value hedges.
Other Investment and Risk Management Activities
The Company's other investment and risk management activities primarily relate
to strategies used to reduce economic risk or enhance income, and do not receive
hedge accounting treatment. Swap agreements, interest rate cap and floor
agreements and option contracts are used to reduce economic risk. Income
enhancement and replication transactions include the use of written covered call
options, which offset embedded equity call options, total return swaps and
synthetic replication of cash market instruments. The change in the value of all
derivatives held for other investment and risk management purposes is reported
in current period earnings as net realized capital gains and losses. As of March
31, 2003 and December 31, 2002, the Company held $7.1 billion and $6.8 billion,
respectively, in derivative notional value related to strategies categorized as
Other Investment and Risk Management Activities. In addition, Hartford Life,
Inc. ("HLI") issues certain variable annuity products that contain a GMWB. The
GMWB gives the policyholder the right to make periodic surrenders that total an
amount equal to the policyholders' premium payments. This guarantee will remain
in effect if periodic surrenders do not exceed an amount equal to 7% of premium
payments each contract year. If the policyholder chooses to surrender an amount
equal to more than 7% in a contract year, then the guarantee may be reduced to
an amount less than premium payments. The GMWB represents an embedded derivative
liability in the variable annuity contract. It is carried at fair value and
reported in other policyholder funds. The fair value of the GMWB obligations are
calculated based on actuarial assumptions related to the projected benefits and
related contract charges over the lives of the contracts. Because of the dynamic
and complex nature of these cash flows, stochastic techniques under a variety of
market return scenarios and other best estimate actuarial assumptions are used.
This model involves numerous estimates and subjective judgments including those
regarding expected market rates of return and volatility.
The Company has entered into a reinsurance arrangement to offset its exposure to
the GMWB. This arrangement is recognized as a derivative asset and carried at
fair value in reinsurance recoverables. Changes in the fair value of both the
derivative assets and liabilities related to the GMWB are recorded in net
realized capital gains and losses. For further discussion of the Company's other
investment and risk management activities, see "Other Investments and Risk
Management Activities" in Note 1(h) of Notes of Consolidated Financial
Statements included in The Hartford's 2002 Form 10-K Annual Report.
- 11 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
NOTE 4. EARNINGS (LOSS) PER SHARE
The following tables present a reconciliation of net income (loss) and shares
used in calculating basic earnings (loss) per share to those used in calculating
diluted earnings (loss) per share.
MARCH 31, 2003 INCOME/(LOSS) SHARES PER SHARE AMOUNT
- ------------------------------------------------------------------------------------------------------------------------------------
BASIC LOSS PER SHARE
Net loss available to common shareholders $ (1,395) 255.4 $ (5.46)
-------------------
DILUTED LOSS PER SHARE [1]
Options -- --
-----------------------------
Net loss available to common shareholders plus assumed conversions $ (1,395) 255.4 $ (5.46)
====================================================================================================================================
[1] As a result of the net loss in the quarter ended March 31, 2003, SFAS No.
128 requires the Company to use basic weighted average shares outstanding
in the calculation of first quarter 2003 diluted earnings per share, as the
inclusion of options of 0.7 would have been antidilutive to the earnings
per share calculation. In the absence of the net loss, weighted average
common shares outstanding and dilutive potential common shares would have
totaled 256.1.
MARCH 31, 2002
- ------------------------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER SHARE
Net income available to common shareholders $ 292 246.1 $ 1.19
-------------------
DILUTED EARNINGS PER SHARE
Options -- 3.6
-----------------------------
Net income available to common shareholders plus assumed conversions $ 292 249.7 $ 1.17
====================================================================================================================================
Basic earnings (loss) per share reflects the actual weighted average number of
shares outstanding during the period. Diluted earnings (loss) per share includes
the dilutive effect of outstanding options, using the treasury stock method.
Under the treasury stock method exercise of options is assumed, with the
proceeds used to repurchase common stock at the average market price for the
period.
NOTE 5. COMMITMENTS AND CONTINGENCIES
(A) LITIGATION
The Hartford is involved in claims litigation arising in the ordinary course of
business, both as a liability insurer defending third-party claims brought
against insureds and as an insurer defending coverage claims brought against it.
The Hartford accounts for such activity through the establishment of unpaid
claim and claim adjustment expense reserves. Subject to the discussion of the
litigation below involving Mac Arthur Company and its subsidiary, Western
MacArthur Company, both former regional distributors of asbestos products
(collectively or individually, "MacArthur"), and the uncertainties discussed in
(b) below under the caption "Asbestos and Environmental Claims," management
expects that the ultimate liability, if any, with respect to such
ordinary-course claims litigation, after consideration of provisions made for
potential losses and costs of defense, will not be material to the consolidated
financial condition, results of operations or cash flows of The Hartford.
The Hartford is also involved in other kinds of legal actions, some of which
assert claims for substantial amounts. These actions include, among others,
putative state and federal class actions seeking certification of a state or
national class. Such putative class actions have alleged, for example,
underpayment of claims or improper underwriting practices in connection with
various kinds of insurance policies, such as personal and commercial automobile,
premises liability and inland marine. The Hartford also is involved in
individual actions in which punitive damages are sought, such as claims alleging
bad faith in the handling of insurance claims. Management expects that the
ultimate liability, if any, with respect to such lawsuits, after consideration
of provisions made for potential losses and costs of defense, will not be
material to the consolidated financial condition of The Hartford. Nonetheless,
given the large or indeterminate amounts sought in certain of these actions, and
the inherent unpredictability of litigation, it is possible that an adverse
outcome in certain matters could, from time to time, have a material adverse
effect on the Company's consolidated results of operations or cash flows in
particular quarterly or annual periods.
The MacArthur Litigation - Hartford Accident and Indemnity Company ("Hartford
A&I"), a subsidiary of the Company, issued primary general liability policies to
MacArthur during the period 1967 to 1976. MacArthur sought coverage for
asbestos-related claims from Hartford A&I under these policies beginning in
1978. During the period between 1978 and 1987, Hartford A&I paid its full
aggregate limits under these policies plus defense costs. In 1987, Hartford A&I
notified MacArthur that its available limits under these policies had been
exhausted, and MacArthur ceased submitting claims to Hartford A&I under these
policies.
On October 3, 2000, thirteen years after it had accepted Hartford A&I's notice
of exhaustion, MacArthur filed an action against Hartford A&I and another
insurer in the U.S. District Court for the Eastern District of New York,
seeking, for the first time, additional coverage for asbestos bodily injury
claims under the Hartford A&I primary policies on the theory that Hartford A&I
had exhausted only its products aggregate limit of liability, not separate
limits MacArthur alleges to be available for non-products liability. The
complaint sought a declaration of coverage and unquantified damages. On March
28, 2003, the District Court dismissed this action without prejudice on
MacArthur's motion.
- 12 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
NOTE 5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
(A) LITIGATION (CONTINUED)
On June 3, 2002, The St. Paul Companies, Inc. ("St. Paul") announced a
settlement of a coverage action brought by MacArthur against United States
Fidelity and Guaranty Company ("USF&G"), a subsidiary of St. Paul. Under the
settlement, St. Paul agreed to pay a total of $975 to resolve its asbestos
liability to MacArthur in conjunction with a proposed bankruptcy petition and
pre-packaged plan of reorganization to be filed by MacArthur. USF&G provided at
least twelve years of primary general liability coverage to MacArthur, but,
unlike Hartford A&I, had denied coverage and had refused to pay for defense or
indemnity.
On October 7, 2002, MacArthur filed an action in the Superior Court in Alameda
County, California, against Hartford A&I and two other insurers. As in the
now-dismissed New York action, MacArthur seeks a declaration of coverage and
damages for asbestos bodily injury claims. Five asbestos claimants who allegedly
have obtained default judgments against MacArthur also are joined as plaintiffs;
they seek to recover the amount of their default judgments and additional
damages directly from the defendant insurers and assert a right to an
accelerated trial.
In its October 7, 2002 complaint, MacArthur alleges that it has approximately
$1.8 billion of unpaid asbestos liability judgments against it to date. The
ultimate amount of MacArthur's alleged non-products asbestos liability,
including any unresolved current claims and future demands, is currently
unknown.
On November 22, 2002, MacArthur filed a bankruptcy petition and proposed plan of
reorganization, which seeks to implement the terms of its settlement with St.
Paul. MacArthur's bankruptcy filings indicate that it will seek to have the full
amount of its current and future asbestos liability estimated in an amount
substantially more than the amount of the alleged unpaid judgments in
conjunction with plan confirmation. If such an estimation is made, MacArthur
intends to ask the Alameda County court to enter judgment against the insurers
for the amount of its total liability, including unliquidated claims and future
demands, less the estimated amount ultimately paid by St. Paul. Hartford A&I has
filed an adversary complaint in the MacArthur bankruptcy seeking a declaratory
judgment that any estimation made in the bankruptcy proceedings is not an
adjudication of MacArthur's asbestos liability for purposes of insurance
coverage.
Hartford A&I intends to defend the MacArthur action vigorously. In the opinion
of management, the ultimate outcome is highly uncertain for many reasons. It is
not yet known, for example, whether Hartford A&I's defenses based on MacArthur's
long delay in asserting claims for further coverage will be successful; how
other significant coverage defenses will be decided; or the extent to which the
claims and default judgments against MacArthur involve injury outside of the
products and completed operations hazard definitions of the policies. In the
opinion of management, an adverse outcome could have a material adverse effect
on the Company's results of operations, financial condition and liquidity.
Bancorp Services, LLC - On March 15, 2002, a jury in the U.S. District Court for
the Eastern District of Missouri issued a verdict in Bancorp Services, LLC
("Bancorp") v. Hartford Life Insurance Company ("HLIC"), et al., in favor of
Bancorp in the amount of $118. The case involved claims of patent infringement,
misappropriation of trade secrets, and breach of contract against HLIC and its
affiliate International Corporate Marketing Group, LLC ("ICMG"). The judge
dismissed the patent infringement claim on summary judgment. The jury's award
was based on the last two claims. On August 28, 2002, the Court entered an order
awarding Bancorp prejudgment interest on the breach of contract claim in the
amount of $16.
HLIC and ICMG have appealed the judgment on the trade secret and breach of
contract claims. Bancorp has cross-appealed the pretrial dismissal of its patent
infringement claim. The Company's management, based on the advice of its legal
counsel, believes that there is a substantial likelihood that the judgment will
not survive at its current amount. Based on the advice of legal counsel
regarding the potential outcomes of this litigation, the Company recorded an $11
after-tax charge for this matter in the first quarter of 2002 to increase
litigation reserves. Should HLIC and ICMG not succeed in eliminating or reducing
the judgment, a significant additional expense would be recorded in the future.
Reinsurance Arbitration - On March 16, 2003, a final decision and award was
issued in the previously disclosed arbitration between subsidiaries of The
Hartford and one of their primary reinsurers relating to policies with
guaranteed death benefits written from 1994 to 1999. The arbitration involved
alleged breaches under the reinsurance treaties. Under the terms of the final
decision and award, the reinsurer's reinsurance obligations to The Hartford's
subsidiaries were unchanged and not limited or reduced in any manner. The award
was confirmed by the Connecticut Superior Court on May 5, 2003.
(B) ASBESTOS AND ENVIRONMENTAL CLAIMS
The Hartford continues to receive claims that assert damages from asbestos- and
environmental-related exposures. Asbestos claims relate primarily to bodily
injuries asserted by those who came in contact with asbestos or products
containing asbestos. Environmental claims relate primarily to pollution and the
related clean-up costs.
The Hartford wrote several different categories of insurance coverage to which
asbestos and environmental claims may apply. First, The Hartford wrote direct
policies as a primary liability insurance carrier. Second, The Hartford wrote
direct excess insurance policies providing additional coverage for insureds that
exhausted their underlying liability insurance coverage. Third, The Hartford
acted as a reinsurer assuming a portion of risks previously assumed by other
insurers writing primary, excess and reinsurance coverages. Fourth, The Hartford
participated as a London Market company that wrote both direct insurance and
assumed reinsurance business.
With regard to both environmental and particularly asbestos claims, significant
uncertainty limits the ability of insurers and reinsurers to estimate the
ultimate reserves necessary for unpaid losses and related settlement expenses.
Traditional reserving techniques cannot reasonably estimate the ultimate cost of
these
- 13 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
NOTE 5. COMMITMENTS AND CONTINGENCIES (CONTINUED)
(B) ASBESTOS AND ENVIRONMENTAL CLAIMS (CONTINUED)
claims, particularly during periods where theories of law are in flux. As a
result of the factors discussed in the following paragraphs, the degree of
variability of reserve estimates for these exposures is significantly greater
than for other, more traditional exposures. In particular, The Hartford believes
there is a high degree of uncertainty inherent in the estimation of asbestos
loss reserves.
In the case of the reserves for asbestos exposures, factors contributing to the
high degree of uncertainty include inadequate development patterns, plaintiffs'
expanding theories of liability, the risks inherent in major litigation and
inconsistent emerging legal doctrines. Courts have reached inconsistent
conclusions as to when losses are deemed to have occurred and which policies
provide coverage; what types of losses are covered; whether there is an insurer
obligation to defend; how policy limits are applied; whether particular claims
are product/completed operation claims subject to an aggregate limit; and how
policy exclusions and conditions are applied and interpreted. Furthermore,
insurers in general, including The Hartford, have recently experienced an
increase in the number of asbestos-related claims due to, among other things,
more intensive advertising by lawyers seeking asbestos claimants, plaintiffs'
increased focus on new and previously peripheral defendants, and an increase in
the number of insureds seeking bankruptcy protection as a result of
asbestos-related liabilities. Plaintiffs and insureds have sought to use
bankruptcy proceedings, including "pre-packaged" bankruptcies, to accelerate and
increase loss payments by insurers. In addition, some policyholders have begun
to assert new classes of claims for so-called "non-product" coverages to which
an aggregate limit of liability may not apply. Recently, many insurers,
including the Hartford, also have been sued directly by asbestos claimants
asserting that insurers had a duty to protect the public from the dangers of
asbestos. Management believes these issues are not likely to be resolved in the
near future.
In the case of the reserves for environmental exposures, factors contributing to
the high degree of uncertainty include court decisions that have interpreted the
insurance coverage to be broader than originally intended; inconsistent
decisions, especially across jurisdictions; and uncertainty as to the monetary
amount being sought by the claimant from the insured.
Further uncertainties include the effect of the recent acceleration in the rate
of bankruptcy filings by asbestos defendants on the rate and amount of The
Hartford's asbestos claims payments; a further increase or decrease in asbestos
and environmental claims which cannot now be anticipated; whether some
policyholders' liabilities will reach the umbrella or excess layer of their
coverage; the resolution or adjudication of some disputes pertaining to the
amount of available coverage for asbestos claims in a manner inconsistent with
The Hartford's previous assessment of these claims; the number and outcome of
direct actions against The Hartford; and unanticipated developments pertaining
to The Hartford's ability to recover reinsurance for asbestos and environmental
claims. It is also not possible to predict changes in the legal and legislative
environment and their impact on the future development of asbestos and
environmental claims. In particular, recently there has been a variety of
potential federal legislative changes concerning asbestos litigation under
discussion among business, labor, plaintiffs' lawyer groups, and Congressional
leaders. Whether any such legislation will be enacted and, if so, what its
effect will be on The Hartford's aggregate asbestos liabilities is unknown.
Additionally, the reporting pattern for excess insurance and reinsurance claims
is much longer than direct claims. In many instances, it takes months or years
to determine that the policyholder's own obligations have been met and how the
reinsurance in question may apply to such claims. The delay in reporting excess
and reinsurance claims and exposures adds to the uncertainty of estimating the
related reserves.
Given the factors and emerging trends described above, The Hartford believes the
actuarial tools and other techniques it employs to estimate the ultimate cost of
claims for more traditional kinds of insurance exposure are less precise in
estimating reserves for its asbestos and environmental exposures. The Hartford
regularly evaluates new information in assessing its potential asbestos
exposures.
In the first quarter of 2003, The Hartford conducted a detailed study of its
asbestos exposures. Based on the results of the study, the Company strengthened
its gross and net asbestos reserves by $3.9 billion and $2.6 billion,
respectively. The Company believes that its current asbestos reserves are
reasonable and appropriate. However, analyses of future developments could cause
The Hartford to change its estimates of its asbestos and environmental reserves
and the effect of these changes could be material to the Company's consolidated
operating results, financial condition and liquidity.
As of March 31, 2003 and December 31, 2002, the Company reported $3.7 billion
and $1.1 billion of net asbestos and $559 and $591 of net environmental
reserves, respectively. Because of the significant uncertainties previously
described, principally those related to asbestos, the ultimate liabilities may
exceed the currently recorded reserves. Any such additional liability (or any
range of additional amounts) cannot be reasonably estimated now but could be
material to The Hartford's future consolidated operating results, financial
condition and liquidity. Consistent with the Company's longstanding reserving
practices, The Hartford will continue to regularly review and monitor these
reserves and, where future circumstances indicate, make appropriate adjustments
to the reserves.
(C) TAX MATTERS
The Hartford's federal income tax returns are routinely audited by the Internal
Revenue Service ("IRS"). The Company is currently under audit for the 1998-2001
tax years. No material issues have been raised to date by the IRS. Management
believes that adequate provision has been made in the financial statements for
any potential assessments that may result from tax examinations and other tax
related matters.
- 14 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
NOTE 6. SEGMENT INFORMATION
The Hartford is organized into two major operations: Life and Property &
Casualty. Within these operations, The Hartford conducts business principally in
nine operating segments. Additionally, the capital raising and purchase
accounting adjustment activities related to the June 27, 2000 acquisition of all
of the outstanding shares of HLI that the Company did not already own, as well
as capital that has not been contributed to the Company's insurance subsidiaries
are included in Corporate.
Life is organized into four reportable operating segments: Investment Products,
Individual Life, Group Benefits and Corporate Owned Life Insurance ("COLI").
Investment Products offers individual variable and fixed annuities, mutual
funds, retirement plan services and other investment products. Individual Life
sells a variety of life insurance products, including variable life, universal
life, interest sensitive whole life and term life insurance. Group Benefits
sells group insurance products, including group life and group disability
insurance as well as other products, including stop loss and supplementary
medical coverages to employers and employer sponsored plans, accidental death
and dismemberment, travel accident and other special risk coverages to employers
and associations. COLI primarily offers variable products used by employers to
fund non-qualified benefits or other postemployment benefit obligations as well
as leveraged COLI. Life also includes in an Other category its international
operations, which are primarily located in Japan and Latin America; realized
capital gains and losses; as well as corporate items not directly allocated to
any of its reportable operating segments, principally interest expense; and
intersegment eliminations.
Property & Casualty is organized into five reportable operating segments: the
North American underwriting segments of Business Insurance, Personal Lines,
Specialty Commercial and Reinsurance; and the Other Operations segment, which
includes substantially all of the Company's asbestos and environmental
exposures. "North American" includes the combined underwriting results of the
Business Insurance, Personal Lines, Specialty Commercial and Reinsurance
underwriting segments along with income and expense items not directly allocated
to these segments, such as net investment income, net realized capital gains and
losses, other expenses including interest and income taxes.
Business Insurance provides standard commercial insurance coverage to small
commercial and middle market commercial business primarily throughout the United
States. This segment offers workers' compensation, property, automobile,
liability, umbrella and marine coverages. Commercial risk management products
and services are also provided.
Personal Lines provides automobile, homeowners' and home-based business
coverages to the members of AARP through a direct marketing operation; to
individuals who prefer local agent involvement through a network of independent
agents in the standard personal lines market; and through the Omni Insurance
Group in the non-standard automobile market. Personal Lines also operates a
member contact center for health insurance products offered through AARP's
Health Care Options.
The Specialty Commercial segment offers a variety of customized insurance
products and risk management services. Specialty Commercial provides standard
commercial insurance products including workers' compensation, automobile and
liability coverages to large-sized companies. Specialty Commercial also provides
bond, professional liability, specialty casualty and agricultural coverages, as
well as core property and excess and surplus lines coverages not normally
written by standard lines insurers. Alternative markets, within Specialty
Commercial, provides insurance products and services primarily to captive
insurance companies, pools and self-insurance groups. In addition, Specialty
Commercial provides third party administrator services for claims
administration, integrated benefits, loss control and performance measurement
through Specialty Risk Services, a subsidiary of the Company.
The Reinsurance segment assumes reinsurance in North America and primarily
writes treaty reinsurance through professional reinsurance brokers covering
various property, casualty, property catastrophe, marine and alternative risk
transfer ("ART") products. ART includes non-traditional reinsurance products
such as multi-year property catastrophe treaties, aggregate of excess of loss
agreements and quota share treaties with single event caps. International
property catastrophe, marine and ART are also written outside of North America
through a London contact office. On May 12, 2003, the Company announced plans to
exit the assumed reinsurance business.
The Other Operations segment consists of certain property and casualty insurance
operations of The Hartford which have discontinued writing new business and
includes substantially all of the Company's asbestos and environmental
exposures.
The measure of profit or loss used by The Hartford's management in evaluating
the performance of its Life segments is net income. However, the North American
underwriting segments are evaluated by The Hartford's management primarily based
upon underwriting results. Underwriting results represent premiums earned less
incurred claims, claim adjustment expenses and underwriting expenses.
Certain transactions between segments occur during the year that primarily
relate to tax settlements, insurance coverage, expense reimbursements, services
provided, security transfers and capital contributions. In addition, certain
reinsurance stop loss agreements exist between the segments which specify that
one segment will reimburse another for losses incurred in excess of a
predetermined limit. Also, one segment may purchase group annuity contracts from
another to fund pension costs and claim annuities to settle casualty claims. In
addition, certain intersegment transactions occur in Life. These transactions
include interest income on allocated surplus and the allocation of certain net
realized capital gains and losses through net investment income utilizing the
duration of the segment's investment portfolios. During the first quarter of
2003, $750 of securities were sold by the Property & Casualty operation to the
- 15 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
NOTE 6. SEGMENT INFORMATION (CONTINUED)
Life operation. An additional $1.0 billion of securities were sold in April
2003. For segment reporting, the net gain on this sale was deferred by the
Property & Casualty operation and will be reported as realized when the
underlying securities are sold by the Life operation. On December 1, 2002, The
Hartford entered into a contract with a subsidiary, Fencourt Reinsurance
Company, Ltd. ("Fencourt"), whereby Fencourt will provide reinsurance for the
Property & Casualty operations. The financial results of this reinsurance
program, net of retrocessions to unrelated reinsurers, will be included in the
Specialty Commercial segment.
The following tables present revenues and net income (loss). Underwriting
results are presented for the Business Insurance, Personal Lines, Specialty
Commercial and Reinsurance segments, while net income is presented for all other
segments, along with Life and Property & Casualty, including North American.
REVENUES
FIRST QUARTER ENDED
MARCH 31,
-----------------------------
2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Life
Investment Products $ 773 $ 810
Individual Life 244 232
Group Benefits 667 644
COLI 127 160
Other [1] (25) (10)
- ------------------------------------------------------------------------------------------------------------------------------------
Total Life 1,786 1,836
- ------------------------------------------------------------------------------------------------------------------------------------
Property & Casualty
North American
Earned premiums and other revenue
Business Insurance 880 732
Personal Lines 800 747
Specialty Commercial 422 290
Reinsurance 151 171
- ------------------------------------------------------------------------------------------------------------------------------------
Total North American earned premiums and other revenue 2,253 1,940
Net investment income 243 217
Net realized capital gains (losses) (15) 7
- ------------------------------------------------------------------------------------------------------------------------------------
Total North American 2,481 2,164
Other Operations 60 56
- ------------------------------------------------------------------------------------------------------------------------------------
Total Property & Casualty 2,541 2,220
- ------------------------------------------------------------------------------------------------------------------------------------
Corporate 4 4
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES $ 4,331 $ 4,060
====================================================================================================================================
[1] Amounts include net realized capital losses of $(48), and $(15) for the
first quarter ended March 31, 2003 and 2002, respectively.
- 16 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
NOTE 6. SEGMENT INFORMATION (CONTINUED)
NET INCOME (LOSS) FIRST QUARTER ENDED
MARCH 31,
------------------------------
2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Life
Investment Products $ 98 $ 117
Individual Life 32 31
Group Benefits 34 28
COLI 10 --
Other (48) (6)
- ------------------------------------------------------------------------------------------------------------------------------------
Total Life 126 170
- ------------------------------------------------------------------------------------------------------------------------------------
Property & Casualty
North American
Underwriting results
Business Insurance (12) 4
Personal Lines 52 (11)
Specialty Commercial -- (10)
Reinsurance (19) (4)
- ------------------------------------------------------------------------------------------------------------------------------------
Total North American underwriting results 21 (21)
Net servicing and other income [1] 3 2
Net investment income 243 217
Other expenses (45) (51)
Net realized capital gains (losses) (15) 7
Income tax (expense) (39) (27)
- ------------------------------------------------------------------------------------------------------------------------------------
Total North American 168 127
Other Operations (1,681) 1
- ------------------------------------------------------------------------------------------------------------------------------------
Total Property & Casualty (1,513) 128
- ------------------------------------------------------------------------------------------------------------------------------------
Corporate (8) (6)
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ (1,395) $ 292
====================================================================================================================================
[1] Net of expenses related to service business.
NOTE 7. DEBT
(A) SHELF REGISTRATIONS
On March 19, 2003, The Hartford filed with the SEC a shelf registration
statement (Registration No. 333-103915) for the potential offering and sale of
debt and equity securities in an aggregate amount of up to $1.3 billion. On
April 10, 2003, The Hartford amended the registration statement (as amended, the
"Registration Statement"), to allow for the offering and sale of up to
approximately $2.6 billion in debt and equity securities. Specifically, the
Registration Statement allows for the following types of securities to be
offered: (i) debt securities, preferred stock, common stock, depositary shares,
warrants, stock purchase contracts, stock purchase units and junior subordinated
deferrable interest debentures of the Company, and (ii) preferred securities of
any of one or more capital trusts organized by The Hartford ("The Hartford
Trusts"). The Company may enter into guarantees with respect to the preferred
securities of any of The Hartford Trusts. The Registration Statement became
effective on April 10, 2003. As of that date, The Hartford had no remaining
availability under its previously filed shelf registration statement
(Registration No. 333-88762).
- 17 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
NOTE 7. DEBT (CONTINUED)
(B) SHORT-TERM DEBT
OUTSTANDING
-------------------------------
EFFECTIVE EXPIRATION MAXIMUM MARCH 31, DECEMBER 31,
DESCRIPTION DATE DATE AVAILABLE 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Commercial Paper
The Hartford 11/10/86 N/A $ 2,000 $ 315 $ 315
HLI 2/7/97 N/A 250 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total commercial paper $ 2,250 $ 315 $ 315
Revolving Credit Facility
5-year revolving credit facility 6/20/01 6/20/06 $ 1,000 $ -- $ --
3-year revolving credit facility 12/31/02 12/31/05 490 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total revolving credit facility $ 1,490 $ -- $ --
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM DEBT $ 3,740 $ 315 $ 315
====================================================================================================================================
On December 31, 2002, the Company and HLI entered into a joint three-year
Competitive Advance and Revolving Credit Facility with 12 participating banks to
enable the Company and HLI to borrow an aggregate amount of up to $490. As of
March 31, 2003 and December 31, 2002, there were no outstanding borrowings under
this facility.
On February 26, 2003, the Company entered into a Second Amended and Restated
Five-Year Competitive Advance and Revolving Credit Facility with 11
participating banks to amend and restate the Company's ability to borrow an
aggregate amount of up to $1,000. As of March 31, 2003 and December 31, 2002,
there were no outstanding borrowings under this facility.
(C) INTEREST EXPENSE
The following table presents interest expense incurred related to debt and trust
preferred securities for first quarter ended March 2003 and 2002, respectively.
FIRST QUARTER ENDED
MARCH 31,
----------------------------
2003 2002
- -----------------------------------------------------------------
Short-term debt $ 1 $ 1
Long-term debt (including current
maturities of long-term debt) 43 42
Company obligated mandatorily
redeemable preferred securities of
subsidiary trusts holding solely
junior subordinated debentures 22 23
- -----------------------------------------------------------------
TOTAL INTEREST EXPENSE $ 66 $ 66
=================================================================
- 18 -
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(unaudited)
NOTE 8. ACCUMULATED OTHER COMPREHENSIVE INCOME
Comprehensive income is defined as all changes in stockholders' equity, except
those arising from transactions with stockholders. Comprehensive income includes
net income (loss) and other comprehensive income (loss), which for the Company
consists of changes in unrealized appreciation or depreciation of investments
carried at market value, changes in gains or losses on cash-flow hedging
instruments, changes in foreign currency translation gains or losses and changes
in the Company's minimum pension liability.
The components of AOCI or loss were as follows:
UNREALIZED NET GAIN ON FOREIGN MINIMUM
GAIN (LOSS) CASH-FLOW CURRENCY PENSION
ON HEDGING CUMULATIVE LIABILITY ACCUMULATED OTHER
SECURITIES, INSTRUMENTS, TRANSLATION ADJUSTMENT, COMPREHENSIVE
FOR THE FIRST QUARTER ENDED MARCH 31, 2003 NET OF TAX NET OF TAX ADJUSTMENTS NET OF TAX INCOME (LOSS)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, BEGINNING OF PERIOD $1,444 $128 $(95) $(383) $1,094
Unrealized gain (loss) on securities [1] [2] 177 -- -- -- 177
Foreign currency translation adjustments -- -- 9 -- 9
Net loss on cash-flow hedging instruments [1] [3] -- (23) -- -- (23)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, END OF PERIOD $1,621 $105 $(86) $(383) $1,257
====================================================================================================================================
FOR THE FIRST QUARTER ENDED MARCH 31, 2002
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, BEGINNING OF PERIOD $606 $63 $(116) $(19) $534
Unrealized gain (loss) on securities [1] [2] (235) -- -- -- (235)
Foreign currency translation adjustments -- -- (4) -- (4)
Net loss on cash-flow hedging instruments [1] [3] -- (17) -- -- (17)
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE, END OF PERIOD $371 $46 $(120) $(19) $278
====================================================================================================================================
[1] Unrealized gain (loss) on securities is net of tax and other items of $131
and $(127) for the first quarter ended March 31, 2003 and 2002,
respectively. Net gain on cash-flow hedging instruments is net of tax
(benefit) of $(12) and $(9) for the first quarter ended March 31, 2003 and
2002, respectively.
[2] Net of reclassification adjustment for gains (losses) realized in net
income of $(31) and $0 for the first quarter ended March 31, 2003 and
2002, respectively.
[3] Net of amortization adjustment of $9 and $1 to net investment income for
the first quarter ended March 31, 2003 and 2002, respectively.
NOTE 9. SUBSEQUENT EVENTS
On May 12, 2003, the Company announced the results of the first quarter 2003
detailed study of asbestos exposures. Based on the results of the study, the
Company strengthened its net asbestos reserves by $2.6 billion in the first
quarter ended March 31, 2003. Accordingly, the Company plans to raise capital,
which may include concurrent offerings of equity and equity-linked securities
and debt securities.
In addition, the Company announced plans to exit the assumed reinsurance
business. The Company has also announced several expense reduction initiatives,
which are intended to result in lower operating costs. These expense initiatives
include centralizing redundant operations to leverage spending and lower costs,
eliminating non-essential functions and reducing overall consumption and costs
of spending for various administrative expenses including travel, conferences
and outside consultants. During 2003 and 2004, the Company expects these
initiatives to result in a reduction in the Company's workforce by approximately
4%. The Company expects to incur severance costs associated with these
reductions ranging from $25 to $35, after-tax, during the second quarter of
2003.
- 19 -
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(Dollar amounts in millions except share data unless otherwise stated)
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") addresses the financial condition of The Hartford Financial
Services Group, Inc. and its subsidiaries (collectively, "The Hartford" or the
"Company") as of March 31, 2003, compared with December 31, 2002, and its
results of operations for the first quarter ended March 31, 2003, compared to
the equivalent 2002 period. This discussion should be read in conjunction with
the MD&A in The Hartford's 2002 Form 10-K Annual Report.
Certain of the statements contained herein are forward-looking statements. These
forward-looking statements are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995 and include estimates and
assumptions related to economic, competitive and legislative developments. These
forward-looking statements are subject to change and uncertainty which are, in
many instances, beyond the Company's control and have been made based upon
management's expectations and beliefs concerning future developments and their
potential effect upon the Company. There can be no assurance that future
developments will be in accordance with management's expectations or that the
effect of future developments on The Hartford will be those anticipated by
management. Actual results could differ materially from those expected by the
Company, depending on the outcome of various factors. These factors include: the
difficulty in predicting the Company's potential exposure for asbestos and
environmental claims and related litigation, in particular, significant
uncertainty with regard to the outcome of the Company's current dispute with Mac
Arthur Company and its subsidiary, Western MacArthur Company (collectively or
individually, "MacArthur"); the uncertain nature of damage theories and loss
amounts and the development of additional facts related to the September 11
terrorist attack ("September 11"); the uncertain impact on the Company of
various tax reduction proposals being considered by Congress that relate to the
lowering of the capital gains rate and the application of that rate to dividend
distributions or the exclusion of some or all of such distributions from gross
income; the response of reinsurance companies under reinsurance contracts, the
impact of increasing reinsurance rates and the availability and adequacy of
reinsurance to protect the Company against losses; the possibility of more
unfavorable loss experience than anticipated; the possibility of general
economic and business conditions that are less favorable than anticipated; the
incidence and severity of catastrophes, both natural and man-made; the effect of
changes in interest rates, the stock markets or other financial markets;
stronger than anticipated competitive activity; unfavorable legislative,
regulatory or judicial developments; the Company's ability to distribute its
products through distribution channels, both current and future; the uncertain
effects of emerging claim and coverage issues; the effect of assessments and
other surcharges for guaranty funds and second-injury funds and other mandatory
pooling arrangements; a downgrade in the Company's claims-paying, financial
strength or credit ratings; the ability of the Company's subsidiaries to pay
dividends to the Company; and other factors described in such forward-looking
statements.
Certain reclassifications have been made to prior year financial information to
conform to the current year presentation.
- --------------------------------------------------------------------------------
INDEX
- --------------------------------------------------------------------------------
Recent Developments 20
Critical Accounting Estimates 21
Consolidated Results of Operations: Operating Summary 22
Life 25
Investment Products 26
Individual Life 27
Group Benefits 27
Corporate Owned Life Insurance ("COLI") 28
Property & Casualty 28
Business Insurance 30
Personal Lines 31
Specialty Commercial 32
Reinsurance 33
Other Operations (Including Asbestos and
Environmental Claims 33
Investments 37
Capital Markets Risk Management 40
Capital Resources and Liquidity 48
Accounting Standards 51
- --------------------------------------------------------------------------------
RECENT DEVELOPMENTS
- --------------------------------------------------------------------------------
On May 12, 2003, the Company announced the completion of its ground-up study of
asbestos-related exposures. Based on the results of the study, the Company
strengthened its gross and net asbestos reserves by $3.9 billion and $2.6
billion, respectively. The asbestos reserve strengthening resulted in a $1.7
billion after-tax charge to net income in the first quarter of 2003.
In connection with the announcement of the asbestos study, the Company announced
that it intends to issue $1.6 billion of equity and equity-linked securities and
$250 of debt securities to replace the surplus lost as a result of the asbestos
reserve strengthening. To enhance capital further, the Company intends to exit
certain higher-risk asset classes (equities and certain limited partnerships) in
its investment portfolio and to realize a small percentage of its unrealized
capital gains. The Company expects to complete the majority of the steps in its
capital plan, including raising the external capital, by the end of the second
quarter of 2003.
The Company also announced that it will exit the assumed property-casualty
reinsurance business. The Company is in negotiations with a third party for the
possible sale of most of the business. However, regardless of whether a
transaction is completed, the Company will cease writing new business in the
assumed property-casualty reinsurance market no later than June 30, 2003. The
Company also announced the initiation of a cost
- 20 -
reduction program. As a significant part of the program, 850 employees will lose
their jobs by the end of the second quarter of 2003 and 650 vacant positions
were eliminated. The job cuts will come primarily from the Company's
property-casualty businesses and, to a lesser extent, from the consolidation of
some corporate services. The Company expects to incur a related after-tax
severance charge of $25 to $35 in the second quarter of 2003.
- --------------------------------------------------------------------------------
CRITICAL ACCOUNTING ESTIMATES
- --------------------------------------------------------------------------------
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States of America, requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
The 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: reserves; valuation of investments and derivative instruments;
deferred policy acquisition costs; pension and other postretirement benefits;
and contingencies. In developing these estimates management makes subjective and
complex judgments that are inherently uncertain and subject to material change
as facts and circumstances develop. Although variability is inherent in these
estimates, management believes the amounts provided are appropriate based upon
the facts available upon compilation of the financial statements.
RESERVES
ASBESTOS AND ENVIRONMENTAL CLAIMS
In the first quarter of 2003, The Hartford conducted a detailed study of its
asbestos exposures. The Company undertook the study consistent with its practice
of regularly updating its reserve estimates as new information becomes
available. As a result of the study, the Company strengthened its gross and net
asbestos reserves by, $3.9 billion and $2.6 billion, respectively, during the
quarter ended March 31, 2003.
The process of estimating asbestos reserves remains subject to a wide variety of
uncertainties, which are detailed in Note 5(b) of Notes to Condensed
Consolidated Financial Statements. Due to these uncertainties, further
developments could cause The Hartford to change its estimates of asbestos
reserves and the effect of these changes could be material to the Company's
consolidated operating results, financial condition and liquidity.
DEFERRED POLICY ACQUISITION COSTS
LIFE
Policy acquisition costs, which include commissions and certain other expenses
that vary with and are primarily associated with acquiring business, are
deferred and amortized over the estimated lives of the contracts, usually 20
years. These deferred costs, together with the present value of future profits
of acquired business, are recorded as an asset commonly referred to as deferred
policy acquisition costs and present value of future profits ("DAC"). At March
31, 2003 and December 31, 2002, the carrying value of the Company's Life
operations' DAC was $5.9 billion and $5.8 billion, respectively. For statutory
accounting purposes, such costs are expensed as incurred.
DAC related to traditional policies are amortized over the premium-paying period
in proportion to the present value of annual expected premium income. DAC
related to investment contracts and universal life-type contracts are deferred
and amortized using the retrospective deposit method. Under the retrospective
deposit method, acquisition costs are amortized in proportion to the present
value of the estimated gross profits ("EGPs") arising principally from projected
investment, mortality and expense margins and surrender charges. The
attributable portion of the DAC amortization is allocated to realized gains and
losses on investments. The DAC balance is also adjusted through other
comprehensive income by an amount that represents the amortization of deferred
policy acquisition costs that would have been required as a charge or credit to
operations had unrealized gains and losses on investments been realized. Actual
gross profits can vary from management's estimates, resulting in increases or
decreases in the rate of amortization.
The Company regularly evaluates its EGPs to determine if actual experience or
other evidence suggests that earlier estimates should be revised. In the event
that the Company were to revise its EGPs, the cumulative DAC amortization would
be adjusted to reflect such revised EGPs in the period the revision was
determined to be necessary. Several assumptions considered to be significant in
the development of EGPs include separate account fund performance, surrender and
lapse rates, estimated interest spread and estimated mortality. The separate
account fund performance assumption is critical to the development of the EGPs
related to the Company's variable annuity and variable life insurance
businesses. The average long-term rate of assumed separate account fund
performance (before mortality and expense charges) used in estimating gross
profits for the variable annuity and variable life business was 9% for the
periods ended March 31, 2003 and March 31, 2002. For other products, including
fixed annuities and other universal life-type contracts, the average assumed
investment yield ranged from 5% to 8.5% for the periods ended March 31, 2003 and
March 31, 2002.
Due to increased volatility and the decline experienced by the U.S. equity
markets in recent periods, the Company continues to enhance its DAC evaluation
process. The Company has developed sophisticated modeling capabilities which
allowed it to run a large number of stochastically determined scenarios of
separate account fund performance. These scenarios were then utilized to
calculate a statistically significant range of reasonable estimates of EGPs.
This range was then compared to the present value of EGPs currently utilized in
the DAC amortization model. As of March 31, 2003, the present value of the EGPs
utilized in the DAC amortization model fall at the margin of a reasonable range
of statistically calculated present value of EGPs. As a result, the Company does
not believe there is sufficient evidence to suggest that a revision to the EGPs
(and therefore, a revision to the DAC) as of March 31, 2003 is necessary;
however, if the EGPs utilized in the DAC amortization model remain at or above
the margin of the reasonable range of statistically calculated EGPs, a revision
would be necessary within the next two quarters.
- 21 -
Furthermore, the Company has estimated that such a revision to the future EGPs
may occur if the overall separate account fund performance does not meet the 9%
return assumption discussed above, or if certain other assumptions that are
implicit in the computations of the EGP's are not achieved.
Additionally, the Company has performed an analysis with respect to the
potential impact of a revision to future EGPs. If such a revision to EGPs were
deemed necessary, the Company would adjust, as appropriate, all of its
assumptions for products accounted for in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 97, "Accounting and Reporting by Insurance
Enterprises for Certain Long-Duration Contracts and for Realized Gains and
Losses from the Sale of Investments", and reproject its future EGPs based on
current account values at the end of the quarter in which a revision is deemed
to be necessary. To illustrate the effects of this process, assume the Company
had concluded that a revision of the Company's EGPs was required at March 31,
2003. If the Company assumed a 9% average long-term rate of growth from
March 31, 2003 forward along with other appropriate assumption changes in
determining the revised EGPs, the Company estimates the cumulative positive
adjustment to amortization would be approximately $325-$360, after tax. If
instead the Company was to assume a long-term growth rate of 8% in determining
the revised EGPs, the adjustment would be approximately $375-$425, after tax.
Assuming that such an adjustment were to have been required, the Company
anticipates that there would have been immaterial impacts on its DAC
amortization income for the 2003 and 2004 years exclusive of the adjustment, and
that there would have been positive earnings effects in later years. Any such
adjustment would not affect statutory income or surplus, due to the prescribed
accounting for such amounts that is discussed above.
Aside from absolute levels and timing of market performance assumptions,
additional factors that will influence this determination include the degree of
volatility in separate account fund performance and shifts in asset allocation
within the separate account made by policyholders. The overall return generated
by the separate account is dependent on several factors, including the relative
mix of the underlying sub-accounts among bond funds and equity funds as well as
equity sector weightings. The Company's overall separate account fund
performance has been reasonably correlated to the overall performance of the S&P
500 Index (which closed at 848 on March 31, 2003), although no assurance can be
provided that this correlation will continue in the future.
The overall recoverability of the DAC asset is dependent on the future
profitability of the business. The Company tests the aggregate recoverability of
the DAC asset by comparing the amounts deferred to the present value of total
EGPs. In addition, the Company routinely stress tests its DAC asset for
recoverability against severe declines in its separate account assets, which
could occur if the equity markets experienced another significant sell-off, as
the majority of policyholders' funds in the separate accounts is invested in the
equity market. As of March 31, 2003, the Company believed variable annuity
separate account assets could fall by at least 19% before portions of its DAC
asset would be unrecoverable.
OTHER CRITICAL ACCOUNTING ESTIMATES
There have been no material changes to the Company's critical accounting
estimates regarding Property & Casualty DAC; valuation of investments and
derivative instruments; pension and other postretirement benefits; and
contingencies since the filing of the Company's 2002 Form 10-K Annual Report.
- --------------------------------------------------------------------------------
CONSOLIDATED RESULTS OF OPERATIONS: OPERATING SUMMARY
- --------------------------------------------------------------------------------
OPERATING SUMMARY FIRST QUARTER ENDED
MARCH 31,
-----------------------------------
2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums $ 2,849 $ 2,586 10%
Fee income 617 662 (7%)
Net investment income 796 706 13%
Other revenues 122 113 8%
Net realized capital losses (53) (7) NM
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 4,331 4,060 7%
Benefits, claims and claim adjustment expenses 5,245 2,416 117%
Amortization of deferred policy acquisition costs and present value
of future profits 564 555 2%
Insurance operating costs and expenses 567 534 6%
Other expenses 180 187 (4%)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 6,556 3,692 78%
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES (2,225) 368 NM
Income tax expense (benefit) (830) 76 NM
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ (1,395) $ 292 NM
====================================================================================================================================
The Hartford defines "NM" as not meaningful, increases or decreases greater than
200%.
OPERATING RESULTS
Revenues for the first quarter ended March 31, 2003 increased $271 over the
comparable prior year period, primarily as a result of double-digit earned
premium growth in the Specialty
- 22 -
Commercial and Business Insurance segments, as well as increased net investment
income in Investment Products.
Net income decreased $1.7 billion with $1.7 billion, after-tax, in reserve
strengthening resulting from the completion of the Company's study of its
asbestos exposure and an increase of $46 in net realized capital losses. The
remaining difference, an increase of $60, or 20%, was primarily the result of
strong earned pricing in the Business Insurance and Specialty Commercial
segments and improved underwriting results in Personal Lines automobile and
homeowners, partially offset by a decrease in net income for the Investment
Products segment. This decrease reflects the impact of the lower equity markets
on individual annuity results.
First quarter 2002 net income includes $11 of after-tax expense at Hartford
Life, Inc. ("HLI") related to litigation with Bancorp Services, LLC ("Bancorp"),
partially offset by an $8 after-tax benefit related to the reduction of HLI's
reserves associated with September 11. (For further discussion of the Bancorp
litigation, see Note 5(a) of Notes to Condensed Consolidated Financial
Statements.)
INCOME TAXES
The effective tax rate for the first quarter ended March 31, 2003 was a benefit
of 37% compared with a 21% expense for the comparable period in 2002. Tax-exempt
interest earned on invested assets and the dividends received deduction were the
principal causes of the effective tax rates being different than the 35% U.S.
statutory rate.
ADOPTION OF FAIR-VALUE RECOGNITION PROVISIONS FOR STOCK COMPENSATION
In December 2002, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure,
an Amendment to SFAS No. 123", which provides three optional transition methods
for entities that decide to voluntarily adopt the fair value recognition
principles of SFAS No. 123, "Accounting for Stock Issued to Employees", and
modifies the disclosure requirements of that Statement. In January 2003, the
Company adopted the fair value recognition provisions of accounting for employee
stock compensation and used the prospective transition method. Under the
prospective method, stock-based compensation expense is recognized for awards
granted or modified after the beginning of the fiscal year in which the change
is made. The Company will expense all stock-based compensation awards granted or
modified after January 1, 2003. The fair value of stock-based awards granted
during the quarter ended March 31, 2003 was $29, after-tax. The fair value of
these awards will be recognized over the awards' vesting period, generally 3
years. The expense associated with these awards for the first quarter ending
March 31, 2003 was $1, after-tax.
All stock-based awards granted or modified prior to January 1, 2003, will
continue to be valued using the intrinsic value-based provisions set forth in
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees". Under the intrinsic value method, compensation expense is
determined on the measurement date, which is the first date on which both the
number of shares the employee is entitled to receive and the exercise price are
known. Compensation expense, if any, is measured based on the award's intrinsic
value, which is the excess of the market price of the stock over the exercise
price on the measurement date. The expense, including non-option plans, related
to stock-based employee compensation included in the determination of net income
for the first quarter ended March 31, 2003 and 2002 is less than that which
would have been recognized if the fair value method had been applied to all
awards since the effective date of SFAS No. 123. (For further discussion of the
Company's stock compensation plans, see Note 11 of Notes to Consolidated
Financial Statements included in The Hartford's 2002 Form 10-K Annual Report.)
The following table illustrates the effect on net income and earnings per share
as if the fair value method had been applied to all outstanding and unvested
awards in each period.
FIRST QUARTER ENDED
MARCH 31,
----------------------------------
2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Net income (loss), as reported $ (1,395) $ 292 NM
Add: Stock-based employee compensation expense included in
reported net income(loss), net of related tax effects [1] 1 1 --
Deduct: Total stock-based employee compensation expense
determined under the fair value method for all awards,
net of related tax effects (9) (9) --
- ------------------------------------------------------------------------------------------------------------------------------------
Pro forma net income (loss) [2] $ (1,403) $ 284 NM
====================================================================================================================================
Earnings (loss) per share:
Basic - as reported $ (5.46) $ 1.19 NM
Basic - pro forma [2] $ (5.49) $ 1.15 NM
Diluted - as reported [3] $ (5.46) $ 1.17 NM
Diluted - pro forma [2] [3] $ (5.49) $ 1.14 NM
====================================================================================================================================
[1] Excludes impact of non-option plans of $1 for the first quarters ended
March 31, 2003 and 2002.
[2] The pro forma disclosures are not representative of the effects on net
income and earnings (loss) per share in future years.
[3] As a result of the net loss in the quarter ended March 31, 2003, SFAS No.
128, "Earnings Per Share", requires the Company to use basic weighted
average shares outstanding in the calculation of first quarter 2003
diluted earnings per share, as the inclusion of options of 0.7 would have
been antidilutive to the earnings per share calculation. In the absence of
the net loss, weighted average common shares outstanding and dilutive
potential common shares would have totaled 256.1.
- 23 -
ORGANIZATIONAL STRUCTURE
The Hartford is organized into two major operations: Life and Property &
Casualty. Within these operations, The Hartford conducts business principally in
nine operating segments. Additionally, the capital raising and purchase
accounting adjustment activities related to the June 27, 2000 acquisition of all
of the shares of HLI that the Company did not already own ("the HLI
Repurchase"), as well as capital raised that has not been contributed to the
Company's insurance subsidiaries are included in Corporate.
Life is organized into four reportable operating segments: Investment Products,
Individual Life, Group Benefits and Corporate Owned Life Insurance ("COLI").
Life also includes in an Other category its international operations, which are
primarily located in Japan and Latin America; realized capital gains and losses;
as well as corporate items not directly allocated to any of its reportable
operating segments, principally interest expense; and intersegment eliminations.
Property & Casualty is organized into five reportable operating segments: the
North American underwriting segments of Business Insurance, Personal Lines,
Specialty Commercial and Reinsurance; and the Other Operations segment, which
includes substantially all of the Company's asbestos and environmental
exposures. "North American" includes the combined underwriting results of the
Business Insurance, Personal Lines, Specialty Commercial and Reinsurance
underwriting segments along with income and expense items not directly allocated
to these segments, such as net investment income, net realized capital gains and
losses, other expenses including interest, and income taxes.
On May 12, 2003, the Company announced plans to exit the assumed reinsurance
business.
The measure of profit or loss used by The Hartford's management in evaluating
the performance of its Life segments is net income. However, North American
underwriting segments are evaluated by The Hartford's management primarily based
upon underwriting results. Underwriting results represent premiums earned less
incurred claims, claim adjustment expenses and underwriting expenses.
Certain transactions between segments occur during the year that primarily
relate to tax settlements, insurance coverage, expense reimbursements, services
provided, security transfers and capital contributions. In addition, certain
reinsurance stop loss agreements exist between the segments which specify that
one segment will reimburse another for losses incurred in excess of a
predetermined limit. Also, one segment may purchase group annuity contracts from
another to fund pension costs and claim annuities to settle casualty claims. In
addition, certain intersegment transactions occur in Life. These transactions
include interest income on allocated surplus and the allocation of certain net
realized capital gains and losses through net investment income, utilizing the
duration of the segment's investment portfolios. During the first quarter of
2003, $750 of securities were sold by the Property & Casualty operation to the
Life operation. An additional $1.0 billion of securities were sold in April
2003. For segment reporting, the net gain on this sale was deferred by the
Property & Casualty operation and will be reported as realized when the
underlying securities are sold by the Life operation. On December 1, 2002, The
Hartford entered into a contract with a subsidiary, Fencourt Reinsurance
Company, Ltd. ("Fencourt"), whereby Fencourt will provide reinsurance for the
Property & Casualty operations. The financial results of this reinsurance
program, net of retrocessions to unrelated reinsurers, will be included in the
Specialty Commercial segment.
SEGMENT RESULTS
The following is a summary of net income for each of the Company's Life segments
and aggregate net income for the Company's Property & Casualty operations.
NET INCOME (LOSS) FIRST QUARTER ENDED
MARCH 31,
---------------------------------
2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Life
Investment Products $ 98 $ 117 (16%)
Individual Life 32 31 3%
Group Benefits 34 28 21%
COLI 10 -- NM
Other (48) (6) NM
- ------------------------------------------------------------------------------------------------------------------------------------
Total Life 126 170 (26%)
Property & Casualty
North American 168 127 32%
Other Operations (1,681) 1 NM
- ------------------------------------------------------------------------------------------------------------------------------------
Total Property & Casualty (1,513) 128 NM
Corporate (8) (6) (33%)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL NET INCOME (LOSS) $ (1,395) $ 292 NM
====================================================================================================================================
The following is a summary of North American underwriting results by
underwriting segment within Property & Casualty. Underwriting results represent
premiums earned less incurred claims, claim adjustment expenses and underwriting
expenses.
- 24 -
UNDERWRITING RESULTS (BEFORE-TAX) FIRST QUARTER ENDED
MARCH 31,
---------------------------------
North American 2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Business Insurance $ (12) $ 4 NM
Personal Lines 52 (11) NM
Specialty Commercial -- (10) 100%
Reinsurance (19) (4) NM
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL NORTH AMERICAN UNDERWRITING RESULTS $ 21 $ (21) NM
====================================================================================================================================
In the sections that follow, the Company analyzes the results of operations of
its various segments using the performance measurements that the Company
believes are meaningful.
- --------------------------------------------------------------------------------
LIFE
- --------------------------------------------------------------------------------
OPERATING SUMMARY FIRST QUARTER ENDED
MARCH 31,
-----------------------------------
2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums $ 683 $ 709 (4%)
Fee income 617 662 (7%)
Net investment income 507 448 13%
Other revenues 27 32 (16%)
Net realized capital (losses) (48) (15) NM
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 1,786 1,836 (3%)
Benefits, claims and claim adjustment expenses 1,083 1,057 2%
Amortization of deferred policy acquisition costs and present value
of future profits 163 152 7%
Insurance operating costs and expenses 351 357 (2%)
Other expenses 33 48 (31%)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 1,630 1,614 1%
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 156 222 (30%)
Income tax expense 30 52 (42%)
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 126 $ 170 (26%)
====================================================================================================================================
Revenues in the Life operation decreased primarily as a result of revenue
decreases in its Investment Products and COLI segments. Investment Products
revenues decreased as average individual annuity account values declined
compared to prior year. The decline in account values was due primarily to
weakness in the equity markets. Additionally, COLI revenues decreased primarily
as a result of lower net investment income, as average leveraged COLI account
values declined as compared to a year ago and lower fee income resulting from
lower sales in the first quarter of 2003 as compared to the prior year.
Partially offsetting these decreases were increases in revenues in Group
Benefits and Individual Life. Individual Life revenues increased as a result of
an increase in fee revenues as life insurance in-force increased. Revenues
within Group Benefits increased due to an increase in total buyout premium
activity.
Benefits, claims and expenses increased slightly primarily due to increases in
Individual Life and Group Benefits loss costs associated with the growth in
these segments. Partially offsetting this increase was a decrease in COLI
expenses consistent with lower COLI revenues. Additionally, in the first quarter
of 2002, the Company incurred a charge associated with the Bancorp litigation.
(For further discussion of the Bancorp litigation, see Note 5 of Notes to
Condensed Consolidated Financial Statements.)
Net income decreased as a result of the decrease in revenues described above and
higher net realized capital losses compared to a year ago. Additionally, Life
net income for the first quarter 2002 was positively impacted by an $8 after-tax
expense benefit related to favorable development on the Company's estimated
September 11 exposure. Net income for the Investment Products segment decreased
from the prior year as a result of the impact of the lower equity markets on the
individual annuity business. Net income for other investment products was
consistent with the comparable prior year period. Net income related to the
Other category decreased $42, primarily related to increased realized capital
losses noted above. Partially offsetting these decreases were increases in net
income related to the Group Benefits and COLI segments. Group Benefits net
income increased driven principally by an improved loss ratio (defined as
benefits and claims as a percentage of premiums and other considerations
excluding buyouts) and expense management initiatives. COLI net income increased
$10 as compared to the prior year period, primarily due to the $11 after-tax
expense related to the Bancorp litigation accrued in the first quarter of 2002.
- 25 -
- --------------------------------------------------------------------------------
INVESTMENT PRODUCTS
- --------------------------------------------------------------------------------
OPERATING SUMMARY FIRST QUARTER ENDED
MARCH 31,
-----------------------------------
2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Fee income and other $ 373 $ 432 (14%)
Earned premiums 91 132 (31%)
Net investment income 309 246 26%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 773 810 (5%)
Benefits, claims and claim adjustment expenses 394 373 6%
Insurance operating costs and other expenses 144 168 (14%)
Amortization of deferred policy acquisition costs 109 114 (4%)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 647 655 (1%)
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 126 155 (19%)
Income tax expense 28 38 (26%)
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 98 $ 117 (16%)
- ------------------------------------------------------------------------------------------------------------------------------------
MARCH 31, MARCH 31,
2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Individual variable annuity account values $ 64,047 $ 75,044 (15%)
Other individual annuity account values 10,602 10,080 5%
Other investment products account values 20,381 19,894 2%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ACCOUNT VALUES [1] 95,030 105,018 (10%)
Mutual fund assets under management 15,045 17,695 (15%)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT PRODUCTS ASSETS UNDER MANAGEMENT $ 110,075 $ 122,713 (10%)
====================================================================================================================================
[1] Includes policyholder balances for investment contracts and reserves for
future policy benefits for insurance contracts.
Revenues in the Investment Products segment decreased primarily due to lower fee
income, which was partially offset by higher net investment income. Fee income
generated by the individual annuity operation decreased, as average account
values decreased from prior year levels, principally due to the lower equity
markets. Fee income from other investment products decreased, driven by lower
retail mutual fund assets. Mutual fund assets under management decreased,
primarily due to weakness in the equity markets. In addition, the equity market
performance has negatively affected sales of retail mutual funds over the last
twelve months. The decrease in earned premiums are due to lower sales of certain
products in the institutional investment products business. Net investment
income increased due to higher general account assets in the individual annuity
business. General account individual annuity assets were $9.5 billion as of
March 31, 2003, an increase of $4.1 billion, or 74%, from March 31, 2002.
Additionally, net investment income related to other investment products
increased as a result of the growth over the last twelve months in the
institutional investment business, where related assets under management
increased $614, or 7%, since March 31, 2002 to $10.0 billion as of March 31,
2003. Assets under management is an internal performance measure used by the
Company since a significant portion of the Company's revenue is based upon asset
values. These revenues increase or decrease with a rise or fall, respectively,
in the level of assets under management.
Total benefits, claims and expenses decreased, primarily driven by lower
commissions and wholesaling expenses related to lower sales in the other
investment products business, including the mutual fund operation, for the first
quarter ended March 31, 2003 as well as disciplined operating expense
management. Additionally, there was a decrease in amortization of deferred
policy acquisition costs in the individual annuity operation which declined as a
result of lower gross profits in the first quarter of 2003. Partially offsetting
these lower expenses was an increase in interest credited resulting from growth
in the segment's general account assets.
Net income related to the individual annuity operation decreased, primarily as a
result of the lower equity markets. Net income for other investment products was
consistent with the comparable prior year period.
- 26 -
- --------------------------------------------------------------------------------
INDIVIDUAL LIFE
- --------------------------------------------------------------------------------
OPERATING SUMMARY FIRST QUARTER ENDED
MARCH 31,
-----------------------------------
2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Fee income and other $ 178 $ 169 5%
Net investment income 66 63 5%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 244 232 5%
Benefits, claims and claim adjustment expenses 112 114 (2%)
Amortization of deferred policy acquisition costs 46 33 39%
Insurance operating costs and other expenses 39 39 --
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 197 186 6%
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 47 46 2%
Income tax expense 15 15 --
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 32 $ 31 3%
- ------------------------------------------------------------------------------------------------------------------------------------
MARCH 31, MARCH 31,
2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Variable life account values $ 3,673 $ 4,119 (11%)
Total account values $ 7,583 $ 7,983 (5%)
- ------------------------------------------------------------------------------------------------------------------------------------
Variable life insurance in force $ 66,631 $ 63,288 5%
Total life insurance in force $ 127,029 $ 121,935 4%
====================================================================================================================================
Revenues in the Individual Life segment increased as cost of insurance charges
were higher as the result of higher total life insurance in force. Amortization
of unearned revenue also increased due to favorable mortality results which
drove higher gross profits. Additionally, net investment income was higher due
primarily to higher average general account assets and higher prepayment income
on certain assets as compared to the prior year.
Total benefits, claims and expenses increased principally due to the increase in
amortization of deferred policy acquisition costs resulting from higher gross
profits driven by more favorable mortality results.
Net income increased primarily due to the in-force growth, favorable mortality
experience, and higher net investment income.
- --------------------------------------------------------------------------------
GROUP BENEFITS
- --------------------------------------------------------------------------------
OPERATING SUMMARY FIRST QUARTER ENDED
MARCH 31,
-----------------------------------
2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums and other $ 602 $ 582 3%
Net investment income 65 62 5%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 667 644 4%
Benefits, claims and claim adjustment expenses 489 474 3%
Amortization of deferred policy acquisition costs 4 4 --
Insurance operating costs and other expenses 131 131 --
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 624 609 2%
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 43 35 23%
Income tax expense 9 7 29%
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 34 $ 28 21%
====================================================================================================================================
Revenues in the Group Benefits segment increased primarily due to earned premium
growth. The premium increase is primarily attributable to an increase in total
buyouts of $28 compared to prior year. Premiums, excluding buyouts, for the
first quarter of 2003 were down slightly as a result of the Group Benefits
division's continued risk management discipline in light of a challenging
competitive and economic environment.
Total benefits, claims and expenses increased due to the buyouts described above
which were partially offset by favorable loss costs as compared to a year ago.
The segment's loss ratio (defined as benefits and claims as a percentage of
premiums and other considerations excluding buyouts) was approximately 80.3% for
the first quarter ended March 31, 2003, as compared to 81.4% for the comparable
prior year period due to favorable claims experience.
Net income increased due to favorable loss ratios noted above and continued
expense discipline, which resulted in maintaining consistent expense levels as
compared to the prior year period.
- 27 -
- --------------------------------------------------------------------------------
CORPORATE OWNED LIFE INSURANCE ("COLI")
- --------------------------------------------------------------------------------
OPERATING SUMMARY FIRST QUARTER ENDED
MARCH 31,
-----------------------------------
2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Fee income and other $ 68 $ 84 (19%)
Net investment income 59 76 (22%)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 127 160 (21%)
Benefits, claims and claim adjustment expenses 88 115 (23%)
Insurance operating costs and expenses 10 40 (75%)
Dividends to policyholders 14 5 180%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 112 160 (30%)
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 15 -- NM
Income tax expense 5 -- NM
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 10 $ -- NM
- ------------------------------------------------------------------------------------------------------------------------------------
MARCH 31, MARCH 31,
2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Variable COLI account values $ 19,863 $ 18,764 6%
Leveraged COLI account values 3,159 4,293 (26%)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ACCOUNT VALUES $ 23,022 $ 23,057 --
====================================================================================================================================
COLI revenues decreased mostly due to lower net investment and fee income. Net
investment income decreased, primarily related to the decline in leveraged COLI
account values from surrender activity. Fee income was reduced as the result of
lower sales in the first quarter of 2003 as compared to the first quarter of
2002, and the decline in leveraged COLI.
Total benefits, claims and expenses decreased as a result of the decline in the
leveraged COLI block noted above and a decline in insurance operating costs and
expenses related to the $11 after-tax expense related to the Bancorp litigation
accrued in the first quarter of 2002. Dividends to policyholders increased due
to an increase in mortality dividends on the leveraged COLI block.
Net income increased compared to the prior year principally as a result of the
Bancorp litigation expense recorded in the first quarter of 2002.
- --------------------------------------------------------------------------------
PROPERTY & CASUALTY
- --------------------------------------------------------------------------------
OPERATING SUMMARY FIRST QUARTER ENDED
MARCH 31,
-----------------------------------
2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums $ 2,166 $ 1,877 15%
Net investment income 285 254 12%
Other revenues [1] 95 81 17%
Net realized capital gains (losses) (5) 8 NM
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 2,541 2,220 14%
Benefits, claims and claim adjustment expenses 4,161 1,358 NM
Amortization of deferred policy acquisition costs 401 403 --
Insurance operating costs and expenses 216 177 22%
Other expenses 132 126 5%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 4,910 2,064 138%
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES (2,369) 156 NM
Income tax expense (benefit) (856) 28 NM
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) [2] $ (1,513) $ 128 NM
- ------------------------------------------------------------------------------------------------------------------------------------
NORTH AMERICAN PROPERTY & CASUALTY GAAP UNDERWRITING RATIOS
Loss ratio 58.9 59.2 0.3
Loss adjustment expense ratio 12.1 11.6 (0.5)
Expense ratio 26.2 29.0 2.8
Policyholder dividend ratio 0.4 0.5 0.1
Combined ratio 97.7 100.2 2.5
Catastrophe ratio 2.6 1.1 (1.5)
====================================================================================================================================
[1] Represents servicing revenue.
[2] Includes net realized capital gains (losses), after-tax, of $(3) and $6
for the quarters ended March 31, 2003 and 2002, respectively.
- 28 -
Revenues for Property & Casualty increased $321, or 14%, for the first quarter
ended March 31, 2003 compared with the first quarter of 2002. The increase was
due primarily to earned premium growth in the Business Insurance and Specialty
Commercial segments as a result of earned pricing increases, new business growth
and strong premium renewal retention.
Net income decreased $1.6 billion for the first quarter ended March 31, 2003,
from the comparable prior year period. The decrease was primarily due to the net
asbestos reserve strengthening of $1.7 billion, after-tax, resulting from the
completion of the Company's detailed study of its asbestos exposures. The
remaining difference, an increase of $60, or 47%, was due to improved
underwriting results in Personal Lines automobile and homeowners and strong
earned pricing in the Specialty Commercial segment. Pre-tax net investment
income rose $31, or 12%, over the prior year period due to higher invested
assets, primarily from strong cash flows.
RATIOS
The previous table and the following segment discussions for the quarters ended
March 31, 2003 and 2002 include various operating ratios. Management believes
that these ratios are useful in understanding the underlying trends in The
Hartford's current business. However, these measures should only be used in
conjunction with, and not in lieu of, underwriting income and may not be
comparable to other performance measures used by the Company's competitors. The
"loss ratio" is the ratio of claims expense (exclusive of claim adjustment
expenses) to earned premiums. The "loss adjustment expense ratio" represents the
ratio of claim adjustment expenses to earned premiums. The "expense ratio" is
the ratio of underwriting expenses, excluding bad debts expense, to earned
premiums. The "policyholder dividend ratio" is the ratio of policyholder
dividends to earned premiums. The "combined ratio" is the sum of the loss ratio,
the loss adjustment expense ratio, the expense ratio and the policyholder
dividend ratio. These ratios are relative measurements that describe for every
$100 of net premiums earned, the cost of losses and expenses, respectively. A
combined ratio below 100 demonstrates underwriting profit; a combined ratio
above 100 demonstrates underwriting losses. The "catastrophe ratio" represents
the ratio of catastrophe losses to earned premiums.
REINSURANCE RECOVERABLES
The Company's net reinsurance recoverables from various property and casualty
reinsurance arrangements amounted to $5.6 billion and $4.2 billion at March 31,
2003 and December 31, 2002, respectively. With respect to the reinsurance
recoverables, the Company is subject to credit risks or other settlement risks
that could cause one or more reinsurer(s) to fail to reimburse the Company under
the terms of these reinsurance arrangements. The Company mitigates this risk by
transacting business with reinsurers that are financially sound and historically
have demonstrated a willingness to live up to their contractual obligations. Of
the total net reinsurance recoverables as of December 31, 2002 (excluding the
Company's mandatory participation in various involuntary assigned risk pools),
$2.7 billion, or 72%, are rated by A.M. Best. Of the total rated by A.M. Best,
91% are rated A- (excellent) or better. The remaining net recoverables from
reinsurers comprise the following: 9% relates to Equitas, 6% relates to
voluntary pools in which the Company participates, 1% relates to captive
insurance companies, and 12% are not rated by A.M. Best, of which no single
reinsurer constitutes more than 0.75% of the Company's reinsurance recoverable.
Where its contracts permit, the Company secures future claim obligations with
various forms of collateral including irrevocable letters of credit, New York
Regulation 114 trusts, funds held accounts and group wide offsets.
To address the risk of non-payment for the related reinsurance recoverable, the
Company estimated an allowance for unrecoverable reinsurance of $461 at March
31, 2003 and $211 at December 31, 2002.
WRITTEN PREMIUMS
Written premium is the amount of premiums charged for policies issued during a
fiscal period. Earned premium is a GAAP measure. Premiums are considered earned
and are included in the financial results on a pro rata basis over the policy
period. The following segment discussions for the quarters ended March 31, 2003
and 2002 include the presentation of written premiums, in addition to earned
premiums. Management believes that this forward-looking performance measure is
useful to investors as it provides a better understanding of the underlying
trends in the Company's current business.
RESERVES
Reserving for property and casualty losses is an estimation process. As
additional experience and other relevant claim data become available, reserve
levels are adjusted accordingly. Such adjustments of reserves related to claims
incurred in prior years are a natural occurrence in the loss reserving process
and are referred to as "reserve development". Reserve development that increases
previous estimates of ultimate cost is called "reserve strengthening". Reserve
development that decreases previous estimates of ultimate cost is called
"reserve releases". Reserve development can influence the comparability of year
over year underwriting results and is set forth in the paragraphs and tables
that follow. The "prior accident year development" in the following table
represents the ratio of reserve development to earned premiums. For a detailed
discussion of the Company's reserve policies, see Notes 1(l), 7 and 16(b) of
Notes to Consolidated Financial Statements and the Critical Accounting Estimates
section of the MD&A included in The Hartford's 2002 Form 10-K Annual Report.
There was no overall reserve strengthening or release in the Business Insurance,
Personal Lines and Specialty Commercial segments for the quarter ended March 31,
2003. Reserve strengthening in the Reinsurance segment occurred across multiple
accident years, primarily 1997 through 2000, and primarily in the casualty line
of traditional reinsurance.
A rollforward of liabilities for unpaid claims and claim adjustment expenses by
segment for the first quarter ended March 31, 2003 for Property & Casualty
follows:
- 29 -
FOR THE QUARTER ENDED MARCH 31, 2003
- ------------------------------------------------------------------------------------------------------------------------------------
BUSINESS PERSONAL SPECIALTY NORTH OTHER
INSURANCE LINES COMMERCIAL REINSURANCE AMERICAN P&C OPERATIONS TOTAL P&C
- ------------------------------------------------------------------------------------------------------------------------------------
BEGINNING LIABILITIES FOR UNPAID CLAIMS
AND CLAIM ADJUSTMENT EXPENSES-GROSS $ 4,744 $ 1,692 $ 4,957 $ 1,614 $ 13,007 $ 4,084 $ 17,091
Reinsurance and other recoverables 366 49 1,998 388 2,801 1,149 3,950
- ------------------------------------------------------------------------------------------------------------------------------------
BEGINNING LIABILITIES FOR UNPAID CLAIMS
AND CLAIM ADJUSTMENT EXPENSES-NET 4,378 1,643 2,959 1,226 10,206 2,935 13,141
- ------------------------------------------------------------------------------------------------------------------------------------
Add provision for unpaid claims and
claim adjustment expenses 598 540 265 129 1,532 2,629 4,161
Less payments 442 531 209 111 1,293 98 1,391
- ------------------------------------------------------------------------------------------------------------------------------------
ENDING LIABILITIES FOR UNPAID CLAIMS AND
CLAIM ADJUSTMENT EXPENSES-NET 4,534 1,652 3,015 1,244 10,445 5,466 15,911
Reinsurance and other recoverables 388 48 2,007 373 2,816 2,485 5,301
- ------------------------------------------------------------------------------------------------------------------------------------
ENDING LIABILITIES FOR UNPAID CLAIMS AND
CLAIM ADJUSTMENT EXPENSES-GROSS $ 4,922 $ 1,700 $ 5,022 $ 1,617 $ 13,261 $ 7,951 $ 21,212
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premium $ 880 $ 772 $ 355 $ 151 $ 2,158 $ 8 $ 2,166
Combined ratio 99.2 92.7 98.4 112.5 97.7
Loss and loss expense paid ratio 50.2 68.6 59.1 74.6 59.9
Loss and loss expense incurred ratio 67.9 69.7 75.1 86.1 71.0
Catastrophe ratio 4.6 1.4 0.9 1.5 2.6
Prior accident year development (pts.)[1] -- -- -- 23.2 1.6
====================================================================================================================================
[1] Reinsurance excludes prior year accident premium adjustment of $(10).
- --------------------------------------------------------------------------------
BUSINESS INSURANCE
- --------------------------------------------------------------------------------
UNDERWRITING SUMMARY FIRST QUARTER ENDED
MARCH 31,
-----------------------------------
2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Written premiums $ 990 $ 825 20%
Change in unearned premium reserve 110 93 18%
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums $ 880 $ 732 20%
Benefits, claims and claim adjustment expenses 598 466 28%
Amortization of deferred policy acquisition costs 204 195 5%
Insurance operating costs and expenses 90 67 34%
- ------------------------------------------------------------------------------------------------------------------------------------
UNDERWRITING RESULTS $ (12) $ 4 NM
- ------------------------------------------------------------------------------------------------------------------------------------
Loss ratio 55.0 51.6 (3.4)
Loss adjustment expense ratio 12.9 12.0 (0.9)
Expense ratio 30.5 33.4 2.9
Policyholder dividend ratio 0.8 1.0 0.2
Combined ratio 99.2 98.0 (1.2)
Catastrophe ratio 4.6 0.6 (4.0)
====================================================================================================================================
PREMIUM BREAKDOWN WRITTEN PREMIUMS [1] EARNED PREMIUMS [1]
------------------------------------- ----------------------------------
FIRST QUARTER ENDED FIRST QUARTER ENDED
MARCH 31, MARCH 31,
------------------------------------- ----------------------------------
2003 2002 CHANGE 2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Small Commercial $ 480 $ 408 18% $ 430 $ 369 17%
Middle Market 510 417 22% 450 363 24%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 990 $ 825 20% $ 880 $ 732 20%
====================================================================================================================================
[1] The difference between written premiums and earned premiums is
attributable to the change in unearned premium reserve.
Business Insurance achieved written premium growth of $165 primarily due to
written pricing increases of 13% and new business growth of 22%. Strong premium
renewal retention of 90% was consistent with prior year. Premium renewal
retention is defined as renewal premium written in the current period divided by
new and renewal premium written in the prior period. The increase in middle
market of $93 was driven primarily by double-digit written pricing increases and
continued strong new business growth and premium renewal retention. Small
commercial increased $72 reflecting double-digit written pricing increases as
well as strong new business growth and premium renewal retention.
- 30 -
Earned premiums for the segment increased $148 due to strong 2002 and 2003
written pricing increases impacting 2003 earned premium. Middle market increased
$87 to $450 and small commercial increased $61 to $430 reflecting double-digit
earned pricing increases.
Underwriting results decreased $16, with a corresponding 1.2 point increase in
the combined ratio, for the first quarter of 2003 as compared with the prior
year period primarily due to significantly higher catastrophes after relatively
low catastrophe experience in the prior year period. Before catastrophes,
underwriting results improved $19, or 2.8 points, to $28 primarily due to strong
earned pricing increases, the beneficial effects of which have also contributed
to improvement in the expense ratio. Additionally, the improved results were
also attributable to the segment's continued successful focus on distribution
strategies. Partially offsetting the improvement in underwriting results were
higher loss ratios for small commercial package policies due to increased
severity.
- --------------------------------------------------------------------------------
PERSONAL LINES
- --------------------------------------------------------------------------------
UNDERWRITING SUMMARY FIRST QUARTER ENDED
MARCH 31,
-----------------------------------
2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Written premiums $ 770 $ 726 6%
Change in unearned premium reserve (2) 8 NM
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums $ 772 $ 718 8%
Benefits, claims and claim adjustment expenses 540 550 (2%)
Amortization of deferred policy acquisition costs 104 108 (4%)
Insurance operating costs and expenses 76 71 7%
- ------------------------------------------------------------------------------------------------------------------------------------
UNDERWRITING RESULTS $ 52 $ (11) NM
- ------------------------------------------------------------------------------------------------------------------------------------
Loss ratio 58.4 65.0 6.6
Loss adjustment expense ratio 11.3 11.8 0.5
Expense ratio 23.0 24.4 1.4
Combined ratio 92.7 101.2 8.5
Catastrophe ratio 1.4 2.2 0.8
Other revenues [1] $ 28 $ 29 (3%)
====================================================================================================================================
[1] Represents servicing revenue.
PREMIUM BREAKDOWN WRITTEN PREMIUMS [1] EARNED PREMIUMS [1]
------------------------------------- ----------------------------------
FIRST QUARTER ENDED FIRST QUARTER ENDED
MARCH 31, MARCH 31,
------------------------------------- ----------------------------------
2003 2002 CHANGE 2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Business Unit
AARP $ 475 $ 427 11% $ 466 $ 413 13%
Other Affinity 42 49 (14%) 44 50 (12%)
Agency 253 250 1% 262 255 3%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 770 $ 726 6% $ 772 $ 718 8%
Product Line
Automobile $ 609 $ 583 4% $ 598 $ 563 6%
Homeowners 161 143 13% 174 155 12%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 770 $ 726 6% $ 772 $ 718 8%
COMBINED RATIOS
Automobile 96.1 103.6 7.5
Homeowners 80.8 92.5 11.7
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL 92.7 101.2 8.5
====================================================================================================================================
[1] The difference between written premiums and earned premiums is
attributable to the change in unearned premium reserve.
Written premiums increased $44 due to growth in both the automobile and
homeowners lines. The increase in automobile of $26 was primarily due to written
pricing increases of 10% and premium renewal retention of 90%. Homeowners growth
of $18 was also driven by written pricing increases of 14% and premium renewal
retention of 103%. The increases in both automobile and homeowners written
premiums were primarily due to growth in the AARP program. AARP increased $48
primarily as a result of double-digit written pricing increases and strong
premium renewal retention. Partially offsetting the increase was a $7 decrease
in written premiums in other affinity due to an expected reduction in policy
counts. Personal Lines new business growth was negatively impacted by
profitability objectives.
Earned premiums increased $54 due primarily to growth in AARP. AARP increased
$53 to $466 primarily as a result of earned pricing increases.
- 31 -
Underwriting results increased $63, with a corresponding 8.5 point decrease in
the combined ratio, for the first quarter of 2003 as compared with the same
prior year period. Automobile results improved 7.5 combined ratio points due to
earned pricing increases and favorable frequency loss costs. The underwriting
experience related to homeowners continued to remain favorable and improved 11.7
combined ratio points over the same prior year period due primarily to
double-digit earned pricing increases and favorable frequency loss costs.
Personal Lines pre-tax catastrophes improved $5 or 0.8 points. Improvement in
the other underwriting expense ratio, primarily due to double-digit earned
pricing increases and prudent expense management, resulted in a 1.4 point
decrease in the expense ratio.
- --------------------------------------------------------------------------------
SPECIALTY COMMERCIAL
- --------------------------------------------------------------------------------
UNDERWRITING SUMMARY FIRST QUARTER ENDED
MARCH 31,
-----------------------------------
2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Written premiums $ 406 $ 300 35%
Change in unearned premium reserve 51 62 (18%)
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums $ 355 $ 238 49%
Benefits, claims and claim adjustment expenses 265 168 58%
Amortization of deferred policy acquisition costs 56 61 (8%)
Insurance operating costs and expenses 34 19 79%
- ------------------------------------------------------------------------------------------------------------------------------------
UNDERWRITING RESULTS $ -- $ (10) 100%
- ------------------------------------------------------------------------------------------------------------------------------------
Loss ratio 60.3 55.6 (4.7)
Loss adjustment expense ratio 14.9 14.0 (0.9)
Expense ratio 22.6 32.5 9.9
Policyholder dividend ratio 0.7 0.7 --
Combined ratio 98.4 102.8 4.4
Catastrophe ratio 0.9 -- (0.9)
Other revenues [1] $ 67 $ 52 29%
====================================================================================================================================
[1] Represents servicing revenue.
PREMIUM BREAKDOWN WRITTEN PREMIUMS [1] EARNED PREMIUMS [1]
------------------------------------- ----------------------------------
FIRST QUARTER ENDED FIRST QUARTER ENDED
MARCH 31, MARCH 31,
------------------------------------- ----------------------------------
2003 2002 CHANGE 2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Risk Management Division $ 105 $ 65 62% $ 76 $ 45 69%
Property 97 91 7% 89 60 48%
Casualty 82 60 37% 72 52 38%
Bond 45 36 25% 42 35 20%
Professional Liability 65 43 51% 64 41 56%
Other 12 5 140% 12 5 140%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 406 $ 300 35% $ 355 $ 238 49%
- ------------------------------------------------------------------------------------------------------------------------------------
[1] The difference between written premiums and earned premiums is
attributable to the change in unearned premium reserve.
Specialty Commercial written premiums increased $106 primarily due to growth in
the risk management division as well as in the specialty casualty and
professional liability lines of business. Written premiums for the risk
management division increased $40 and specialty casualty grew $22 both driven
primarily by strong premium renewal retention and double-digit written pricing
increases reflecting an improved operating environment. The growth rate for the
risk management division was also impacted by unusually low premiums in the
first quarter of 2002 as a result of the division's reduced appetite from
aggregation of risk issues surfaced by September 11. Professional liability
written premiums grew $22 driven by significant written pricing increases. While
property pricing continues to be strong, the growth rate for the first quarter
was negatively impacted by the timing of premium booked in the previous year.
Earned premiums increased $117 primarily due to earned premium growth in the
risk management division of $31 property of $29 professional liability of $23
and specialty casualty of $20 as a result of double-digit earned pricing
increases.
Underwriting results improved $10, with a corresponding 4.4 point decrease in
the combined ratio, for the first quarter as compared with the same prior year
period. Improved underwriting and combined ratio results were primarily due to
continued favorable property results primarily as a result of strong earned
pricing as well as significant improvement in the bond loss ratio. In addition,
underwriting results were negatively impacted by growth in the risk management
division. The expense ratio for Specialty Commercial improved due to higher
ceding commissions in professional liability and property, earned pricing
increases, and prudent expense management.
- 32 -
- --------------------------------------------------------------------------------
REINSURANCE
- --------------------------------------------------------------------------------
UNDERWRITING SUMMARY FIRST QUARTER ENDED
MARCH 31,
-----------------------------------
2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Written premiums $ 274 $ 214 28%
Change in unearned premium reserve 123 43 186%
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums 151 $ 171 (12%)
Benefits, claims and claim adjustment expenses 129 131 (2%)
Amortization of deferred policy acquisition costs 37 39 (5%)
Insurance operating costs and expenses 4 5 (20%)
- ------------------------------------------------------------------------------------------------------------------------------------
UNDERWRITING RESULTS $ (19) $ (4) NM
- ------------------------------------------------------------------------------------------------------------------------------------
Loss ratio 80.5 72.3 (8.2)
Loss adjustment expense ratio 5.6 5.0 (0.6)
Expense ratio 26.4 25.1 (1.3)
Combined ratio 112.5 102.4 (10.1)
Catastrophe ratio 1.5 (0.5) (2.0)
====================================================================================================================================
PREMIUM BREAKDOWN WRITTEN PREMIUMS [1] EARNED PREMIUMS [1]
------------------------------------- ----------------------------------
FIRST QUARTER ENDED FIRST QUARTER ENDED
MARCH 31, MARCH 31,
------------------------------------- ----------------------------------
2003 2002 CHANGE 2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Traditional reinsurance $ 240 $ 149 61% $ 135 $ 145 (7%)
Alternative risk transfer ("ART") 34 65 (48%) 16 26 (38%)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 274 $ 214 28% $ 151 $ 171 (12%)
====================================================================================================================================
[1] The difference between written premiums and earned premiums is
attributable to the change in unearned premium reserve.
On May 12, 2003, the Company announced plans to exit the assumed reinsurance
business.
Reinsurance written premiums increased $60 due to growth of $91 in traditional
reinsurance written premiums primarily due to increased participations and
growth in subject premium as a result of continued increases in primary rates.
Casualty premium and premium written through direct channels increased $81 over
prior year as a result of increased subject premium on casualty excess of loss
contracts and a new direct channel account representing $25 in premium. ART
written premiums decreased $31 primarily due to the non-renewal of two
contracts.
The decrease in earned premiums of $20 was primarily impacted by premium
reductions due to underwriting requirements to maintain profitability targets,
partially offset by earned premium on new business written in the first quarter.
Underwriting results decreased $15, with a corresponding 10.1 point increase in
the combined ratio, for the first quarter of 2003 as compared with the same
prior year period. The decrease in underwriting results and corresponding
increase in the combined ratio were primarily attributable to adverse loss
development on prior underwriting years, primarily in the casualty lines of
traditional reinsurance.
- --------------------------------------------------------------------------------
OTHER OPERATIONS (INCLUDING ASBESTOS AND ENVIRONMENTAL CLAIMS)
- --------------------------------------------------------------------------------
OPERATING SUMMARY FIRST QUARTER ENDED
MARCH 31,
-----------------------------------
2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums $ 8 $ 18 (56%)
Net investment income 42 37 14%
Net realized capital gains 10 1 NM
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 60 56 7%
Benefits, claims and claim adjustment expenses 2,629 43 NM
Insurance operating costs and expenses 12 15 (20%)
Other expenses (5) (4) 25%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 2,636 54 NM
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES (2,576) 2 NM
Income tax expense (benefit) (895) 1 NM
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) $ (1,681) $ 1 NM
====================================================================================================================================
The Other Operations segment includes operations that are under a single
management structure, Heritage Holdings, which is responsible for two related
activities. The first activity is the management of certain subsidiaries and
operations of The Hartford that have discontinued writing new business. The
second is the management of claims (and the associated reserves) related to
- 33 -
asbestos and environmental exposures.
Revenues increased $4 primarily due to an increase in net realized capital gains
and net investment income, partially offset by a decrease in earned premiums.
The decline in earned premiums was due primarily to the runoff of the
international reinsurance business that was transferred to the Other Operations
segment in January 2002. Net income (loss) decreased $1.7 billion for the first
quarter ended March 31, 2003 due to net reserve strengthening of $1.7 billion
based on the results of a detailed study of asbestos exposures.
The paragraphs that follow are background information and a discussion of
asbestos and environmental claims and a summary of the Company's detailed study
of asbestos reserves that gave rise to the reserves strengthening in the first
quarter of 2003.
Asbestos and Environmental Claims
The Hartford continues to receive asbestos and environmental claims, both of
which affect Other Operations. These claims are made pursuant to several
different categories of insurance coverage. First, The Hartford wrote direct
policies as a primary liability insurance carrier. Second, The Hartford wrote
direct excess insurance policies providing additional coverage for insureds that
exhaust their underlying liability insurance coverage. Third, The Hartford acted
as a reinsurer assuming a portion of risks previously assumed by other insurers
writing primary, excess and reinsurance coverages. Fourth, The Hartford
participated as a London Market company that wrote both direct insurance and
assumed reinsurance business.
With regard to both environmental and particularly asbestos claims, significant
uncertainty limits the ability of insurers and reinsurers to estimate the
ultimate reserves necessary for unpaid losses and related settlement expenses.
Traditional actuarial reserving techniques cannot reasonably estimate the
ultimate cost of these claims, particularly during periods where theories of law
are in flux. As a result of the factors discussed in the following paragraphs,
the degree of variability of reserve estimates for these exposures is
significantly greater than for other more traditional exposures. In particular,
The Hartford believes there is a high degree of uncertainty inherent in the
estimation of asbestos loss reserves.
In the case of the reserves for asbestos exposures, factors contributing to the
high degree of uncertainty include inadequate development patterns, plaintiffs'
expanding theories of liability, the risks inherent in major litigation, and
inconsistent emerging legal doctrines. Courts have reached inconsistent
conclusions as to when losses are deemed to have occurred and which policies
provide coverage; what types of losses are covered; whether there is an insurer
obligation to defend; how policy limits are applied; whether particular claims
are product/completed operation claims subject to an aggregate limit; and how
policy exclusions and conditions are applied and interpreted. Furthermore,
insurers in general, including The Hartford, have recently experienced an
increase in the number of asbestos-related claims due to, among other things,
more intensive advertising by lawyers seeking asbestos claimants, plaintiffs'
increased focus on new and previously peripheral defendants and an increase in
the number of insureds seeking bankruptcy protection as a result of
asbestos-related liabilities. Plaintiffs and insureds have sought to use
bankruptcy proceedings, including "pre-packaged" bankruptcies, to accelerate and
increase loss payments by insurers. In addition, some policyholders have begun
to assert new classes of claims for so-called "non-product" coverages to which
an aggregate limit of liability may not apply. Recently, many insurers,
including The Hartford, also have been sued directly by asbestos claimants
asserting that insurers had a duty to protect the public from the dangers of
asbestos. Management believes these issues are not likely to be resolved in the
near future.
In the case of the reserves for environmental exposures, factors contributing to
the high degree of uncertainty include: court decisions that have interpreted
the insurance coverage to be broader than originally intended; inconsistent
decisions, especially across jurisdictions; and uncertainty as to the monetary
amount being sought by the claimant from the insured.
Further uncertainties include the effect of the recent acceleration in the rate
of bankruptcy filings by asbestos defendants on the rate and amount of The
Hartford's asbestos claims payments; a further increase or decrease in asbestos
and environmental claims which cannot now be anticipated; whether some
policyholders' liabilities will reach the umbrella or excess layer of their
coverage; the resolution or adjudication of some disputes pertaining to the
amount of available coverage for asbestos claims in a manner inconsistent with
The Hartford's previous assessment of these claims; the number and outcome of
direct actions against The Hartford; and unanticipated developments pertaining
to The Hartford's ability to recover reinsurance for asbestos and environmental
claims. It is also not possible to predict changes in the legal and legislative
environment and their impact on the future development of asbestos and
environmental claims. In particular, recently there has been a variety of
potential federal legislative changes concerning asbestos litigation under
discussion among business, labor, plaintiffs' lawyer groups, and Congressional
leaders. Whether any such legislation will be enacted and, if so, what its
effect will be on The Hartford's aggregate asbestos liabilities is unknown.
Additionally, the reporting pattern for excess insurance and reinsurance claims
is much longer than direct claims. The delay in reporting excess and reinsurance
claims adds to the uncertainty of estimating the related reserves.
Given the factors and emerging trends described above, The Hartford believes the
actuarial tools and other techniques it employs to estimate the ultimate cost of
claims for more traditional kinds of insurance exposure are less precise in
estimating reserves for its asbestos and environmental exposures. The Hartford
regularly evaluates new information in assessing its potential asbestos
exposures.
In the first quarter 2003, The Hartford conducted a detailed study of its
asbestos exposures. Based on the results of the study, the Company strengthened
its gross and net asbestos reserves by $4.0 billion and 2.6 billion,
respectively. The Company believes that its current asbestos reserves are
reasonable and appropriate. However, analyses of future developments could cause
The Hartford to change its estimates of its asbestos and environmental reserves
and the effect of these changes could be material to the Company's consolidated
operating results, financial condition and liquidity.
- 34 -
Reserve Activity
Reserves and reserve activity in the Other Operations segment are categorized
and reported as asbestos, environmental or "all other" activity. The discussion
below relates to reserves and reserve activity, net of applicable reinsurance.
There are a wide variety of claims that drive the reserves associated with
asbestos, environmental and the all other category the Company has defined in
Other Operations. Asbestos claims relate primarily to bodily injuries asserted
by those who came in contact with asbestos or products containing asbestos.
Environmental claims relate primarily to pollution and related clean-up costs.
The all other category of reserves covers a wide range of insurance coverages,
including liability for breast implants, blood products, construction defects
and lead paint as well as unallocated loss adjustment expense for the Other
Operations segment.
The Other Operations historic book of business contains policies written from
the 1940s to 1992, with the majority of the business spanning the interval 1960
to 1990. The Hartford's experience has been that this book of business has over
time produced significantly higher claims and losses than were contemplated at
inception. The areas of active claim activity have also shifted based on changes
in plaintiff focus and the overall litigation environment. A significant portion
of the claim reserves of the Other Operations segment relates to exposure to the
insurance businesses of other insurers or reinsurers ("whole account" exposure).
Many of these whole account exposures arise from reinsurance agreements
previously written by The Hartford. The Hartford's net exposure in these
arrangements has increased for a variety of reasons, including The Hartford's
commutation of previous retrocessions of such business. Due to the reporting
practices of cedants to their reinsurers, determination of the nature of the
individual risks involved in these whole account exposures (such as asbestos,
environmental, or other exposures) requires various assumptions and estimates,
which are subject to uncertainty, as previously discussed.
Consistent with the Company's long-standing reserving practices, The Hartford
will continue to regularly review and monitor these reserves and, where future
developments indicate, make appropriate adjustments to the reserves. The loss
reserving assumptions, drawn from both industry data and the Company's
experience, have over time been applied to all of this business and have
resulted in strengthening or weakening actions at various times over the past
decade.
The following table presents reserve activity, inclusive of estimates for both
reported and incurred but not reported claims, net of reinsurance, for Other
Operations, categorized by asbestos, environmental and all other claims, for the
quarter ended March 31, 2003. Also included are the remaining asbestos and
environmental exposures of North American Property & Casualty.
OTHER OPERATIONS CLAIMS AND CLAIM ADJUSTMENT EXPENSES
FOR THE FIRST QUARTER ENDED MARCH 31, 2003 ASBESTOS ENVIRONMENTAL ALL OTHER [1] TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
Beginning liability - net $ 1,118 $ 591 $ 1,250 $ 2,959
Claims and claim adjustment expenses incurred 2,604 1 25 2,630
Claims and claim adjustment expenses paid 37 33 30 100
- ------------------------------------------------------------------------------------------------------------------------------------
ENDING LIABILITY - NET [2] [3] $ 3,685 [4] $ 559 $ 1,245 $ 5,489
====================================================================================================================================
[1] Includes unallocated loss adjustment expense reserves.
[2] Ending liabilities include asbestos and environmental reserves reported in
North American Property & Casualty of $14 and $9, respectively, as of
March 31, 2003 and of $14 and $10, respectively, as of December 31, 2002.
[3] Gross of reinsurance, asbestos and environmental reserves were $5,902 and
$635, respectively, as of March 31, 2003 and $1,994 and $682,
respectively, as of December 31, 2002.
[4] As of March 31, 2003, the one year and average three year net paid amounts
for asbestos claims are $149 and $99, respectively, resulting in one year
and three year net survival ratios of 24.7 and 37.2 years, respectively.
At March 31, 2003, asbestos reserves were $3.7 billion, an increase of $2.6
billion compared to $1.1 billion as of December 31, 2002. Net incurred losses
and loss adjustment expenses were $2.6 billion for the first quarter of 2003
compared to $5 for the first quarter 2002. The increase in reserves reflects
asbestos claim and litigation trends and is based on a detailed study of
asbestos exposures performed by the Company during the first quarter 2003. As
part of the study, the Company reviewed all 990 of its open direct domestic
insurance accounts exposed to asbestos liability as well as assumed reinsurance
accounts and certain closed accounts. In the course of the study, the Company
prepared a detailed exposure analysis for each of more than 600 of these
accounts, comprising more than 98% of the Company's year-end 2002 domestic
asbestos case reserves. The outcome of this direct exposure analysis was also
applied to the Company's domestic reinsurance exposure and all known cedants.
The Company also examined its London Market exposures for both direct insurance
and assumed reinsurance. This detailed study was the basis for the increase in
reserves recorded in this quarter.
As part of the study, the Company classified its asbestos reserves into three
categories: direct insurance; reinsurance and London Market. Direct insurance
includes primary and excess coverage. Assumed Reinsurance includes both "treaty"
reinsurance (covering broad categories of claims or blocks of business) and
"facultative" reinsurance (covering specific risks or individual policies of
primary or excess insurance companies). London Market business includes the
business written by one or more of The Hartford's subsidiaries in the United
Kingdom, which are no longer active in the insurance or reinsurance business.
Such business includes both direct insurance and assumed reinsurance.
In reporting the results of the asbestos study, the Company has divided its
direct asbestos exposures into the following categories: Major Asbestos
Defendants (the "Top 70" accounts in Tillinghast's published Tiers 1 and 2 and
Wellington accounts collectively divided into: structured settlements,
Wellington, and Other Major Asbestos Defendants), Accounts with Future Expected
Exposures greater than $2.5 Accounts with
- 35 -
Future Expected Exposures less than $2.5 and Unallocated Incurred But Not
Reported ("IBNR").
Structured settlements are those accounts where the Company has reached an
agreement with the insured as to the amount and timing of the claim payments to
be made to the insured.
The Wellington category includes insureds that entered into the "Wellington
Agreement" dated June 19, 1985. The Wellington Agreement provided terms and
conditions for how the signatory asbestos producers would access their coverage
from the signatory insurers.
The Other Major Asbestos Defendants subcategory represents insureds included in
Tiers 1 and 2, as defined by Tillinghast. The Tier 1 and 2 classifications are
meant to capture the insureds for which there is expected to be significant
exposure to asbestos claims.
Unallocated IBNR is an estimate of the necessary reserves for asbestos claims
related to direct insureds with no known asbestos claims, adverse development on
allocated reserves, and potential non-products exposures.
Assumed Reinsurance exposures are inherently less predictable than direct
insurance exposures because the Company may not receive notice of a reinsurance
claim until the underlying direct insurance claim is mature. This causes a delay
in the receipt of information at the reinsurer level reflecting changes in the
asbestos tort litigation and direct insurance coverage environments.
As a participant in the London Market (comprised of both Lloyd's of London and
London Company Markets), the Company wrote business on a subscription basis,
with the Company's involvement being limited to a relatively small percentage of
a total contract placement. Claims are reported, via a broker, to the "lead"
underwriter and, once agreed to, are presented to the following markets for
concurrence. This reporting and claim agreement process makes estimating
liabilities for this business more uncertain than claims in the Direct and
Assumed reinsurance categories.
The following table displays asbestos reserves and other statistics by
policyholder category, after recording the effects of the first quarter asbestos
reserve study:
SUMMARY OF GROSS ASBESTOS RESERVES
For the First Quarter Ended March 31, 2003
-------------------------------------------------------------------------------------------
Total % of Estimated 3 Year 3 Year Gross
Number of All Time Recorded Asbestos All Time Total Paid Survival
Accounts Paid Reserves Reserves Ultimate Losses Ratio [1] [2]
- ------------------------------------------------------------------------------------------------------------------------------------
(in years)
Major asbestos defendants
Structured settlements (includes 2
Wellington accounts) 5 $ 203 $ 289 5% $ 492 $ 86 10.1
Wellington (direct only) 31 612 316 5% 928 250 3.8
Other major asbestos defendants 29 150 449 8% 599 41 32.5
No known policies (includes 3
Wellington accounts) 5 -- -- -- -- -- --
Accounts with future exposure > $2.5 127 288 1,474 25% 1,762 104 42.7
Accounts with future exposure < $2.5 826 292 124 2% 416 18 20.3
Unallocated IBNR -- -- 1,810 30% 1,810 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total direct [3] 1,545 4,462 75% 6,007 567 23.6
Assumed reinsurance 506 907 15% 1,413 140 19.4
London market 333 596 10% 929 75 23.8
- ------------------------------------------------------------------------------------------------------------------------------------
Subtotal [3] 2,384 5,965 100% 8,349 $ 782 22.9
First quarter 2003 payments 63 (63) --
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL GROSS ASBESTOS RESERVES $ 2,447 $ 5,902 $ 8,349
====================================================================================================================================
[1] Survival ratio provides an estimate of the number of years that reserves
would be available at the current average claim payment rate. This is a
gross three year survival ratio calculated by dividing gross reserves by
the average three year paid losses.
[2] The one year gross paid amount for total asbestos claims is $308 resulting
in a one year gross survival ratio of 19.2 years.
[3] Three year total paid losses include payments of $68 on closed claims (not
presented by category).
The Hartford has been experiencing lower than previously expected claim activity
with respect to claims classified as environmental. At the same time, The
Hartford has also been experiencing higher than previously expected claim
activity with respect to claims classified as asbestos. The increase in both the
number of claims being submitted and the number of asbestos-related policyholder
bankruptcies, including "pre-packaged" bankruptcies, have accelerated over the
last twelve months. The following table sets forth, for the quarter ended March
31, 2003, paid and incurred loss activity by the three categories of claims for
asbestos and environmental. The tables below show that asbestos and
environmental payments, net of reinsurance, have been generally consistent with
the trend from the prior year.
- 36 -
PAID AND INCURRED LOSS AND LOSS ADJUSTMENT EXPENSE ("LAE") DEVELOPMENT - ASBESTOS AND ENVIRONMENTAL
ASBESTOS ENVIRONMENTAL
-------------------------------------- ------------------------------------
PAID INCURRED PAID INCURRED
FOR THE FIRST QUARTER ENDED MARCH 31, 2003 LOSS & LAE LOSS & LAE LOSS & LAE LOSS & LAE
- ------------------------------------------------------------------------------------------------------------------------------------
Gross
Direct $ 55 $ 3,068 $ 43 $ 1
Assumed - Domestic 3 541 3 --
London Market 5 363 2 --
- ------------------------------------------------------------------------------------------------------------------------------------
Total 63 3,972 48 1
Ceded (26) (1,368) (15) --
- ------------------------------------------------------------------------------------------------------------------------------------
NET $ 37 $ 2,604 $ 33 $ 1
====================================================================================================================================
ASBESTOS ENVIRONMENTAL
-------------------------------------- ------------------------------------
PAID INCURRED PAID INCURRED
FOR THE YEAR ENDED DECEMBER 31, 2002 LOSS & LAE LOSS & LAE LOSS & LAE LOSS & LAE
- ------------------------------------------------------------------------------------------------------------------------------------
Gross
Direct $ 212 $ 559 $ 124 $ (9)
Assumed - Domestic 66 89 15 (39)
London Market 35 26 24 (26)
- ------------------------------------------------------------------------------------------------------------------------------------
Total 313 674 163 (74)
Ceded (187) (46) (51) 123
- ------------------------------------------------------------------------------------------------------------------------------------
NET $ 126 $ 628 $ 112 $ 49
====================================================================================================================================
- --------------------------------------------------------------------------------
INVESTMENTS
- --------------------------------------------------------------------------------
The Hartford's investment portfolios are divided between Life and Property &
Casualty. The investment portfolios are managed based on the underlying
characteristics and nature of each operation's respective liabilities and within
established risk parameters. (For a further discussion on The Hartford's
approach to managing risks, see the Capital Markets Risk Management section.)
Please refer to the Investments section of the MD&A in The Hartford's 2002 Form
10-K Annual Report for a description of the Company's investment objectives and
policies.
Return on general account invested assets is an important element of The
Hartford's financial results. Significant fluctuations in the fixed income or
equity markets could weaken the Company's financial condition or its results of
operations. Additionally, changes in market interest rates may impact the period
of time over which certain investments, such as mortgage-backed securities, are
repaid and whether certain investments are called by the issuers. Such changes
may, in turn, impact the yield on these investments and also may result in
reinvestment of funds received from calls and prepayments at rates below the
average portfolio yield.
Fluctuations in interest rates affect the Company's return on, and the fair
value of, fixed maturity investments, which comprised approximately 91% and 90%
of the fair value of its invested assets as of March 31, 2003 and December 31,
2002, respectively. Other events beyond the Company's control could also
adversely impact the fair value of these investments. Specifically, a downgrade
of an issuer's credit rating or default of payment by an issuer could reduce the
Company's investment return.
A decrease in the fair value of any investment that is deemed other than
temporary would result in the Company's recognition of a realized loss in its
financial results prior to the actual sale of the investment.
LIFE
The following table identifies invested assets by type held in the Life general
account as of March 31, 2003 and December 31, 2002.
- 37 -
COMPOSITION OF INVESTED ASSETS
- ------------------------------------------------------------------------------------------------------------------------------------
MARCH 31, 2003 DECEMBER 31, 2002
------------------------------ ---------------------------
AMOUNT PERCENT AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------------------------------
Fixed maturities, at fair value $ 31,676 87.9% $ 29,377 86.7%
Equity securities, at fair value 410 1.1% 458 1.3%
Policy loans, at outstanding balance 2,876 8.0% 2,934 8.7%
Limited partnerships, at fair value 442 1.2% 519 1.5%
Other investments 629 1.8% 603 1.8%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS $ 36,033 100.0% $ 33,891 100.0%
====================================================================================================================================
Fixed maturity investments increased 8% since December 31, 2002, primarily the
result of operating cash flows. In March 2003, the Company decided to liquidate
its hedge fund limited partnership investments and reinvest the proceeds into
fixed maturity investments. A total of $86 of hedge fund investments was sold
during March 2003. The limited partnership agreements allow for the withdrawal
proceeds to be paid over a period of time. A majority of the limited partnership
proceeds are expected to be received by June 30, 2003 with the remainder to be
received no later than March 31, 2004.
INVESTMENT RESULTS
The table below summarizes Life's investments results.
FIRST QUARTER ENDED
MARCH 31,
--------------------------
(Before-tax) 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Net investment income - excluding policy loan income $ 449 $ 381
Policy loan income 58 67
--------------------------
Net investment income - total $ 507 $ 448
Yield on average invested assets [1] 6.1% 6.3%
- ------------------------------------------------------------------------------------------------------------------------------------
Gross gains on sale $ 57 $ 37
Gross losses on sale (47) (37)
Impairments (67) (15)
Other, net [2] 9 --
--------------------------
Net realized capital losses $ (48) $ (15)
====================================================================================================================================
[1] Represents annualized net investment income (excluding net realized capital
losses) divided by average invested assets at cost (fixed maturities at
amortized cost).
[2] Primarily consists of changes in fair value and hedge ineffectiveness on
derivative instruments.
For the quarter ended March 31, 2003, net investment income, excluding policy
loans, increased $68, or 18%, compared to the same period in 2002. The increase
was primarily due to income earned on a higher invested asset base, the result
of increased cash flow, partially offset by lower investment yields. Yields on
average invested assets decreased as a result of lower rates on new investment
purchases and decreased policy loan income.
Net realized capital losses for the first quarter ended March 31, 2003 increased
by $33 compared to the same period in 2002, primarily the result of higher
write-downs for other than temporary impairments on fixed maturities. For the
quarter ended March 31, 2003, fixed maturity impairment losses of $46 consisted
of asset-backed securities of $26 and corporate securities of $20. The
asset-backed securities primarily consisted of $12 backed by credit card
receivables and $10 of corporate debt. These amounts included one asset-backed
security supported by sub-prime credit card receivables that the Company no
longer had the intent to hold even though the Company's best estimate of future
cash flows indicated a full recovery of interest and principal amounts. In
addition to the impairment, the Company also recognized a $10 loss on the sale
of a portion of this security. The corporate securities impaired were
concentrated in the following sectors: $7 in transportation, $7 in consumer
non-cyclical, $3 in technology and communications and $3 in financial services.
Also included in net realized capital losses for the quarter ended March 31,
2003 were write-downs for other than temporary impairments on seeded equity and
mutual fund investments of $21.
For the quarter ended March 31, 2002, the fixed maturity impairment losses of
$15 consisted of corporate securities of $12 and asset-backed securities of $3.
The corporate securities impaired were $9 in the technology and communications
sector and $3 in the energy sector. The asset-backed securities impaired were
backed by corporate debt. Additionally, the Company realized a $1 loss on the
sale of the remainder of its international business in Argentina.
PROPERTY & CASUALTY
The following table identifies invested assets by type as of March 31, 2003 and
December 31, 2002.
- 38 -
COMPOSITION OF INVESTED ASSETS
- ------------------------------------------------------------------------------------------------------------------------------------
MARCH 31, 2003 DECEMBER 31, 2002
------------------------------ ---------------------------
AMOUNT PERCENT AMOUNT PERCENT
- ------------------------------------------------------------------------------------------------------------------------------------
Fixed maturities, at fair value $ 20,384 96.0% $ 19,446 94.5%
Equity securities, at fair value 209 1.0% 459 2.2%
Limited partnerships, at fair value 318 1.5% 362 1.8%
Other investments 318 1.5% 306 1.5%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS $ 21,229 100.0% $ 20,573 100.0%
- ------------------------------------------------------------------------------------------------------------------------------------
Total fixed maturities increased 5% since December 31, 2002, primarily due to
increased operating cash flow and changes in portfolio allocation. In March
2003, the Company decided to liquidate its hedge fund limited partnership
investments and certain equity securities and reinvest the proceeds into fixed
maturity investments. A total of $37 of hedge fund investments and $239 of
equity securities was sold during March 2003. The limited partnership agreements
allow for the withdrawal proceeds to be paid over a period of time. A majority
of the limited partnership proceeds are expected to be received by June 30, 2003
with the remainder to be received no later than March 31, 2004.
INVESTMENT RESULTS
The table below summarizes Property & Casualty's investment results.
FIRST QUARTER ENDED
MARCH 31,
--------------------------
2003 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Net investment income, before-tax $ 285 $ 254
--------------------------
Net investment income, after-tax [1] $ 218 $ 199
Yield on average invested assets, before-tax [2] 5.8% 5.7%
Yield on average invested assets, after-tax [1] [2] 4.5% 4.5%
- ------------------------------------------------------------------------------------------------------------------------------------
Gross gains on sale $ 80 $ 62
Gross losses on sale (60) (26)
Impairments (22) (27)
Other, net [3] (3) (1)
--------------------------
Net realized capital gains (losses), before-tax $ (5) $ 8
====================================================================================================================================
[1] Due to the significant holdings in tax-exempt investments, after-tax net
investment income and yield are also included.
[2] Represents annualized net investment income (excluding net realized capital
gains (losses)) divided by average invested assets at cost (fixed
maturities at amortized cost).
[3] Primarily consists of changes in fair value and hedge ineffectiveness on
derivative instruments.
For the first quarter ended March 31, 2003, before- and after-tax net investment
income increased $31, or 12%, and $19, or 10%, respectively, compared to the
prior year periods. The increase in net investment income was primarily due to
income earned on a higher invested asset base, the result of increased cash
flow. Yields on average invested assets remained flat.
Net realized capital losses for the first quarter ended March 31, 2003 were $5
compared to net realized capital gains of $8 in the same period in 2002. For the
first quarter of 2003, fixed maturity impairment losses of $16 consisted of
corporate securities of $8 and asset-backed securities of $8. The asset-backed
securities impaired primarily consisted of securities backed by corporate debt
of $5 and credit card receivables of $2. These amounts included one asset-backed
security supported by sub-prime credit card receivables that the Company no
longer had the intent to hold that even though the Company's best estimate of
future cash flows indicated a full recovery of all interest and principal
amounts. In addition to the impairment, The Company also recognized a $2 loss on
the sale of a portion of this security. The corporate securities impaired were
primarily concentrated in the following sectors: $3 in transportation, $2 in
technology and communications and $2 in consumer non-cyclical. Also included in
net realized capital losses for the quarter ended March 31, 2003 were
write-downs for other than temporary impairments on equity mutual fund
investments of $6.
For the quarter ended March 31, 2002, the fixed maturity impairment losses of
$19 consisted of corporate securities of $17 and asset-backed securities of $2.
The corporate securities impaired included $16 in the technology and
communications sector and $1 in the energy sector. The asset-backed securities
impaired were backed by corporate debt. Also included in net realized capital
losses for the quarter ended March 31, 2002 were other than temporary
impairments on equity securities of $8.
CORPORATE
In connection with the HLI Repurchase, the carrying value of the purchased fixed
maturity investments was adjusted to fair market value as of the date of the
repurchase. This adjustment was reported in Corporate. The amortization of the
adjustment to the fixed maturity investments' carrying values is reported in
Corporate's net investment income. The total amount of amortization for the
quarters ended March 31, 2003 and 2002 was $4. As of March 31, 2003 and December
31, 2002, Corporate held $66 of short-term fixed maturity investments.
- 39 -
- --------------------------------------------------------------------------------
CAPITAL MARKETS RISK MANAGEMENT
- --------------------------------------------------------------------------------
The Hartford 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, while asset/liability management is the responsibility
of dedicated risk management units supporting Life, including guaranteed
separate accounts, and Property & Casualty operations. Derivative instruments
are utilized in compliance with established Company policy and regulatory
requirements and are monitored internally and reviewed by senior management.
The Company is exposed to two primary sources of investment and asset/liability
management risk: credit risk, relating to the uncertainty associated with the
ability of an obligor or counter party to make timely payments of principal
and/or interest, and market risk, relating to the market price and/or cash flow
variability associated with changes in interest rates, securities prices, market
indices, yield curves or currency exchange rates. The Company does not hold any
financial instruments purchased for trading purposes.
Please refer to the Capital Markets Risk Management section of the MD&A in The
Hartford's 2002 Form 10-K Annual Report for a description of the Company's
objectives, policies and strategies.
CREDIT RISK
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 an internal credit
evaluation supplemented by consideration of external determinants of
creditworthiness, typically ratings assigned by nationally recognized ratings
agencies. Obligor, asset sector and industry concentrations are subject to
established limits and are monitored on a regular basis. The Hartford is not
exposed to any credit concentration risk of a single issuer greater than 10% of
the Company's stockholders' equity.
The following tables identify fixed maturity securities for Life, including
guaranteed separate accounts, and Property & Casualty, by type and credit
quality. The ratings referenced in the credit quality tables 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. In
addition, an aging of the gross unrealized loss position is presented for fixed
maturity and equity securities.
LIFE
The Fixed Maturities by Type tables that follow identify fixed maturities by
type held in the general and guaranteed separate accounts as of March 31, 2003
and December 31, 2002.
FIXED MATURITIES BY TYPE
- ------------------------------------------------------------------------------------------------------------------------------------
MARCH 31, 2003
---------------------------------------------------------------------
UNREALIZED UNREALIZED
AMORTIZED COST GAINS LOSSES FAIR VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
Asset-backed securities ("ABS") $ 5,371 $ 110 $ (184) $ 5,297
Commercial mortgage-backed securities ("CMBS") 6,445 487 (9) 6,923
Collateralized mortgage obligation ("CMO") 994 35 (5) 1,024
Corporate
Basic industry 2,481 156 (6) 2,631
Capital goods 1,054 81 (9) 1,126
Consumer cyclical 1,635 94 (7) 1,722
Consumer non cyclical 2,709 196 (16) 2,889
Energy 1,463 123 (5) 1,581
Financial services 5,521 366 (95) 5,792
Technology and communications 3,230 329 (15) 3,544
Transportation 652 49 (10) 691
Utilities 1,831 158 (23) 1,966
Other 485 25 -- 510
Government/Government agencies - Foreign 801 85 (5) 881
Government/Government agencies - United States 688 46 (1) 733
Mortgage-backed securities ("MBS") - agency 1,909 47 (1) 1,955
Municipal - tax-exempt 1,850 155 (1) 2,004
Municipal - taxable 95 16 (1) 110
Redeemable preferred stock 32 3 (1) 34
Short-term 1,499 1 -- 1,500
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 40,745 $ 2,562 $ (394) $ 42,913
====================================================================================================================================
Total general account fixed maturities $ 30,092 $ 1,871 $ (287) $ 31,676
Total guaranteed separate account fixed maturities $ 10,653 $ 691 $ (107) $ 11,237
- ------------------------------------------------------------------------------------------------------------------------------------
- 40 -
At March 31, 2003 the Life fixed maturity portfolio had gross unrealized losses
of $394, of which 77% were concentrated in the financial services and utilities
sectors and asset-backed securities. The Company's current view of risk factors
relative to these fixed maturity types is as follows:
Financial Services - This sector has been adversely impacted by security
write-offs, especially in the energy, utilities and communications industries,
along with reserve increases by property and casualty insurers as a result of
poor underwriting and asbestos-related exposures. In general, industry balance
sheets are strong and security credit quality is improving.
Utilities - The utilities sector remains adversely impacted by several events
that primarily occurred in 2001 including the bankruptcy of Enron Corporation,
the decline in the energy trading industry and the regulatory, political and
legal effect of the California Utility Crisis. In the short-term, restructuring
and possible bankruptcies may continue as companies seek liquidity sources.
Asset sales of non-core operations are expected to continue to be a significant
source of liquidity. The short-term events are expected to reduce the number of
power suppliers, which, in the longer term, the Company believes will lead to a
gradual rise in power prices and allow this sector to recover.
ABS- As of March 31, 2003, asset-backed securities supported by corporate debt
obligations ("CDO"), aircraft lease and credit card receivables were in a gross
unrealized loss position of $35, $60 and $60, respectively. Adverse CDO
experience can be attributable to higher than expected default rates especially
in the technology and utilities sectors and lower than expected recovery rates.
Approximately 85% of the CDOs owned by Life at March 31, 2003 were investment
grade.
The securities supported by aircraft and aircraft lease payments have declined
in value due to a reduction in lease payments and aircraft values driven by
bankruptcies and other financial difficulties of airline carriers. These
securities may continue to be stressed due to a continued decline in air
passenger traffic. Approximately 83% of Life's investments supported by aircraft
and aircraft lease payments at March 31, 2003 were investment grade.
The unrealized loss position in credit card securities has primarily been caused
by exposure to companies originating loans to sub-prime borrowers. The Company
expects this sub-sector will continue to be under stress and holdings to be very
sensitive to changes in collateral performance. Approximately 99% of Life's
investments supported by credit card receivables at March 31, 2003 were
investment grade.
FIXED MATURITIES BY TYPE
- ------------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2002
---------------------------------------------------------------------
UNREALIZED UNREALIZED
AMORTIZED COST GAINS LOSSES FAIR VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
Asset-backed securities ("ABS") $ 5,403 $ 111 $ (154) $ 5,360
Commercial mortgage-backed securities ("CMBS") 5,529 467 (8) 5,988
Collateralized mortgage obligation ("CMO") 866 39 (2) 903
Corporate
Basic industry 2,155 144 (9) 2,290
Capital goods 1,097 75 (7) 1,165
Consumer cyclical 1,477 92 (4) 1,565
Consumer non cyclical 2,584 186 (18) 2,752
Energy 1,477 112 (8) 1,581
Financial services 5,210 333 (91) 5,452
Technology and communications 3,083 263 (71) 3,275
Transportation 601 49 (12) 638
Utilities 1,833 118 (43) 1,908
Other 429 20 -- 449
Government/Government agencies - Foreign 774 77 (5) 846
Government/Government agencies - United States 645 48 -- 693
Mortgage-backed securities ("MBS") - agency 2,233 63 -- 2,296
Municipal - tax-exempt 1,854 146 -- 2,000
Municipal - taxable 99 16 (1) 114
Redeemable preferred stock 31 3 -- 34
Short-term 1,153 -- -- 1,153
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 38,533 $ 2,362 $ (433) $ 40,462
====================================================================================================================================
Total general account fixed maturities $ 27,982 $ 1,704 $ (309) $ 29,377
Total guaranteed separate account fixed maturities $ 10,551 $ 658 $ (124) $ 11,085
- ------------------------------------------------------------------------------------------------------------------------------------
- 41 -
The following table identifies fixed maturities by credit quality held in the
general and guaranteed separate accounts as of March 31, 2003 and December 31,
2002.
FIXED MATURITIES BY CREDIT QUALITY
- ------------------------------------------------------------------------------------------------------------------------------------
MARCH 31, 2003 DECEMBER 31, 2002
--------------------------------------- ------------------------------------
PERCENT OF PERCENT OF
AMORTIZED TOTAL FAIR AMORTIZED TOTAL FAIR
COST FAIR VALUE VALUE COST FAIR VALUE VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
United States Government/Government agencies $ 3,465 $ 3,582 8.3% $ 3,596 $ 3,737 9.2%
AAA 7,027 7,475 17.4% 6,519 6,960 17.2%
AA 4,246 4,487 10.5% 4,161 4,396 10.9%
A 12,296 13,069 30.5% 11,745 12,467 30.8%
BBB 10,027 10,608 24.7% 9,211 9,665 23.9%
BB & below 2,185 2,192 5.1% 2,148 2,084 5.2%
Short-term 1,499 1,500 3.5% 1,153 1,153 2.8%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 40,745 $ 42,913 100.0% $ 38,533 $ 40,462 100.0%
====================================================================================================================================
Total general account fixed maturities $ 30,092 $ 31,676 73.8% $ 27,982 $ 29,377 72.6%
Total guaranteed separate account fixed maturities $ 10,653 $ 11,237 26.2% $ 10,551 $ 11,085 27.4%
====================================================================================================================================
As of March 31, 2003 and December 31, 2002, over 94% of the fixed maturity
portfolio was invested in securities rated investment grade (BBB and above). As
of March 31, 2003, below investment grade ("BIG") holdings were diversified by
sector and issuer with the greatest concentration of securities, based upon fair
value, in the following sectors: 21% in technology and communications, 14% in
utilities, 10% in consumer cyclical, 10% in basic industry, 10% in consumer
non-cyclical and 8% in foreign government. At March 31, 2003, Life held no
issuer of a BIG security with a fair value in excess of 2% of the total fair
value for BIG securities. As of December 31, 2002, BIG holdings were
concentrated, based upon fair value, in the following sectors: 20% in the
technology and communications, 17% in utilities, 11% in consumer cyclical, 11%
in basic industry and 9% in foreign government. At December 31, 2002, Life held
no issuer of a BIG security with a fair value in excess of 2% of the total fair
value for BIG securities.
Life's total and BIG fixed maturity and equity securities held as of March 31,
2003 and December 31, 2002 that were in an unrealized loss position are
presented in the tables below by length of time the security was in an
unrealized loss position.
UNREALIZED LOSS AGING AT MARCH 31, 2003
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL SECURITIES BIG AND EQUITY SECURITIES
------------------------------------------ ----------------------------------------
AMORTIZED UNREALIZED AMORTIZED UNREALIZED
COST FAIR VALUE LOSS COST FAIR VALUE LOSS
- ------------------------------------------------------------------------------------------------------------------------------------
Three months or less $ 2,117 $ 2,063 $ (54) $ 141 $ 126 $ (15)
Greater than three months to six months 774 725 (49) 48 37 (11)
Greater than six months to nine months 706 665 (41) 106 91 (15)
Greater than nine months to twelve months 230 213 (17) 86 73 (13)
Greater than twelve months 2,728 2,483 (245) 603 519 (84)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 6,555 $ 6,149 $(406) $ 984 $ 846 $ (138)
====================================================================================================================================
The total securities that were in an unrealized loss position for longer than
six months as of March 31, 2003 primarily consisted of asset-backed and
corporate debt. Asset-backed securities backed by credit card receivables,
aircraft lease receivables, and corporate debt comprised 19%, 12% and 10%,
respectively, of the greater than six months unrealized loss amount. The
significant corporate security industry sectors of financial services, utilities
and technology and communications comprised 24%, 6%, and 5%, respectively, of
the greater than six months unrealized loss amount. At March 31, 2003, Life held
no securities of a single issuer that were at an unrealized loss in excess of 7%
of total unrealized losses. The total unrealized loss position of $(406)
consisted of $(298) in general account losses and $(108) in guaranteed separate
account losses.
As of March 31, 2003, fixed maturities represented $394, or 97%, of total Life
unrealized losses. Approximately 98% of the fixed maturities in an unrealized
loss position for longer than six months represented asset-backed and commercial
mortgage-backed securities and fixed maturities with a fair value greater than
80% of amortized cost. As of March 31, 2003, Life held four corporate debt
securities from two issuers with a fair value that was less than 80% of the
security's amortized cost basis for six continuous months. The securities had an
aggregate fair value of $15 and were in a unrealized loss position of $6. The
issuers have made all contractually obligated principal and interest payments
and their operating fundamentals continue to improve. As a result, the Company
concluded the security price depression was temporary.
Other than temporary impairments for certain asset-backed and commercial
mortgage-backed securities are recognized if the fair value of the security is
less than its carrying amount and there has been a decrease in the present value
of the expected cash flows since the last revised estimate. There were no
asset-backed or mortgage-backed securities included in the tables above for
which
- 42 -
management's best estimate of future cash flows adversely changed during the
quarter ended March 31, 2003. For a detailed discussion of the other than
temporary impairment criteria for asset backed securities, see "Valuation of
Investments and Derivative Instruments" included in the Critical Accounting
Estimates section of the MD&A and in Note 1(g) of Notes to Consolidated
Financial Statements both of which are included in The Hartford's 2002 Form 10-K
Annual Report.
As of March 31, 2003, one asset-backed security had an unrealized loss in excess
of $20. The security is backed by sub-prime credit card receivables and was in
an unrealized loss position of $27. See the overview of the sub-prime credit
card receivable market under the Fixed Maturities by Type table in this section
of the MD&A. The security issuer has had poor underwriting and servicing
results, which has contributed to a higher collateral loss rate than expected.
Management's best estimate of future cash flows based upon historical payment
and default rates and future interest rate assumptions indicate that the Company
will receive all interest and principal amounts.
The BIG and equity securities that were in an unrealized loss position for
longer than six months as of March 31, 2003 primarily consisted of asset-backed
securities backed by credit card receivables and corporate debt. The
asset-backed securities along with corporate securities in the utilities,
technology and communications and financial services sectors and diversified
equity securities including mutual funds comprised 40%, 13%, 8%, 7% and 11%,
respectively, of the BIG and equity securities that were in an unrealized loss
position for greater than six months at March 31, 2003. The total unrealized
loss position of BIG and equity securities of $(138) consisted of $(118) in
general account losses and $(20) in guaranteed separate account losses.
UNREALIZED LOSS AGING AT DECEMBER 31, 2002
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL SECURITIES BIG AND EQUITY SECURITIES
------------------------------------------ ----------------------------------------
AMORTIZED UNREALIZED AMORTIZED UNREALIZED
COST FAIR VALUE LOSS COST FAIR VALUE LOSS
- ------------------------------------------------------------------------------------------------------------------------------------
Three months or less $ 1,532 $ 1,459 $ (73) $ 162 $ 130 $ (32)
Greater than three months to six months 1,294 1,239 (55) 208 185 (23)
Greater than six months to nine months 568 508 (60) 175 145 (30)
Greater than nine months to twelve months 1,334 1,264 (70) 330 293 (37)
Greater than twelve months 2,135 1,927 (208) 501 431 (70)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 6,863 $ 6,397 $(466) $ 1,376 $ 1,184 $ (192)
====================================================================================================================================
The total securities that were in an unrealized loss position for longer than
six months as of December 31, 2002 primarily consisted of corporate and
asset-backed securities. The significant corporate security industry sectors of
financial services, utilities, technology and communications and transportation
comprised 20%, 13%, 13% and 3%, respectively, of the greater than six months
unrealized loss amount. Asset-backed securities comprised 33% of the greater
than six month unrealized loss amount and included securities backed by
corporate debt, aircraft lease receivables and credit card receivables. At
December 31, 2002, Life held no securities of a single issuer that were at an
unrealized loss in excess of 4% of total unrealized losses. The total unrealized
loss position of $(466) consisted of $(344) in general account losses and $(122)
in guaranteed separate account losses.
The BIG and equity securities that were in an unrealized loss position for
longer than six months as of December 31, 2002 primarily consisted of corporate
securities in the technology and communications and utilities sectors as well as
asset-backed securities backed by corporate debt, equipment loans and credit
card receivables. The technology and communications and utilities sectors along
with diversified equity mutual funds and asset-backed securities comprised 26%,
22%, 18% and 15%, respectively, of the BIG and equity securities that were in an
unrealized loss position for greater than six months at December 31, 2002. The
total unrealized loss position of BIG and equity securities of $(192) consisted
of $(157) in general account losses and $(35) in guaranteed separate account
losses.
As part of the Company's ongoing monitoring process by a committee of investment
and accounting professionals, the Company has reviewed these securities and
concluded that there were no additional other than temporary impairments as of
March 31, 2003 and December 31, 2002. Due to the issuers' continued satisfaction
of the securities' obligations in accordance with their contractual terms and
their continued expectation to do so, as well as the evaluation of the
fundamentals of the issuers' financial condition, the Company believes that the
prices of the securities in the sectors identified above were temporarily
depressed primarily as a result of a market dislocation and generally poor
cyclical economic conditions and sentiment. See "Valuation of Investments and
Derivative Instruments" included in the Critical Accounting Estimates section of
the MD&A and in Note 1(g) of Notes to Consolidated Financial Statements both of
which are included in The Hartford's 2002 Form 10-K Annual Report.
The evaluation for other than temporary impairments is a quantitative and
qualitative process, which is subject to risks and uncertainties in the
determination of whether declines in the fair value of investments are other
than temporary. The risks and uncertainties include changes in general economic
conditions, the issuer's financial condition or near term recovery prospects and
the effects of changes in interest rates. In addition, for securitized financial
assets with contractual cash flows (e.g. asset-backed securities), projections
of expected future cash flows may change based upon new information regarding
the performance of the underlying collateral.
EQUITY RISK
The Company's Life operations are significantly influenced by changes in the
equity markets. The Company's profitability depends largely on the amount of
assets under management, which is primarily driven by the level of sales, equity
market appreciation and depreciation and the persistency of the in-force block
of business. A prolonged and precipitous decline in the equity markets, as has
been experienced of late, can have a
- 43 -
significant impact on the Company's operations, as sales of variable products
may decline and surrender activity may increase, as customer sentiment towards
the equity market turns negative. The lower assets under management will have a
negative impact on the Company's financial results, primarily due to lower fee
income related to the Investment Products and Individual Life segments, where a
heavy concentration of equity-linked products are administered and sold.
Furthermore, the Company may experience a reduction in profit margins if a
significant portion of the assets held in the variable annuity separate accounts
move to the general account and the Company is unable to earn an acceptable
investment spread, particularly in light of the low interest rate environment
and the presence of contractually guaranteed minimum interest credited rates,
which for the most part are at a 3% rate.
In addition, prolonged declines in the equity market may also decrease the
Company's expectations of future gross profits, which are utilized to determine
the amount of DAC to be amortized in a given financial statement period. A
significant decrease in the Company's estimated gross profits would require the
Company to accelerate the amount of DAC amortization in a given period,
potentially causing a material adverse deviation in that period's net income.
Although an acceleration of DAC amortization would have a negative impact on the
Company's earnings, it would not affect the Company's cash flow or liquidity
position.
Additionally, the Investment Products segment sells variable annuity contracts
that offer various guaranteed death benefits. For certain guaranteed death
benefits, The Hartford pays the greater of (1) the account value at death; (2)
the sum of all premium payments less prior withdrawals; or (3) the maximum
anniversary value of the contract, plus any premium payments since the contract
anniversary, minus any withdrawals following the contract anniversary. The
Company currently reinsures a significant portion of these death benefit
guarantees associated with its in-force block of business. The Company currently
records the death benefit costs, net of reinsurance, as they are incurred.
Declines in the equity market may increase the Company's net exposure to death
benefits under these contracts.
The Company's total gross exposure (i.e. before reinsurance) to these guaranteed
death benefits as of March 31, 2003 is $23.6 billion. Due to the fact that 81%
of this amount is reinsured, the Company's net exposure is $4.4 billion. This
amount is often referred to as the net amount at risk. However, the Company will
only incur these guaranteed death benefit payments in the future if the
policyholder has an in-the-money guaranteed death benefit at their time of
death. In order to analyze the total costs that the Company may incur in the
future related to these guaranteed death benefits, the Company performed an
actuarial present value analysis. This analysis included developing a model
utilizing 250 stochastically generated investment performance scenarios and best
estimate assumptions related to mortality and lapse rates. A range of projected
costs was developed and discounted back to the statement date utilizing the
Company's cost of capital, which for this purpose was assumed to be 9.25%. Based
on this analysis, the Company estimated that the present value of the retained
death benefit costs to be incurred in the future fell within a range of $108 to
$396. This range was calculated utilizing a 95% confidence interval. The median
of the 250 stochastically generated scenarios was $191.
In addition, Hartford Life issues certain variable annuity products that contain
a guaranteed minimum withdrawal benefit ("GMWB"). The GMWB gives the
policyholder the right to make periodic surrenders that total an amount equal to
the policyholders' premium payments. This guarantee will remain in effect if
periodic surrenders do not exceed an amount equal to 7% of premium payments each
contract year. If the policyholder chooses to surrender an amount equal to more
than 7% in a contract year, then the guarantee may be reduced to an amount less
than premium payments. The value of the GMWB obligations are calculated based on
actuarial assumptions related to the projected benefits and related contract
charges over the lives of the contracts. Because of the dynamic and complex
nature of these cash flows, stochastic techniques under a variety of market
return scenarios and other best estimate actuarial assumptions are used. This
model involves numerous estimates and subjective judgments including those
regarding expected market rates of return and volatility. Declines in the equity
market may increase the Company's exposure (prior to reinsurance) to benefits
under these contracts. The Company has entered into a reinsurance arrangement to
offset its exposure to the GMWB and currently reinsures 100% of these benefits.
PROPERTY & CASUALTY
The Fixed Maturities by Type tables that follow identify fixed maturities by
type as of March 31, 2003 and December 31, 2002.
- 44 -
FIXED MATURITIES BY TYPE
- ------------------------------------------------------------------------------------------------------------------------------------
MARCH 31, 2003
---------------------------------------------------------------------
UNREALIZED UNREALIZED
AMORTIZED COST GAINS LOSSES FAIR VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
Asset-backed securities ("ABS") $ 673 $ 31 $ (16) $ 688
Commercial mortgage-backed securities ("CMBS") 1,411 138 (3) 1,546
Collateralized mortgage obligation ("CMO") 53 2 -- 55
Corporate
Basic industry 786 51 (7) 830
Capital goods 288 19 (3) 304
Consumer cyclical 384 31 (3) 412
Consumer non cyclical 563 39 (4) 598
Energy 297 26 (1) 322
Financial services 1,505 99 (11) 1,593
Technology and communications 956 102 (5) 1,053
Transportation 103 7 (5) 105
Utilities 542 34 (7) 569
Other 56 4 -- 60
Government/Government agencies - Foreign 1,086 88 (6) 1,168
Government/Government agencies - United States 172 5 -- 177
Mortgage-backed securities ("MBS") - agency 458 13 -- 471
Municipal - tax-exempt 8,136 679 (5) 8,810
Municipal - taxable 49 5 -- 54
Redeemable preferred stock 66 4 (1) 69
Short-term 1,500 -- -- 1,500
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 19,084 $ 1,377 $ (77) $ 20,384
====================================================================================================================================
At March 31, 2003 the Property & Casualty fixed maturity portfolio had gross
unrealized losses of $77, of which 53% were concentrated in the financial
services, utilities and basic industry sectors and asset-backed securities. The
Company's current view of risk factors relative to these fixed maturity types
are as follows:
Financial Services - This sector has been adversely impacted by security
write-offs especially in the energy, utilities and telecommunications
industries, along with reserve increases by property and casualty insurers as a
result of poor underwriting and asbestos related exposures. In general, industry
balance sheets are strong and security credit quality is improving.
Utilities - The utilities sector remains adversely impacted by several events
that primarily occurred in 2001 including the bankruptcy of Enron Corporation,
the decline in the energy trading industry and the regulatory, political and
legal effect of the California Utility Crisis. In the short-term, restructuring
and possible bankruptcies may continue as companies seek liquidity sources.
Asset sales of non-core operations are expected to continue to be a significant
source of liquidity. The short-term events are expected to reduce the number of
power suppliers, which in the longer term, the Company believes will lead to a
gradual rise in power prices and allow this sector to recover.
Basic Industry - This sector is comprised of cyclical, commodity based
industries including mining, chemicals, metals and forest products. The downturn
in the general economy has reduced demand for many of the products produced by
industries in this sector. If the general economy improves, these cyclical
businesses as well as the securities issued by the companies in this sector
should recover.
ABS- As of March 31, 2003, the asset-backed securities in an unrealized loss
position were primarily supported by $10 of corporate debt ("CDOs").
Adverse CDO experience can be attributable to higher than expected default rates
especially in the technology and utilities sectors and lower than expected
recovery rates. Approximately 57% of the CDOs owned by Property & Casualty at
March 31, 2003 were investment grade.
- 45 -
FIXED MATURITIES BY TYPE
- ------------------------------------------------------------------------------------------------------------------------------------
DECEMBER 31, 2002
---------------------------------------------------------------------
UNREALIZED UNREALIZED
AMORTIZED COST GAINS LOSSES FAIR VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
Asset-backed securities ("ABS") $ 716 $ 34 $ (19) $ 731
Commercial mortgage-backed securities ("CMBS") 1,435 140 (2) 1,573
Collateralized mortgage obligation ("CMO") 46 3 -- 49
Corporate
Basic industry 776 50 (10) 816
Capital goods 302 17 (3) 316
Consumer cyclical 396 29 (1) 424
Consumer non cyclical 517 34 (4) 547
Energy 335 25 (2) 358
Financial services 1,259 93 (9) 1,343
Technology and communications 889 74 (21) 942
Transportation 106 8 (8) 106
Utilities 540 27 (17) 550
Other 54 3 -- 57
Government/Government agencies - Foreign 1,006 85 (3) 1,088
Government/Government agencies - United States 119 5 -- 124
Mortgage-backed securities ("MBS") - agency 506 16 -- 522
Municipal - tax-exempt 8,185 666 (5) 8,846
Municipal - taxable 48 4 -- 52
Redeemable preferred stock 66 3 (1) 68
Short-term 934 -- -- 934
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 18,235 $ 1,316 $ (105) $ 19,446
====================================================================================================================================
FIXED MATURITIES BY CREDIT QUALITY
- ------------------------------------------------------------------------------------------------------------------------------------
MARCH 31, 2003 DECEMBER 31, 2002
---------------------------------------- -------------------------------------
PERCENT OF PERCENT OF
AMORTIZED TOTAL FAIR AMORTIZED TOTAL FAIR
COST FAIR VALUE VALUE COST FAIR VALUE VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
United States Government/Government agencies $ 659 $ 678 3.3% $ 638 $ 660 3.4%
AAA 6,951 7,524 36.9% 6,825 7,398 38.1%
AA 3,049 3,291 16.1% 3,146 3,388 17.4%
A 3,380 3,621 17.8% 3,337 3,567 18.3%
BBB 2,532 2,698 13.2% 2,320 2,456 12.6%
BB & below 1,013 1,072 5.3% 1,035 1,043 5.4%
Short-term 1,500 1,500 7.4% 934 934 4.8%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 19,084 $ 20,384 100.0% $ 18,235 $ 19,446 100.0%
====================================================================================================================================
As of March 31, 2003 and December 31, 2002, over 94% of the fixed maturity
portfolio was invested in securities rated investment grade. As of March 31,
2003, BIG holdings were diversified by sector and issuer with the greatest
concentration of securities, based upon fair value, in the following sectors:
22% in foreign government, 16% in technology and communications, 11% in basic
industry and 10% in utilities. In addition, commercial mortgage backed
securities represented 8% of the BIG holdings as of March 31, 2003. At March 31,
2003, Property & Casualty held no issuer of a BIG security with a fair value in
excess of 3% of the total market value for BIG securities. As of December 31,
2002, BIG holdings were concentrated, based upon fair value, in the following
sectors: 24% in foreign government, 16% in technology and communications, 13% in
utilities and 11% in basic industry. In addition, commercial mortgage backed
securities represented 9% of the BIG holdings as of December 31, 2002. At
December 31, 2002, Property & Casualty held no issuer of a BIG security with a
fair value in excess of 3% of the total fair value for BIG securities.
Property & Casualty's total and BIG fixed maturity and equity securities held as
of March 31, 2003 and December 31, 2002 that were in an unrealized loss position
are presented in the tables below by length of time the security was in an
unrealized loss position.
- 46 -
UNREALIZED LOSS AGING AT MARCH 31, 2003
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL SECURITIES BIG AND EQUITY SECURITIES
------------------------------------------ ----------------------------------------
AMORTIZED UNREALIZED AMORTIZED UNREALIZED
COST FAIR VALUE LOSS COST FAIR VALUE LOSS
- ------------------------------------------------------------------------------------------------------------------------------------
Three months or less $ 562 $ 545 $ (17) $ 96 $ 89 $ (7)
Greater than three months to six months 228 220 (8) 10 9 (1)
Greater than six months to nine months 84 75 (9) 25 21 (4)
Greater than nine months to twelve months 70 65 (5) 66 61 (5)
Greater than twelve months 691 651 (40) 182 166 (16)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 1,635 $ 1,556 $ (79) $ 379 $ 346 $ (33)
====================================================================================================================================
The total securities that were in an unrealized loss position for longer than
six months as of March 31, 2003 primarily consisted of corporate and
asset-backed securities. The corporate security sectors of financial services,
utilities, transportation and technology and communications comprised 15%, 10%,
9%, and 9%, respectively, of the greater than six months unrealized loss amount.
Asset-backed securities backed by corporate debt and aircraft lease receivables
comprised 14% and 4% respectively, of the greater than six months unrealized
loss amount. At March 31, 2003, Property & Casualty held no securities of a
single issuer that were at an unrealized loss in excess of 5% of total
unrealized losses.
As of March 31, 2003, fixed maturities represented $77, or 97%, of total
Property & Casualty unrealized losses. Approximately 98% of the fixed maturities
in an unrealized loss position for longer than six months represented
asset-backed and commercial mortgage-backed securities and fixed maturities with
a fair value greater than 80% of amortized cost. As of March 31, 2003 Property &
Casualty held one corporate debt security with a fair value less than 80% of the
security's amortized cost basis for six continuous months. The security had a
fair value of $2 and was in an unrealized loss position of $1. The issuer has
made all contractually obligated principal and interest payments and their
operating fundamentals continue to improve. As a result, the Company concluded
the security price depression was temporary.
As of March 31, 2003, there were no asset-backed or commercial mortgage-backed
securities in an unrealized loss position in excess of 4% or $3 of total
unrealized losses.
The BIG and equity securities that were in an unrealized loss position for
longer than six months as of March 31, 2003 primarily consisted of corporate and
asset-backed securities backed by aircraft lease receivables. The corporate
securities in the utilities, technology and communications, financial services
and basic industry sectors along with asset-backed securities comprised 22%,
17%, 9%, 7%, and 6%, respectively, of the BIG and equity securities that were in
an unrealized loss position for greater than six months at March 31, 2003.
UNREALIZED LOSS AGING AT DECEMBER 31, 2002
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL SECURITIES BIG AND EQUITY SECURITIES
------------------------------------------ ----------------------------------------
AMORTIZED UNREALIZED AMORTIZED UNREALIZED
COST FAIR VALUE LOSS COST FAIR VALUE LOSS
- ------------------------------------------------------------------------------------------------------------------------------------
Three months or less $ 510 $ 490 $ (20) $ 112 $ 99 $ (13)
Greater than three months to six months 248 224 (24) 100 82 (18)
Greater than six months to nine months 135 103 (32) 91 68 (23)
Greater than nine months to twelve months 486 455 (31) 246 222 (24)
Greater than twelve months 216 176 (40) 109 86 (23)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 1,595 $ 1,448 $(147) $ 658 $ 557 $ (101)
====================================================================================================================================
The total securities that were in an unrealized loss position for longer than
six months as of December 31, 2002 primarily consisted of corporate and
asset-backed securities. The significant corporate security industry sectors of
technology and communications, banking and financial services, utilities and
transportation comprised 22%, 8%, 12% and 6%, respectively, of the greater than
six months unrealized loss amount. Asset-backed securities comprised 17% of the
greater than six month unrealized loss amount and include securities backed by
corporate debt, aircraft lease receivables, home equity loans and credit card
receivables. At December 31, 2002, Property & Casualty held no securities of a
single issuer that were at an unrealized loss in excess of 6% of total
unrealized losses.
The BIG and equity securities that were in an unrealized loss position for
longer than six months as of December 31, 2002 primarily consisted of corporate
securities in the technology and communications and utilities sectors as well as
asset-backed securities backed by corporate debt and aircraft lease receivables.
The technology and communications, utilities and transportation sectors along
with the asset-backed securities comprised 33%, 14%, 6% and 4%, respectively, of
the BIG and equity securities that were in an unrealized loss position for
greater than six months at December 31, 2002.
As part of the Company's ongoing monitoring process by a committee of investment
and accounting professionals, the Company has reviewed these securities and
concluded that there were no additional other than temporary impairments as of
March 31, 2003 and December 31, 2002. Due to the issuers' continued satisfaction
of the securities' obligations in accordance with their contractual terms and
their continued expectation to do so, as well as our evaluation of the
fundamentals of the issuers' financial condition, the Company believes that the
prices of the securities in the sectors identified above, were temporarily
depressed primarily as a result of a market dislocation and generally poor
cyclical
- 47 -
economic conditions and sentiment. See "Valuation of Investments and Derivative
Instruments" included in the Critical Accounting Estimates section of the MD&A
and Note 1(g) of Notes to Consolidated Financial Statements both of which are
included in The Hartford's 2002 Form 10-K Annual Report.
The evaluation for other than temporary impairments is a quantitative and
qualitative process, which is subject to risks and uncertainties in the
determination of whether declines in the fair value of investments are other
than temporary. The risks and uncertainties include changes in general economic
conditions, the issuer's financial condition or near term recovery prospects and
the effects of changes in interest rates. In addition, for securitized financial
assets with contractual cash flows (e.g. asset-backed securities), projections
of expected future cash flows may change based upon new information regarding
the performance of the underlying collateral.
MARKET RISK
The Hartford has material exposure to both interest rate and equity market risk.
The Company analyzes interest rate risk using various models including
multi-scenario cash flow projection models that forecast cash flows of the
liabilities and their supporting investments, including derivative instruments.
There have been no material changes in market risk exposures from December 31,
2002.
DERIVATIVE INSTRUMENTS
The Hartford utilizes a variety of derivative instruments, including swaps,
caps, floors, forwards and exchange traded futures and options, in compliance
with Company policy and regulatory requirements in order to achieve one of four
Company approved objectives: to hedge risk arising from interest rate, price or
currency exchange rate volatility; to manage liquidity, to control transaction
costs; or to enter into income enhancement and replication transactions. The
Company does not make a market or trade in these instruments for the express
purpose of earning short term trading profits. (For further discussion on The
Hartford's use of derivative instruments, refer to Note 3 of Notes to Condensed
Consolidated Financial Statements.)
- --------------------------------------------------------------------------------
CAPITAL RESOURCES AND LIQUIDITY
- --------------------------------------------------------------------------------
Capital resources and liquidity represent the overall financial strength of The
Hartford and its ability to generate strong cash flows from each of the business
segments and borrow funds at competitive rates to meet operating and growth
needs. The capital structure of The Hartford consists of debt and equity
summarized as follows:
MARCH 31, DECEMBER 31,
2003 2002 CHANGE
- ------------------------------------------------------------------------------------------------------------------------------------
Short-term debt $ 315 $ 315 --
Long-term debt 2,596 2,596 --
Company obligated mandatorily redeemable preferred securities of subsidiary trusts
holding solely junior subordinated debentures (trust preferred securities) 1,469 1,468 --
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL DEBT $ 4,380 $ 4,379 --
- ------------------------------------------------------------------------------------------------------------------------------------
Equity excluding accumulated other comprehensive income ("AOCI"), net of tax $ 8,185 $ 9,640 (15)%
AOCI, net of tax 1,257 1,094 15%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY $ 9,442 $ 10,734 (12)%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL CAPITALIZATION INCLUDING AOCI $ 13,822 $ 15,113 (9)%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL CAPITALIZATION EXCLUDING AOCI $ 12,565 $ 14,019 (10)%
- ------------------------------------------------------------------------------------------------------------------------------------
Debt to equity [1] 46% 41%
Debt to capitalization [1] 32% 29%
====================================================================================================================================
[1] Excluding trust preferred securities from total debt and AOCI from total
stockholders' equity and to total capitalization, the debt to equity ratio
was 36% and 30% and the debt to capitalization ratio was 23% and 21% as of
March 31, 2003 and December 31, 2002, respectively.
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
There have been no significant changes to The Hartford's contractual obligations
and commitments since December 31, 2002.
CAPITALIZATION
The Hartford endeavors to maintain a capital structure that provides financial
and operational flexibility to its insurance subsidiaries, ratings that support
its competitive position in the financial services marketplace, and strong
shareholder returns. Due to the results of the comprehensive study of its
asbestos related exposures and the related impact to stockholders' equity and
statutory surplus, the Company will immediately seek to replace the reduction in
stockholders' equity and statutory surplus with external capital and through
certain other actions. Accordingly, the Company plans to raise capital, which
may include concurrent offerings of equity and equity-linked securities and debt
securities. In addition, the Company has taken or intends to take certain
actions that will mitigate operating risk or increase statutory surplus. These
actions include or may include: the potential exit of the assumed reinsurance
business conducted by the Reinsurance segment, the de-emphasis of certain
specialty commercial businesses, the sale of certain invested assets, cost
reductions, and other actions as may be required.
The Company expects to use the net proceeds to replace the reduction in capital
of the property and casualty insurance subsidiaries, to contribute approximately
$150 of the net proceeds to the life subsidiaries, and to use the balance of the
net proceeds for general corporate purposes, which may include additional
capital contributions to subsidiaries. Furthermore, the Company intends to
contribute up to $300 to its qualified pension plan, including up to $100 of its
common stock.
- 48 -
The Hartford's total capitalization decreased $1.3 billion, while total
capitalization excluding AOCI decreased $1.5 billion as of March 31, 2003
compared to December 31, 2002. This decrease was due primarily to the first
quarter 2003 net loss of $1.4 billion, which reflects the $1.7 billion,
after-tax, charge taken to strengthen reserves as a result of the Company's
comprehensive study of its asbestos related exposure.
AOCI - AOCI increased by $163 as of March 31, 2003 compared with December 31,
2002. The increase resulted primarily from the impact of decreased interest
rates on unrealized gains on the fixed maturity portfolio, the recognition of
unrealized losses on other than temporary impairments on fixed maturity and
equity securities partially offset by the net loss on cash-flow hedging
instruments.
SHELF REGISTRATION
On March 19, 2003, The Hartford filed with the SEC a shelf registration
statement (Registration No. 333-103915) for the potential offering and sale of
debt and equity securities in an aggregate amount of up to $1.3 billion. On
April 10, 2003, The Hartford amended the registration statement (as amended, the
"Registration Statement"), to allow for the offering and sale of up to
approximately $2.6 billion in debt and equity securities. Specifically, the
Registration Statement allows for the following types of securities to be
offered: (i) debt securities, preferred stock, common stock, depositary shares,
warrants, stock purchase contracts, stock purchase units and junior subordinated
deferrable interest debentures of the Company, and (ii) preferred securities of
any of one or more capital trusts organized by The Hartford ("The Hartford
Trusts"). The Company may enter into guarantees with respect to the preferred
securities of any of The Hartford Trusts. The Registration Statement became
effective on April 10, 2003. As of that date, The Hartford had no remaining
availability under its previously filed shelf registration statement
(Registration No. 333-88762).
DEBT
The table below details the Company's short-term debt programs and the
applicable balances outstanding.
Outstanding
As of
--------------------------------
Effective Expiration Maximum March 31, December 31,
Description Date Date Available 2003 2002 Change
- ------------------------------------------------------------------------------------------------------------------------------------
Commercial Paper
The Hartford 11/10/86 N/A $ 2,000 $ 315 $ 315 --
HLI 2/7/97 N/A 250 -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total commercial paper $ 2,250 $ 315 $ 315 --
Revolving Credit Facility --
5-year revolving credit facility 6/20/01 6/20/06 $ 1,000 $ -- $ -- --
3-year revolving credit facility 12/31/02 12/31/05 490 -- -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total revolving credit facility $ 1,490 $ -- $ -- --
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM DEBT $ 3,740 $ 315 $ 315 --
====================================================================================================================================
STOCKHOLDERS' EQUITY
Dividends - On February 20, 2003, The Hartford declared a dividend on its common
stock of $0.27 per share payable on April 1, 2003 to shareholders of record as
of March 3, 2003.
CASH FLOWS
FIRST QUARTER ENDED
MARCH 31,
--------------------------
2003 2002
- ------------------------------------------------------------------
Cash provided by operating activities $ 667 $ 387
Cash used for investing activities $ (1,607) $ (775)
Cash provided by financing activities $ 1,216 $ 386
Cash - end of period $ 655 $ 351
==================================================================
The increase in cash provided by financing activities was primarily the result
of increased proceeds from investment and universal life-type contracts. The
increase in cash provided by operating activities was primarily the result of
changes in receivables, payables and accruals balances. The increase in cash
from financing activities accounted for the majority of the change in cash used
for investing activities. Operating cash flows for the quarters ended March 31,
2003 and 2002 were adequate to meet liquidity requirements.
RATINGS
Ratings are an important factor in establishing the competitive position in the
insurance and financial services marketplace. There can be no assurance that the
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 level of
revenues or the persistency of the Company's business may be adversely impacted.
Upon completion and announcement of the Company's asbestos reserve study and
discussion of the Company's financing plans, on May 12, 2003 certain of the
major independent ratings organizations revised The Hartford's financial ratings
as follows:
A.M. Best affirmed the financial strength ratings of A+ (Superior) of The
Hartford Fire Intercompany Pool and the main operating life insurance
subsidiaries of HLI. Concurrently, A.M. Best downgraded to "a-" from "a+" the
senior debt ratings of The Hartford Financial Services Group, Inc. and Hartford
Life Inc. and removed the ratings from under review.
Fitch is maintaining its Rating Watch Negative on the fixed income ratings for
The Hartford Financial Services Group, Inc. and the insurer financial strength
ratings for the Hartford Fire Intercompany Pool and stated if management is
successful in executing its capital raising, Fitch would anticipate affirming
the current ratings and assigning a stable outlook. At the same time, ratings
for the
- 49 -
Hartford's life insurance subsidiaries and fixed income ratings at the life
insurance operation's intermemate holding company, Hartford Life, Inc., have
been affirmed. The Rating Outlook is stable.
Moody's placed the A2 debt ratings of both The Hartford Financial Services
Group, Inc. and Hartford Life, Inc. under review for possible downgrade and
confirmed the insurance financial strength ratings of The Hartford's Insurance
Group's property and casualty intercompany pool as well as those of Hartford
Life and its life affiliates. With respect to insurance financial strength
ratings, Moody's maintained a negative outlook for the property and casualty
intercompany pool and changed its outlook for the life insurance companies to
negative.
Standard & Poor's placed the ratings of Hartford Financial Services Group, Inc.
and related entities on CreditWatch with negative implications and stated the
ratings will remain on CreditWatch until management is successful in raising
external capital, which should be concluded before the close of the second
quarter. Upon successful completion and all else being equal, Standard & Poor's
will affirm all of Hartford's ratings. The outlook will be stable.
The following table summarizes The Hartford's significant United States member
companies' financial ratings from the major independent rating organizations as
of May 12, 2003.
A.M. STANDARD
BEST FITCH & POOR'S MOODY'S
- -----------------------------------------------------------------
INSURANCE FINANCIAL
STRENGTH RATINGS:
Hartford Fire A+ AA AA- Aa3
Hartford Life Insurance
Company A+ AA AA- Aa3
Hartford Life & Accident A+ AA AA- Aa3
Hartford Life & Annuity A+ AA AA- Aa3
OTHER RATINGS:
The Hartford Financial
Services Group, Inc.:
Senior debt a- A A- A2
Commercial paper AMB-2 F1 A-2 P-1
Hartford Capital I
quarterly income
preferred securities bbb A- BBB A3
Hartford Capital III
trust originated
preferred securities bbb A- BBB A3
Hartford Life, Inc.:
Senior debt a- A A- A2
Commercial paper -- F1 A-2 P-1
Hartford Life, Inc.:
Capital I and II trust
preferred securities bbb A- BBB A3
Hartford Life Insurance
Company:
Short Term Rating -- -- A-1+ P-1
- -----------------------------------------------------------------
These ratings are not a recommendation to buy or hold any of The Hartford'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. The table
below sets forth statutory surplus for the Company's insurance companies.
MARCH 31, DECEMBER 31,
2003 2002
- ------------------------------------------------------------------
Life Operations $ 3,007 $ 3,019
Property & Casualty Operations 3,185 4,871
- ------------------------------------------------------------------
TOTAL $ 6,192 $ 7,890
==================================================================
CONTINGENCIES
Legal Proceedings - The Hartford is involved in claims litigation arising in the
ordinary course of business, both as a liability insurer defending third-party
claims brought against insureds and as an insurer defending coverage claims
brought against it. The Hartford accounts for such activity through the
establishment of unpaid claim and claim adjustment expense reserves. Subject to
the discussion of the litigation involving MacArthur in Part I, Item 3. Legal
Proceedings and the uncertainties related to asbestos and environmental claims
discussed in the MD&A under the caption "Other Operations," management expects
that the ultimate liability, if any, with respect to such ordinary-course claims
litigation, after consideration of provisions made for potential losses and
costs of defense, will not be material to the consolidated financial condition,
results of operations or cash flows of The Hartford.
The Hartford is also involved in other kinds of legal actions, some of which
assert claims for substantial amounts. These actions include, among others,
putative state and federal class actions seeking certification of a state or
national class. Such putative class actions have alleged, for example,
underpayment of claims or improper underwriting practices in connection with
various kinds of insurance policies, such as personal and commercial automobile,
premises liability and inland marine. The Hartford also is involved in
individual actions in which punitive damages are sought, such as claims alleging
bad faith in the handling of insurance claims. Management expects that the
ultimate liability, if any, with respect to such lawsuits, after consideration
of provisions made for potential losses and costs of defense, will not be
material to the consolidated financial condition of The Hartford. Nonetheless,
given the large or indeterminate amounts sought in certain of these actions, and
the inherent unpredictability of litigation, it is possible that an adverse
outcome in certain matters could, from time to time, have a material adverse
effect on the Company's consolidated results of operations or cash flows in
particular quarterly or annual periods.
Dependence on Certain Third Party Relationships - The Company distributes its
annuity, life and certain property and casualty insurance products through a
variety of distribution channels, including broker-dealers, banks, wholesalers,
its own internal sales force and other third party organizations. The Company
periodically negotiates provisions and renewals of these relationships and there
can be no assurance that such terms wil,l remain acceptable to the Company or
such third parties. An interruption in the Company's continuing relationship
with certain of these third parties could materially affect the Company's
ability to market its products.
- 50 -
- --------------------------------------------------------------------------------
ACCOUNTING STANDARDS
- --------------------------------------------------------------------------------
For a discussion of accounting standards, see Note 1 of Notes to Condensed
Consolidated Financial Statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information contained in the Capital Markets Risk Management section of
Management's Discussion and Analysis of Financial Condition and Results of
Operations is incorporated herein by reference.
ITEM 4. 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-14(c)) as of a date within 90 days prior to
the filing of this Quarterly Report on Form 10-Q, have concluded that the
Company's disclosure controls and procedures are adequate and effective for the
purposes set forth in the definition thereof in Exchange Act Rule 13a-14(c).
CHANGES IN INTERNAL CONTROLS
There were no significant changes in the Company's internal controls or in other
factors that could significantly affect the Company's internal controls
subsequent to the date of their evaluation.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Hartford is involved in claims litigation arising in the ordinary course of
business, both as a liability insurer defending third-party claims brought
against insureds and as an insurer defending coverage claims brought against it.
The Hartford accounts for such activity through the establishment of unpaid
claim and claim adjustment expense reserves. Subject to the discussion of the
litigation involving Mac Arthur Company and its subsidiary, Western MacArthur
Company, both former regional distributors of asbestos products (collectively or
individually, "MacArthur"), below and the uncertainties discussed in Note 5(b)
of Notes to Condensed Consolidated Financial Statements under the caption
"Asbestos and Environmental Claims," management expects that the ultimate
liability, if any, with respect to such ordinary-course claims litigation, after
consideration of provisions made for potential losses and costs of defense, will
not be material to the consolidated financial condition, results of operations
or cash flows of The Hartford.
The Hartford is also involved in other kinds of legal actions, some of which
assert claims for substantial amounts. These actions include, among others,
putative state and federal class actions seeking certification of a state or
national class. Such putative class actions have alleged, for example,
underpayment of claims or improper underwriting practices in connection with
various kinds of insurance policies, such as personal and commercial automobile,
premises liability, and inland marine. The Hartford also is involved in
individual actions in which punitive damages are sought, such as claims alleging
bad faith in the handling of insurance claims. Management expects that the
ultimate liability, if any, with respect to such lawsuits, after consideration
of provisions made for potential losses and costs of defense, will not be
material to the consolidated financial condition of The Hartford. Nonetheless,
given the large or indeterminate amounts sought in certain of these actions, and
the inherent unpredictability of litigation, it is possible that an adverse
outcome in certain matters could, from time to time, have a material adverse
effect on the Company's consolidated results of operations or cash flows in
particular quarterly or annual periods.
As further discussed in the MD&A under the caption "Other Operations," The
Hartford continues to receive environmental and asbestos claims that involve
significant uncertainty regarding policy coverage issues. Regarding these
claims, The Hartford continually reviews its overall reserve levels,
methodologies and reinsurance coverages.
The MacArthur Litigation - Hartford Accident and Indemnity Company ("Hartford
A&I"), a subsidiary of the Company, issued primary general liability policies to
MacArthur during the period 1967 to 1976. MacArthur sought coverage for
asbestos-related claims from Hartford A&I under these policies beginning in
1978. During the period between 1978 and 1987, Hartford A&I paid its full
aggregate limits under these policies plus defense costs. In 1987, Hartford A&I
notified MacArthur that its available limits under these policies had been
exhausted, and MacArthur ceased submitting claims to Hartford A&I under these
policies.
On October 3, 2000, thirteen years after it had accepted Hartford A&I's notice
of exhaustion, MacArthur filed an action against Hartford A&I and another
insurer in the U.S. District Court for the Eastern District of New York, seeking
for the first time additional coverage for asbestos bodily injury claims under
the Hartford A&I primary policies on the theory that Hartford A&I had exhausted
only its products aggregate limit of liability, not separate limits MacArthur
alleges to be available for non-products liability. The complaint sought a
declaration of coverage and unquantified damages. On March 28, 2003, the
District Court dismissed this action without prejudice on MacArthur's motion.
On June 3, 2002, The St. Paul Companies, Inc. ("St. Paul") announced a
settlement of a coverage action brought by MacArthur against United States
Fidelity and Guaranty Company ("USF&G"), a subsidiary of St. Paul. Under the
settlement, St. Paul agreed to pay a total of $975 to resolve its asbestos
liability to MacArthur in conjunction with a proposed bankruptcy petition and
pre-packaged plan of reorganization to be filed by MacArthur. USF&G provided at
least twelve years of primary general liability coverage to MacArthur, but,
unlike Hartford A&I, had denied coverage and had refused to pay for defense or
indemnity.
- 51 -
On October 7, 2002, MacArthur filed an action in the Superior Court in Alameda
County, California, against Hartford A&I and two other insurers. As in the
now-dismissed New York action, MacArthur seeks a declaration of coverage and
damages for asbestos bodily injury claims. Five asbestos claimants who allegedly
have obtained default judgments against MacArthur also are joined as plaintiffs;
they seek to recover the amount of their default judgments and additional
damages directly from the defendant insurers and assert a right to an
accelerated trial.
In its October 7, 2002 complaint, MacArthur alleges that it has approximately
$1.8 billion of unpaid asbestos liability judgments against it to date. The
ultimate amount of MacArthur's alleged non-products asbestos liability,
including any unresolved current claims and future demands, is currently
unknown.
On November 22, 2002, MacArthur filed a bankruptcy petition and proposed plan of
reorganization, which seeks to implement the terms of its settlement with St.
Paul. MacArthur's bankruptcy filings indicate that it will seek to have the full
amount of its current and future asbestos liability estimated in an amount
substantially more than the amount of the alleged unpaid judgments in
conjunction with plan confirmation. If such an estimation is made, MacArthur
intends to ask the Alameda County court to enter judgment against the insurers
for the amount of its total liability, including unliquidated claims and future
demands, less the estimated amount ultimately paid by St. Paul. Hartford A&I has
filed an adversary complaint in the MacArthur bankruptcy seeking a declaratory
judgment that any estimation made in the bankruptcy proceedings is not an
adjudication of MacArthur's asbestos liability for purposes of insurance
coverage.
Hartford A&I intends to defend the MacArthur action vigorously. In the opinion
of management, the ultimate outcome is highly uncertain for many reasons. It is
not yet known, for example, whether Hartford A&I's defenses based on MacArthur's
long delay in asserting claims for further coverage will be successful; how
other significant coverage defenses will be decided; or the extent to which the
claims and default judgments against MacArthur involve injury outside of the
products and completed operations hazard definitions of the policies. In the
opinion of management, an adverse outcome could have a material adverse effect
on the Company's results of operations, financial condition and liquidity.
Bancorp Services, LLC - On March 15, 2002, a jury in the U.S. District Court for
the Eastern District of Missouri issued a verdict in Bancorp Services, LLC
("Bancorp") v. HLIC, et al., in favor of Bancorp in the amount of $118. The case
involved claims of patent infringement, misappropriation of trade secrets, and
breach of contract against HLIC and its affiliate International Corporate
Marketing Group, LLC ("ICMG"). The judge dismissed the patent infringement claim
on summary judgment. The jury's award was based on the last two claims. On
August 28, 2002, the Court entered an order awarding Bancorp prejudgment
interest on the breach of contract claim in the amount of $16.
HLIC and ICMG have appealed the judgment on the trade secret and breach of
contract claims. Bancorp has cross-appealed the pretrial dismissal of its patent
infringement claim. The Company's management, based on the advice of its legal
counsel, believes that there is a substantial likelihood that the judgment will
not survive at its current amount. Based on the advice of legal counsel
regarding the potential outcomes of this litigation, the Company recorded an $11
after-tax charge for this matter in the first quarter of 2002 to increase
litigation reserves. Should HLIC and ICMG not succeed in eliminating or reducing
the judgment, a significant additional expense would be recorded in the future.
Reinsurance Arbitration - On March 16, 2003, a final decision and award was
issued in the previously disclosed arbitration between subsidiaries of The
Hartford and one of their primary reinsurers relating to policies with
guaranteed death benefits written from 1994 to 1999. The arbitration involved
alleged breaches under the reinsurance treaties. Under the terms of the final
decision and award, the reinsurer's reinsurance obligations to The Hartford's
subsidiaries were unchanged and not limited or reduced in any manner. The award
was confirmed by the Connecticut Superior Court on May 5, 2003.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On April 17, 2003, The Hartford held its annual meeting of shareholders. The
following matters were considered and voted upon: (1) the election of eleven
directors to serve for a 1-year term, (2) a proposal to ratify the appointment
of the Company's Independent Auditors; (3) a proposal to amend the Company's
Amended and Restated By-laws; and (4) a shareholder proposal relating to Auditor
Conflicts.
Set forth below is the vote tabulation relating to the four items presented to
the shareholders at the annual meeting:
(1) The shareholders elected each of the eleven nominees to the Board of
Directors for a one-year term:
Names of Director Shares
Nominees Shares For Withheld
---------------------------- ---------------- ----------------
Rand V. Araskog 210,751,131 4,211,288
Ramani Ayer 210,188,588 4,733,831
Donald R. Frahm 172,049,368 42,913,051
Edward J. Kelly, III 211,123,316 3,839,103
Paul G. Kirk, Jr. 211,039,225 3,923,194
Thomas M. Marra 211,131,830 3,830,589
Robert W. Selander 211,143,595 3,818,824
Charles B. Strauss 211,137,708 3,824,711
H. Patrick Swygert 211,083,824 3,878,595
Gordon I. Ulmer 211,050,155 3,912,264
David K. Zwiener 211,119,159 3,843,260
---------------------------- ---------------- ----------------
(2) The shareholders ratified the appointment of the Company's Independent
Auditors:
Shares For: 209,891,549
Shares Against: 2,545,965
Shares Abstained: 2,524,905
(3) The shareholders approved the amendment to the Company's Amended and
Restated By-laws:
Shares For: 188,346,771
Shares Against: 24,479,163
Shares Abstained: 2,136,485
(4) The shareholders defeated a shareholder proposal relating to Auditor
Conflicts:
Shares For: 39,099,548
Shares Against: 148,857,809
Shares Abstained: 2,961,875
Broker Non-Votes: 24,043,187
- 52 -
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - See Exhibit Index on page 57.
(b) Reports on Form 8-K:
During the quarterly period ended March 31, 2003, the Company filed the
following Current Reports on Form 8-K:
Dated March 17, 2003, Item 5, Other Events, to report a final decision and
award in the previously disclosed arbitration between subsidiaries of The
Hartford and one of their primary reinsurers relating to policies with
death benefit guarantees written from 1994 to 1999.
Dated March 25, 2003, Item 5, Other Events, to report the issuance of a
Memorandum and Order granting the motions of plaintiffs Mac Arthur Company
and Western MacArthur Company to dismiss voluntarily the action captioned
Mac Arthur Company, et al. v. Home Insurance Company, et al., Case No.
00-CV-5940, in favor of a parallel action.
- 53 -
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
The Hartford Financial Services Group, Inc.
(Registrant)
/s/ Robert J. Price
-------------------------------------------
Robert J. Price
Senior Vice President and Controller
MAY 13, 2003
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CERTIFICATIONS
I, Ramani Ayer, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Hartford
Financial Services Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: May 13, 2003
/s/ Ramani Ayer
-----------------------------
Ramani Ayer
Chairman, President and Chief
Executive Officer
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I, David M. Johnson, certify that:
1. I have reviewed this quarterly report on Form 10-Q of The Hartford
Financial Services Group, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: May 13, 2003
/s/ David M. Johnson
----------------------------------
David M. Johnson
Executive Vice President and Chief
Financial Officer
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THE HARTFORD FINANCIAL SERVICES GROUP, INC.
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003
FORM 10-Q
EXHIBITS INDEX
EXHIBIT NO. DESCRIPTION
- ----------- -----------
3.01 Amended and Restated By-Laws of The Hartford, amended effective April
17, 2003.
4.01 Amended and Restated By-Laws of The Hartford (incorporated herein by
reference as indicated in Exhibit 3.01 hereto).
15.01 Deloitte & Touche LLP Letter of Awareness.
99.01 Certification of Ramani Ayer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
99.02 Certification of David M. Johnson pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
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