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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ____________ to ______________
Commission file number 001-12749
HARTFORD LIFE, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 06-1470915
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
200 HOPMEADOW STREET, SIMSBURY, CONNECTICUT 06089
(Address of principal executive offices)
(860) 547-5000
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No[ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act)
Yes [ ] No[X]
As of October 31, 2004 there were outstanding 1,000 shares of Common Stock,
$0.01 par value per share, of the registrant, all of which were directly owned
by Hartford Holdings, Inc., a direct wholly owned subsidiary of The Hartford
Financial Services Group, Inc.
The registrant meets the conditions set forth in General Instruction H (1) (a)
and (b) of Form 10-Q and is therefore filing this form with the reduced
disclosure format.
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INDEX
PAGE
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PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS 3
Report of Independent Registered Public Accounting Firm 3
Condensed Consolidated Statements of Income - Third quarter
and Nine months ended September 30, 2004 and 2003 4
Condensed Consolidated Balance Sheets - September 30, 2004
and December 31, 2003 5
Condensed Consolidated Statements of Changes in
Stockholder's Equity - Nine months ended September 30, 2004 and 2003 6
Condensed Consolidated Statements of Cash Flows - Nine Months
Ended September 30, 2004 and 2003 7
Notes to Condensed Consolidated Financial Statements 8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 20
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 42
ITEM 4. CONTROLS AND PROCEDURES 42
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 42
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 43
Signature 44
Certifications 47
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholder
Hartford Life, Inc.
Hartford, Connecticut
We have reviewed the accompanying condensed consolidated balance sheet of
Hartford Life, Inc. and subsidiaries (the "Company") as of September 30, 2004,
and the related condensed consolidated statements of income for the third
quarter and nine months ended September 30, 2004 and 2003, and changes in
stockholder's equity, and cash flows for the nine months ended September 30,
2004 and 2003. These interim financial statements are the responsibility of the
Company's management.
We conducted our review in accordance with standards of the Public Company
Accounting Oversight Board (United States). A review of interim financial
information consists principally of applying analytical procedures and making
inquiries of persons responsible for financial and accounting matters. It is
substantially less in scope than an audit conducted in accordance with standards
of the Public Company Accounting Oversight Board (United States), the objective
of which is the expression of an opinion regarding the financial statements
taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should
be made to such condensed consolidated interim financial statements for them to
be in conformity with accounting principles generally accepted in the United
States of America.
We have previously audited, in accordance with standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheet of
the Company as of December 31, 2003, and the related consolidated statements of
income, changes in stockholder's equity, and cash flows for the year then ended
(not presented herein); and in our report dated February 25, 2004 we expressed
an unqualified opinion on those consolidated financial statements. In our
opinion, the information set forth in the accompanying condensed consolidated
balance sheet as of December 31, 2003 is fairly stated, in all material
respects, in relation to the consolidated balance sheet from which it has been
derived.
DELOITTE & TOUCHE, LLP
Hartford, Connecticut
November 10, 2004
3
HARTFORD LIFE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
THIRD QUARTER NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
(In millions) (Unaudited) 2004 2003 2004 2003
- --------------------------------------------- ---------------------------- ----------------------------
REVENUES
Fee income and other $ 805 $ 716 $ 2,381 $ 1,989
Earned premiums 1,058 1,016 3,023 2,469
Net investment income 611 512 2,670 1,519
Net realized capital gains 28 4 130 19
------------ ------------ ------------ ------------
TOTAL REVENUES 2,502 2,248 8,204 5,996
------------ ------------ ------------ ------------
BENEFITS, CLAIMS AND EXPENSES
Benefits, claims and claim adjustment expenses 1,325 1,375 4,733 3,544
Insurance expenses and other expenses 522 429 1,542 1,142
Amortization of deferred policy acquisition costs and
present value of future profits 236 202 702 540
Dividends to policyholders 3 15 24 55
Interest expense 20 29 77 87
------------ ------------ ------------ ------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 2,106 2,050 7,078 5,368
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAX (BENEFIT) EXPENSE AND
CUMULATIVE EFFECT OF ACCOUNTING CHANGE 396 198 1,126 628
Income tax (benefit) expense (103) 37 91 98
------------ ------------ ------------ ------------
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE 499 161 1,035 530
Cumulative effect of accounting change, net of tax - - (23) -
------------ ------------ ------------ ------------
NET INCOME $ 499 $ 161 $ 1,012 $ 530
------------ ------------ ------------ ------------
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
4
HARTFORD LIFE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
SEPTEMBER 30, DECEMBER 31,
(In millions, except for share data) 2004 2003
------------------------------------ -----------------------------
(Unaudited)
ASSETS
Investments
Fixed maturities, available-for-sale, at fair value (amortized cost of
$47,807 and $35,569) $ 50,200 $ 37,462
Equity securities, available-for-sale, at fair value (cost of $440 and $335) 449 357
Equity securities, held for trading, at fair value 10,685 -
Policy loans, at outstanding balance 2,665 2,512
Other investments 1,287 823
------------ ------------
Total investments 65,286 41,154
------------ ------------
Cash 625 265
Premiums receivable and agents' balances 412 335
Reinsurance recoverables 713 604
Deferred policy acquisition costs and present value of future profits 7,146 6,623
Deferred income taxes (763) (486)
Goodwill 796 796
Other assets 1,750 1,668
Separate account assets 131,655 136,633
------------ ------------
TOTAL ASSETS $ 207,620 $ 187,592
------------ ------------
LIABILITIES
Reserve for future policy benefits $ 11,805 $ 11,411
Other policyholder funds 49,347 26,186
Short-term debt - 505
Long-term debt 1,050 1,300
Other liabilities 4,948 4,498
Separate account liabilities 131,655 136,633
------------ ------------
TOTAL LIABILITIES 198,805 180,533
------------ ------------
Commitments and Contingent Liabilities, Note 8 - -
STOCKHOLDER'S EQUITY
Common Stock - 1,000 shares authorized, issued and outstanding;
par value $0.01 - -
Capital surplus 3,094 2,489
Accumulated other comprehensive income
Net unrealized capital gains on securities, net of tax
Foreign currency translation adjustments
1,161 903
(41) (43)
------------ ------------
Total accumulated other comprehensive income 1,120 860
Retained earnings 4,601 3,710
------------ ------------
TOTAL STOCKHOLDER'S EQUITY 8,815 7,059
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDER'S EQUITY $ 207,620 $ 187,592
------------ ------------
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
5
HARTFORD LIFE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDER'S EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2004
ACCUMULATED OTHER COMPREHENSIVE INCOME
--------------------------------------
NET UNREALIZED NET (LOSS) ON
CAPITAL CASH FLOW FOREIGN
GAINS (LOSSES) HEDGING CURRENCY TOTAL
COMMON CAPITAL ON SECURITIES, INSTRUMENTS, TRANSLATION RETAINED STOCKHOLDER'S
(In millions) (Unaudited) STOCK SURPLUS NET OF TAX NET OF TAX ADJUSTMENTS EARNINGS EQUITY
------------------------ ----- ------- ---------- ---------- ----------- -------- ------
Balance, December 31, 2003 $ - $ 2,489 $ 928 $ (25) $ (43) $ 3,710 $ 7,059
Comprehensive income
Net income 1,012 1,012
----------
Other comprehensive income, net of
tax (1)
Cumulative effect of accounting 292 292
change
Net change in unrealized capital
losses on securities (2) (24) (24)
Net loss on cash flow hedging
instruments (10) (10)
----------
Cumulative translation adjustments 2 2
----------
Total other comprehensive income 260
----------
Total comprehensive income 1,272
----------
Dividends declared (121) (121)
Capital contributions from parent 605 605
----- --------- -------- --------- ---------- ---------- ----------
BALANCE, SEPTEMBER 30, 2004 $ - $ 3,094 $ 1,196 $ (35) $ (41) $ 4,601 $ 8,815
===== ========= ======== ========= ========== ========== ==========
NINE MONTHS ENDED SEPTEMBER 30, 2003
ACCUMULATED OTHER COMPREHENSIVE INCOME
--------------------------------------
NET GAIN
NET UNREALIZED (LOSS) ON
CAPITAL CASH FLOW FOREIGN
GAINS ON HEDGING CURRENCY TOTAL
COMMON CAPITAL SECURITIES, NET INSTRUMENTS, TRANSLATION RETAINED STOCKHOLDER'S
(In millions) (Unaudited) STOCK SURPLUS OF TAX NET OF TAX ADJUSTMENTS EARNINGS EQUITY
------------------------- ---- ------- ------ ---------- ----------- -------- ------
Balance, December 31, 2002 $ - $ 1,970 $ 621 $ 126 $ (39) $ 3,010 $ 5,688
Comprehensive income
Net income 530 530
---------
Other comprehensive income, net of
tax (1)
Net change in unrealized capital
gains on securities (2) 323 323
Net loss on cash flow hedging
instruments (79) (79)
---------
Cumulative translation adjustments (3) (3)
---------
Total other comprehensive income 241
---------
Total comprehensive income 771
---------
Dividends declared (52) (52)
----- ------- ---------- ------- ---------- ---------- ---------
BALANCE, SEPTEMBER 30, 2003 $ - $ 1,970 $ 944 $ 47 $ (42) $ 3,488 $ 6,407
===== ======= ========== ======= ========== ========== =========
(1) Unrealized gains (losses) on securities is net of tax (benefit) provision
and other items of $(13) and $174 for the nine months ended September 30,
2004 and 2003, respectively. Net gain (loss) on cash flow hedging
instruments is net of tax (benefit) of $(5) and $(43) for the nine months
ended September 30, 2004 and 2003. There is no tax effect on cumulative
translation adjustments.
(2) Net of reclassification adjustment for gains realized in net income of $71
and $8 for the nine months ended September 30, 2004 and 2003,
respectively.
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS.
6
HARTFORD LIFE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------------
(In millions) (Unaudited) 2004 2003
------------------------- ---------------------------
OPERATING ACTIVITIES
Net income $ 1,012 $ 530
ADJUSTMENTS TO RECONCILE NET INCOME TO NET CASH PROVIDED BY OPERATING ACTIVITIES
Net realized capital (gains) losses (130) (19)
Cumulative effect of adoption of SOP 03-1 23 -
Amortization of deferred policy acquisition costs and present value of future profits 702 540
Additions to deferred policy acquisition costs and present value of future profits (1,463) (1,169)
Amortization of sales inducements 19 50
Additions to deferred sales inducements (91) (101)
Depreciation and amortization (14) 112
(Increase) decrease in premiums receivable and agents' balances (77) 3
Increase in receivables (328) (56)
Decrease in accrued liabilities and payables (47) (24)
(Decrease) increase in other liabilities (191) 373
(Decrease) increase in accrued taxes (80) 10
Change in deferred income taxes 743 58
Increase in liabilities for future policy benefits 394 779
Net increase in equity securities, held for trading (4,460) -
Net receipts from investment contracts credited to policyholder accounts associated with
equity securities, held for trading 4,906 -
Decrease (increase) in reinsurance recoverables 72 (6)
Decrease (increase) in other assets 296 (24)
------------ ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 1,286 1,056
------------ ------------
INVESTING ACTIVITIES
Purchases of fixed maturity and equity security investments, available-for-sale (13,034) (10,809)
Sales of fixed maturity and equity security investments, available-for-sale 8,574 4,578
Maturity of fixed maturity and equity security investments, available-for-sale 3,282 2,680
Purchase price adjustment of Business/Affiliate (58) -
Other (24) 35
------------ ------------
NET CASH USED FOR INVESTING ACTIVITIES (1,260) (3,516)
------------ ------------
FINANCING ACTIVITIES
Capital contributions 605 -
Proceeds from issuance of long-term debt - 230
Repayment of short-term debt (505) -
Repayment of company obligated mandatorily redeemable preferred securities of subsidiary
trust holding solely parent junior subordinated debentures (250) -
Dividends paid (115) (52)
Net receipts from investment and universal life-type contracts credited to policyholder
accounts 597 2,399
------------ ------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 332 2,577
------------ ------------
Net increase in cash 358 117
Impact of foreign exchange 2 (3)
------------ ------------
Cash - beginning of period 265 179
------------ ------------
CASH - END OF PERIOD $ 625 $ 293
------------ ------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
NET CASH PAID DURING THE PERIOD FOR
Income taxes $ 24 $ 16
Interest $ 74 $ 80
SEE NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
7
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in millions, unless otherwise stated)
(Unaudited)
1. BASIS OF PRESENTATION AND ACCOUNTING POLICIES
BASIS OF PRESENTATION
Hartford Life, Inc. (a Delaware corporation), together with its consolidated
subsidiaries ("Hartford Life" or the "Company"), is a leading financial services
and insurance organization which provides, primarily in the United States,
investment, retirement, estate planning and group benefits insurance products to
both individual and business customers in the United States and internationally.
Hartford Life, Inc. is a direct wholly-owned subsidiary of Hartford Holdings,
Inc., a direct wholly-owned subsidiary of The Hartford Financial Services Group,
Inc. ("The Hartford").
On December 31, 2003, the Company acquired the group life and accident, and
short-term and long-term disability business of CNA Financial Corporation.
Accordingly, the Company's results of operations for the third quarter and nine
months ended September 30, 2004 reflect the inclusion of this business. For
further discussion of the CNA Financial Corporation acquisition, see Note 4 of
these Notes to Condensed Consolidated Financial Statements and Note 17 of Notes
to Consolidated Financial Statements included in Hartford Life's 2003 Form 10-K
Annual Report.
The condensed consolidated financial statements have been prepared on the basis
of accounting principles generally accepted in the United States of America,
which differ materially from the accounting prescribed by various insurance
regulatory authorities. The financial statements include the accounts of
Hartford Life and its wholly-owned as well as controlled majority owned
subsidiaries. Subsidiaries in which the Company has at least 20% interest, but
less than a majority ownership interest, are reported using the equity method.
All material intercompany transactions and balances among Hartford Life, its
subsidiaries and affiliates have been eliminated.
The accompanying condensed consolidated financial statements and notes as of
September 30, 2004, and for the third quarter and nine months ended September
30, 2004 and 2003 are unaudited. These condensed consolidated financial
statements reflect all adjustments (consisting only of normal accruals) which
are, in the opinion of management, necessary for the fair presentation of the
financial position, results of operations, and cash flows for the interim
periods. These condensed consolidated financial statements and notes should be
read in conjunction with the consolidated financial statements and notes thereto
included in Hartford Life's 2003 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.
RECLASSIFICATIONS
Certain reclassifications have been made to prior period financial information
to conform to the current period classifications.
USE OF ESTIMATES
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States of America, requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
The most significant estimates include those used in determining reserves for
future policy benefits and unpaid claims and claim adjustment expenses; deferred
policy acquisition costs and present value of future profits; investments;
pension and other postretirement benefits; and contingencies.
SIGNIFICANT ACCOUNTING POLICIES
For a description of accounting policies, see Note 2 of Notes to Consolidated
Financial Statements included in Hartford Life's 2003 Form 10-K Annual Report.
INVESTMENTS
As discussed in Note 7 below, on January 1, 2004, the Company reclassified
certain separate account assets to the general account and classified a portion
of these assets as trading securities. Trading securities are recorded at fair
value with subsequent changes in fair value recognized in net investment income.
STOCK-BASED COMPENSATION
In January 2003, the Company began expensing all stock-based compensation awards
granted or modified after January 1, 2003 under the fair value recognition
provisions of Statement of Financial Accounting Standards ("SFAS") No. 123,
"Accounting for Stock-Based
8
Compensation". The fair value of stock-based awards granted or modified during
the nine months ended September 30, 2004 and 2003 was $41 and $40, after-tax,
respectively. The fair value of these awards will be expensed over the awards'
vesting period, generally three years.
Prior to January 1, 2004, The Hartford used the Black-Scholes model to determine
the fair value of The Hartford's stock-based compensation. For all awards
granted or modified on or after January 1, 2004, The Hartford uses a binomial
option-pricing model that incorporates the possibility of early exercise of
options into the valuation. The binomial model also incorporates The Hartford's
historical forfeiture and exercise experience to determine the option value. For
these reasons, The Hartford believes the binomial model provides a fair value
that is more representative of actual historical experience than the value
calculated under the Black-Scholes model.
All stock-based awards granted or modified prior to January 1, 2003, continue to
be valued using the intrinsic value-based provisions set forth in Accounting
Principles Board ("APB") Opinion No. 25, "Accounting for Stock-Issued to
Employees". Under the intrinsic value method, compensation expense is determined
on the measurement date, which is the first date on which both the number of
shares the employee is entitled to receive and the exercise price are known.
Compensation expense, if any, is measured based on the award's intrinsic value,
which is the excess of the market price of the stock over the exercise price on
the measurement date. The expense related to stock-based employee compensation,
including non-option plans, included in the determination of net income for the
second quarters and six months ended June 30, 2004 and 2003 is less than that
which would have been recognized if the fair value method had been applied to
all awards since the effective date of SFAS No. 123. (For further discussion of
the stock compensation plans, see Note 10 of Notes to Consolidated Financial
Statements included in Hartford Life's 2003 Form 10-K Annual Report.)
ADOPTION OF NEW ACCOUNTING STANDARDS
During September 2004, the American Institute of Certified Public Accountants
released a set of technical questions and answers on financial accounting and
reporting issues related to Statement of Position 03-1, "Accounting and
Reporting by Insurance Enterprises for Certain Nontraditional Long Duration
Contracts and for Separate Accounts" (SOP 03-1). The questions and answers
focused on the application of certain provisions of SOP 03-1 to components of
universal life-type contracts, including the definition of an insurance benefit
feature, the definition of an assessment, the appropriate level of aggregation
in determining additional liabilities required by SOP 03-1, situations where the
amounts assessed against the contract holder for an insurance benefit feature
are expected to result in losses in early and subsequent years of a contract's
life, the impact of reinsurance and the accounting for contracts that provide
annuitization benefits. Adoption of this guidance did not have a material impact
on the Company's balance sheet or statement of operations.
FUTURE ADOPTION OF NEW ACCOUNTING STANDARDS
EITF 03-1
In March 2004, the Emerging Issues Task Force ("EITF") reached a final consensus
on Issue 03-1, "The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments". EITF 03-1 was effective for periods
beginning after June 15, 2004 and adopts a three-step impairment model for
securities within its scope. The three-step model must be applied on a
security-by-security basis as follows:
Step 1: Determine whether an investment is impaired. An investment is impaired
if the fair value of the investment is less than its cost basis.
Step 2: Evaluate whether an impairment is other-than-temporary. For debt
securities that cannot be contractually prepaid or otherwise settled
in such a way that the investor would not recover substantially all
of its cost, an impairment is deemed other-than-temporary if the
investor does not have the ability and intent to hold the investment
until a forecasted market price recovery or it is probable that the
investor will be unable to collect all amounts due according to the
contractual terms of the debt security.
Step 3: If the impairment is other-than-temporary, recognize an impairment
loss equal to the difference between the investment's cost basis and
its fair value.
Subsequent to an other-than-temporary impairment loss, a debt security should be
accounted for in accordance with SOP 03-3, "Accounting for Loans and Certain
Debt Securities Acquired in a Transfer". EITF 03-1 does not replace the
impairment guidance for investments accounted for under EITF 99-20, "Recognition
of Interest Income and Impairments on Purchased and Retained Beneficial
Interests in Securitized Financial Assets", however, it requires investors to
determine if a security is other-than-temporarily impaired under EITF 03-1 if
the security is determined not to be other-than-temporarily impaired under EITF
99-20.
In September 2004, the FASB staff issued clarifying guidance for comment in FSP
EITF Issue 03-1-a, "Implementation Guidance for the Application of Paragraph 16
of EITF Issue No. 03-1, `The Meaning of Other-Than-Temporary Impairment and Its
Application to Certain Investments'", (FSP 03-1-a) and subsequently voted to
delay the implementation of the impairment measurement and recognition guidance
contained in paragraphs 10 - 20 of EITF 03-1 in order to reconsider certain
aspects of the consensus as well as the implementation guidance included in FSP
03-1-a. The disclosure guidance in paragraphs 21 and 22 of the standard remains
effective.
9
The ultimate impact the adoption of EITF 03-1 will have on the Company's
consolidated financial condition and results of operations is still unknown.
Depending on the nature of the ultimate guidance, adoption of the standard could
potentially result in the recognition of unrealized losses, including those
declines in value that are attributable to interest rate movements, as
other-than-temporary impairments, except those deemed to be minor in nature. As
of September 30, 2004, the Company had $219 of total gross unrealized losses.
The amount of impairments to be recognized, if any, will depend on the final
standard, market conditions and management's intent and ability to hold
securities with unrealized losses at the time of the impairment evaluation.
2. SEGMENT INFORMATION
The Company has changed its reportable operating segments from Investment
Products, Individual Life, Group Benefits and Corporate Owned Life Insurance
("COLI") to Retail Products Group ("Retail"), Institutional Solutions Group
("Institutional"), Individual Life and Group Benefits. Retail offers individual
variable and fixed annuities, mutual funds, retirement plan products and
services to corporations under Section 401(k) plans and other investment
products. Institutional primarily offers retirement plan products and services
to municipalities under Section 457 plans, other institutional investment
products and private placement life insurance. Individual Life sells a variety
of life insurance products, including variable universal life, universal life,
interest sensitive whole life and term life insurance. Group Benefits sells
group insurance products, including group life and group disability insurance as
well as other products, including medical 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. Hartford Life also includes in an Other category its international
operations, which are primarily located in Japan and Brazil; net realized
capital gains and losses other than periodic net coupon settlements on
non-qualifying derivatives and net realized capital gains and losses related to
guaranteed minimum withdrawal benefits; corporate items not directly allocated
to any of its reportable operating segments; and intersegment eliminations.
Periodic net coupon settlements on non-qualifying derivatives and net realized
capital gains and losses related to guaranteed minimum withdrawal benefits are
reflected in each applicable segment in net realized capital gains and losses.
The accounting policies of the reportable operating segments are the same as
those described in "Basis of Presentation and Accounting Policies" in Note 2 in
the Company's 2003 Form 10-K Annual Report. Hartford Life evaluates performance
of its segments based on revenues, net income and the segment's return on
allocated capital. The Company charges direct operating expenses to the
appropriate segment and allocates the majority of indirect expenses to the
segments based on an intercompany expense arrangement. Intersegment revenues
primarily occur between corporate and the operating segments. These amounts
primarily include interest income on allocated surplus, interest charges on
excess separate account surplus, the allocation of net realized capital gains
and losses, and the allocation of credit risk charges. The Company's revenues
are primarily derived from customers within the United States. The Company's
long-lived assets primarily consist of deferred policy acquisition costs and
deferred tax assets from within the United States. The following tables present
summarized financial information concerning the Company's segments. Segment
information for the previous period has been restated to reflect the change in
composition of reportable operating segments.
Institutional
SEPTEMBER 30, 2004 Retail Solutions Individual Group
THIRD QUARTER ENDED Products Group Group Life Benefits Other Total
- ------------------- -------------- ------------- ---------- -------- ----- -----
Total revenues $ 842 $ 448 $ 263 $ 1,009 $ (60) $ 2,502
Net income [1] 140 33 44 70 212 499
------------ ------------ ------------ ------------ ------------- ---------
Institutional
SEPTEMBER 30, 2003 Retail Solutions Individual Group
THIRD QUARTER ENDED Products Group Group Life Benefits Other Total
- ------------------- -------------- ------------- ---------- -------- ----- -----
Total revenues $ 566 $ 733 $ 249 $ 663 $ 37 $ 2,248
Net income (loss) 107 (8) 36 38 (12) 161
------------ ------------ ------------ ------------ ------------- ---------
Institutional
SEPTEMBER 30, 2004 Retail Solutions Individual Group
NINE MONTHS ENDED Products Group Group Life Benefits Other Total
- ------------------- -------------- ------------- ---------- -------- ----- -----
Total revenues $ 2,369 $ 1,324 $ 769 $ 3,013 $ 729 $ 8,204
Net income [1] 375 89 114 165 269 1,012
------------ ------------ ------------ ------------ ------------- ---------
10
Institutional
SEPTEMBER 30, 2003 Retail Solutions Individual Group
NINE MONTHS ENDED Products Group Group Life Benefits Other Total
- ------------------- -------------- ------------- ---------- -------- ----- -----
Total revenues $ 1,577 $ 1,625 $ 733 $ 1,968 $ 93 $ 5,996
Net income (loss) 305 52 104 107 (38) 530
[1] For the third quarter and nine months ended September 30, 2004, includes a
$190 tax benefit recorded in the Other category, which relates to
agreement with the IRS on the resolution of matters pertaining to tax
years prior to 2004. For further discussion of this tax benefit, see Note
8.
3. INVESTMENTS AND DERIVATIVE INSTRUMENTS
The following table identifies the Company's fixed maturity investments by
sector, as of September 30, 2004 and December 31, 2003.
COMPONENTS OF FIXED MATURITY INVESTMENTS
SEPTEMBER 30, 2004 DECEMBER 31, 2003
------------------------------------------- -------------------------------------------
GROSS GROSS GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE COST GAINS LOSSES VALUE
---------- -------- ------- --------- ---------- --------- ------- --------
Bonds and Notes
U.S. Gov't and Gov't agencies and
authorities (guaranteed and sponsored) $ 864 $ 17 $ (4) $ 877 $ 759 $ 9 $ (2) $ 766
U.S. Gov't and Gov't agencies and
authorities (guaranteed and sponsored) -
asset-backed 2,610 34 (7) 2,637 2,634 38 (4) 2,668
States, municipalities and political
subdivisions 2,739 213 (8) 2,944 2,184 174 (8) 2,350
International governments 726 61 (2) 785 697 65 (1) 761
Public utilities 2,271 180 (9) 2,442 1,452 109 (6) 1,555
All other corporate including
international 21,454 1,574 (78) 22,950 16,166 1,263 (50) 17,379
All other corporate - asset-backed 14,592 516 (95) 15,013 9,672 389 (87) 9,974
Short-term investments 2,540 -- -- 2,540 1,974 2 -- 1,976
Redeemable preferred stock 11 1 -- 12 31 2 -- 33
---------- -------- ------ --------- ---------- --------- ------ --------
TOTAL FIXED MATURITIES $ 47,807 $ 2,596 $ (203) $ 50,200 $ 35,569 $ 2,051 $ (158) $ 37,462
========== ======== ====== ========= ========== ========= ====== ========
Included in the fair value of total fixed maturities as of September 30, 2004
are $11.1 billion of guaranteed separate account assets. Guaranteed separate
account assets were reclassified to the general account on January 1, 2004 as a
result of the adoption of SOP 03-1 (for further discussion see Note 7 of Notes
to Condensed Consolidated Financial Statements).
DERIVATIVE INSTRUMENTS
The Company utilizes a variety of derivative instruments, including swaps, caps,
floors, forwards, futures and options designed to achieve one of four
Company-approved objectives: to hedge risk arising from interest rate, price or
currency exchange rate volatility; to manage liquidity; to control transaction
costs; or to enter into replication transactions.
On the date the derivative contract is entered into, the Company designates the
derivative as (1) a hedge of the fair value of a recognized asset or liability
("fair value" hedge), (2) a hedge of a forecasted transaction or of the
variability of cash flows to be received or paid related to a recognized asset
or liability ("cash flow" hedge), (3) a foreign-currency fair value or cash flow
hedge ("foreign-currency" hedge), (4) a hedge of a net investment in a foreign
operation or (5) held for other investment and risk management activities, which
primarily involve managing asset or liability related risks that do not qualify
for hedge accounting under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities".
The Company's derivative transactions are permitted uses of derivatives under
the derivatives use plan filed and/or approved, as applicable, by the State of
Connecticut, the State of Illinois and the State of New York insurance
departments. The Company does not make a market or trade in these instruments
for the express purpose of earning short-term trading profits.
For a detailed discussion of the Company's use of derivative instruments, see
Notes 2 and 3 of Notes to Consolidated Financial Statements included in Hartford
Life's 2003 Form 10-K Annual Report.
The following table summarizes the notional amount and fair value of derivatives
by hedge designation as of September 30, 2004 and December 31, 2003. The
notional amount of derivative contracts represents the basis upon which pay or
receive amounts are calculated
11
and are not necessarily reflective of credit risk. The fair value amounts of
derivative assets and liabilities are presented on a net basis in the following
table.
SEPTEMBER 30, 2004 DECEMBER 31, 2003
----------------------- -----------------------
NOTIONAL NOTIONAL
AMOUNT FAIR VALUE AMOUNT FAIR VALUE
---------- ---------- ---------- ----------
Cash flow hedge $ 6,430 $ (169) $ 3,285 $ (58)
Fair value hedge 293 (5) 206 (5)
Net investment hedge 401 5 200 (4)
Other investment and risk management activities 45,755 113 29,927 21
---------- ---------- ---------- ----------
TOTAL $ 52,879 $ (56) $ 33,618 $ (46)
========== ========== ========== ==========
The increase in notional amount since December 31, 2003 is primarily due to an
increase in embedded derivatives associated with guaranteed minimum withdrawal
benefits ("GMWB") product sales, and, to a lesser extent, derivatives
transferred to the general account as a result of the adoption of SOP 03-1 and
new hedging strategies. The decrease in the net fair value of derivative
instruments since December 31, 2003 was primarily due to the rise in short-term
interest rates during the third quarter of 2004 and derivatives transferred to
the general account pursuant to the adoption of SOP 03-1, partially offset by
the increase in derivatives associated with GMWB.
Due to the adoption of SOP 03-1, derivatives previously included in separate
accounts were reclassified into various other balance sheet classifications. On
January 1, 2004, the notional amount and net fair value of derivative
instruments reclassified totaled $2.9 billion and $(71), respectively. As of
September 30, 2004, $28 of the derivatives were reported in other investments,
$(114) in other liabilities, and $4 of embedded derivatives in fixed maturities
in the condensed consolidated balance sheets. Management's objectives with
regard to the reclassified derivatives along with the notional amount and net
fair value are as follows:
HEDGING STRATEGY
SEPTEMBER 30, 2004
-----------------------
NOTIONAL
AMOUNT FAIR VALUE
---------- ----------
CASH FLOW HEDGES
Interest rate swaps - Interest rate swaps are primarily used to convert interest receipts on
floating-rate fixed maturity investments to fixed rates. These derivatives are predominantly used to
better match cash receipts from assets with cash disbursements required to fund liabilities. $ 1,597 $ 31
Foreign currency swaps - Foreign currency swaps are used to convert foreign denominated cash flows
associated with certain foreign denominated fixed maturity investments to U.S. dollars. The foreign
fixed maturities are primarily denominated in Euros and are swapped to minimize cash flow
fluctuations due to changes in currency rates. 434 (109)
FAIR VALUE HEDGES
Interest rate caps and floors - Interest rate caps and floors are used to offset the changes in fair
value related to corresponding interest rate caps and floors that exist in certain of the Company's
variable-rate fixed maturity investments. 111 (2)
OTHER INVESTMENT AND RISK MANAGEMENT ACTIVITIES
Credit default and total return swaps - The Company enters into swap agreements in which the Company
assumes credit exposure or reduces credit exposure from an individual entity, referenced index or
asset pool. 419 --
Interest rate swaps - The Company uses interest rate swaps to manage interest rate risk. 210 4
Options - The Company writes option contracts for a premium to monetize the option embedded in
certain of its fixed maturity investments. 121 --
Foreign currency swaps - The Company enters into foreign currency swaps to hedge the foreign currency
exposures in certain of its foreign fixed maturity investments. 62 (6)
---------- ----------
TOTAL $ 2,954 $ (82)
========== ==========
In addition to the derivatives transferred to the general account as a result of
the adoption of SOP 03-1, during the first quarter of 2004, the Company entered
into a series of interest rate swap agreements with a combined notional value of
$350 to hedge a portion of the Company's floating rate guaranteed investment
contracts. These swaps have been designated as cash flow hedges, with the
objective of hedging changes in the benchmark interest rate (LIBOR), and were
structured to offset the payments associated with the guaranteed investment
contracts. As of September 30, 2004, the notional amount and net fair value of
these swaps totaled $350 and $2, respectively.
During the nine months ended September 30, 2004, the Company entered into credit
default swap agreements in which the Company pays a derivative counterparty a
periodic fee in exchange for compensation from the counterparty should a credit
event occur on the part
12
of the referenced security issuer. The Company entered into these agreements as
an efficient means to reduce credit exposure to the specified issuers. As of
September 30, 2004, the notional amount and net fair value of these swaps
totaled $524 and $(1), respectively.
During the nine months ended September 30, 2004, the Company also entered into a
series of forward starting swap agreements to hedge interest rate exposure on
anticipated fixed-rate asset purchases and anticipated variable cash flows on
floating rate assets due to changes in the benchmark interest rate (LIBOR).
These swaps have been designated as cash flow hedges and were structured to
hedge interest rate exposure inherent in the assumptions used to price primarily
certain long-term disability products. As of September 30, 2004, the notional
amount and net fair value of these swaps totaled $850 and $12, respectively.
During the nine months ended September 30, 2004, the Company entered into
interest swaps and swaptions to reduce duration risk in the investment
portfolio. These derivative instruments are structured to hedge the durations of
fixed maturity investments to match certain life product liabilities in
accordance with the Company's asset and liability management policy. As of
September 30, 2004, the notional and fair value of these swaps and swaptions
totaled $1.2 billion and $7, respectively.
Periodically the Company enters into interest rate swap agreements to terminate
existing swaps in hedging relationships, thereby offsetting the prospective
changes in value in the original swap. During the nine months ended September
30, 2004, the Company cash settled both the original and offsetting swap
agreements, resulting in a reduction in notional amount of approximately $3.2
billion from December 31, 2003. No net realized gain or loss was recorded as a
result of the settlement.
The Company offers certain variable annuity products with a GMWB rider. As of
September 30, 2004 and December 31, 2003, $14.7 billion, or 57%, and $6.2
billion, or 36%, respectively, of account value with the GMWB feature was
unreinsured. In order to minimize the volatility associated with the unreinsured
GMWB liabilities, the Company has established an alternative risk management
strategy. In 2003, the Company began hedging its unreinsured GMWB exposure using
interest rate futures, and Standard and Poor's ("S&P") 500 and NASDAQ index
options and futures contracts. During 2004, the Company began using Europe,
Australasia and Far East ("EAFE") Index swaps to hedge GMWB exposure to
international equity markets.
The total notional amount of derivative contracts purchased to hedge the GMWB
exposure, as of September 30, 2004 and December 31, 2003, was $2.9 billion and
$544, respectively, and net fair value was $151 and $21, respectively. For the
third quarter and nine months ended September 30, 2004, net realized capital
gains and losses included the change in market value of both the embedded
derivative related to the GMWB liability and the related derivative contracts
that were purchased as economic hedges, the net effect of which was a gain of $0
and $4, respectively, before deferred policy acquisition costs and tax effects.
Derivative instruments are recorded at fair value and presented in the condensed
consolidated balance sheets as follows:
SEPTEMBER 30, 2004 DECEMBER 31, 2003
----------------------- -----------------------
LIABILITY LIABILITY
ASSET VALUES VALUES ASSET VALUES VALUES
---------- ----------- ---------- ----------
Other investments $ 262 $ -- $ 178 $ --
Reinsurance recoverables -- 58 -- 89
Other policyholder funds 73 -- 115 --
Fixed maturities 4 -- 7 --
Other liabilities -- 337 -- 257
---------- ----------- ---------- ----------
TOTAL $ 339 $ 395 $ 300 $ 346
========== =========== ========== ==========
For the third quarter and nine months ended September 30, 2004 and 2003, the
Company's gross gains and losses, representing the total ineffectiveness of all
fair value and net investment hedges were less than $1, with the net impact
reported as net realized capital gains and losses. For the third quarter and
nine months ended September 30, 2004, the Company recorded a net loss due to
ineffectiveness on cash flow hedges of $(3) and $(6), after-tax, respectively,
primarily associated with interest rate swap hedges, in net realized capital
gains and losses. For the third quarter and nine months ended September 30,
2003, the cash flow hedge ineffectiveness was less than $1.
The total change in value for other derivative-based strategies which do not
qualify for hedge accounting treatment, including periodic net coupon
settlements, are reported as net realized capital gains and losses in the
condensed consolidated statements of income. For the third quarter and nine
months ended September 30, 2004, the Company recognized an after-tax net (loss)
gain of $(9) and $12, respectively, for derivative-based strategies, which do
not qualify for hedge accounting treatment. For the third quarter and nine
months ended September 30, 2003, the after-tax net loss was $(15) and $(10),
respectively.
As of September 30, 2004, the after-tax deferred net gains on derivative
instruments in accumulated other comprehensive income ("AOCI") that are expected
to be reclassified to earnings during the next twelve months are $10. This
expectation is based on the anticipated interest payments on hedged investments
in fixed maturity securities that will occur over the next twelve months, at
which time the Company will recognize the deferred net gains or losses as an
adjustment to interest income over the term of the investment cash flows. The
maximum term over which the Company is hedging its exposure to the variability
of future cash flows (for all forecasted transactions, excluding interest
payments on variable-rate fixed maturities) is twenty-four months. For the third
quarter and
13
nine months ended September 30, 2004 and 2003, there were no reclassifications
from AOCI to earnings resulting from the discontinuance of cash flow hedges.
The net investment hedge of the Japanese Life operation was established in the
fourth quarter of 2003. The after-tax amount of net gain (loss) included in the
foreign currency cumulative translation adjustment associated with the net
investment hedge was $4 and $(3) as of September 30, 2004 and December 31, 2003,
respectively.
4. GOODWILL AND OTHER INTANGIBLE ASSETS
Effective January 1, 2002, the Company adopted SFAS No. 142, "Goodwill and Other
Intangible Assets", and accordingly ceased all amortization of goodwill. As of
September 30, 2004 and December 31, 2003, the carrying amount of goodwill for
the Company's Retail Products segment was $356 and the Company's Individual Life
segment was $440.
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 material intangible assets with indefinite useful
lives.
AS OF SEPTEMBER 30, 2004 AS OF DECEMBER 31, 2003
------------------------ -------------------------
GROSS ACCUMULATED GROSS ACCUMULATED
CARRYING NET CARRYING NET
AMORTIZED INTANGIBLE ASSETS AMOUNT AMORTIZATION AMOUNT AMORTIZATION
---------- ------------ ---------- ------------
Present value of future profits $ 649 $ 146 $ 658 $ 115
---------- ---------- ---------- ----------
TOTAL $ 649 $ 146 $ 658 $ 115
========== ========== ========== ==========
Net amortization expense for the third quarter ended September 30, 2004 and 2003
was $11 and $10, respectively.
Net amortization expense for the nine months ended September 30, 2004 and 2003
was $31 and $27, respectively.
On December 31, 2003, the Company acquired CNA Financial Corporation's group
life and accident, and short-term and long-term disability businesses for $485
in cash. The purchase price paid on December 31, 2003 was based on September 30,
2003 statutory surplus. During the second quarter of 2004, the purchase price
was finalized for $543 in cash based on the actual statutory surplus at December
31, 2003. The Company continues to integrate this acquisition and obtain the
information necessary to finalize the initial estimates in purchase accounting.
The Company expects to finalize those initial fair value estimates within the
one year allocation period, ending December 31, 2004.
Estimated future net amortization expense for the succeeding five years is as
follows:
FOR THE YEAR ENDING DECEMBER 31,
2004 $ 41
2005 $ 34
2006 $ 32
2007 $ 30
2008 $ 27
5. DEATH BENEFITS AND OTHER INSURANCE BENEFIT FEATURES
The Company issues variable annuity contracts, with separate account investment
options, that offer various guaranteed death benefits. The Company currently
reinsures a significant portion of these death benefit guarantees associated
with its in-force block of business. Upon adoption of SOP 03-1, the Company
recorded a liability for GMDB and other benefits sold with variable annuity
products of $225 and a related reinsurance recoverable asset of $108. As of
September 30, 2004, the liability from GMDB and other benefits sold with
variable annuity products was $203 with a related reinsurance recoverable asset
of $71. The net GMDB liability is established by estimating the expected value
of net reinsurance costs and death benefits in excess of the projected account
balance. The excess death benefits and net reinsurance costs are recognized
ratably over the accumulation period based on total expected assessments. The
determination of the GMDB liability and related reinsurance recoverable is based
on models that involve a range of scenarios and assumptions, including those
regarding expected market rates of return and volatility, contract surrender
rates and mortality experience. The assumptions used are consistent with those
used in determining estimated gross profits for purposes of amortizing deferred
acquisition costs.
14
The following table provides details concerning GMDB exposure for the Retail
Products Group which comprises substantially all of the GMDB exposure:
BREAKDOWN OF VARIABLE ANNUITY ACCOUNT VALUE BY GMDB TYPE
ACCOUNT NET AMOUNT RETAINED NET AMOUNT
Maximum anniversary value (MAV) [1] VALUE AT RISK AT RISK
------------ ------------ ------------
MAV only $ 58,782 $ 8,817 $ 1,040
With 5% rollup [2] 3,996 733 137
With Earnings Protection Benefit Rider (EPB) [3] 4,236 146 44
With 5% rollup & EPB 1,425 124 21
Total MAV 68,439 9,820 1,242
Asset Protection Benefit (APB) [4] 13,837 53 31
Ratchet [5] (5 years) 41 4 --
Reset [6] (5-7 years) 8,011 933 933
Return of Premium [7]/Other 1,751 14 14
------------ ------------ ------------
TOTAL $ 92,079 $ 10,824 $ 2,220
============ ============ ============
[1] MAV: the death benefit is the greatest of current account value, net
premiums paid and the highest account value on any anniversary before age
80 (adjusted for withdrawals).
[2] Rollup: the death benefit is the greatest of the MAV, current account
value, net premium paid and premiums (adjusted for withdrawals)
accumulated at generally 5% simple interest up to the earlier of age 80 or
100% of adjusted premiums.
[3] EPB: The death benefit is the greatest of the MAV, current account value,
or contract value plus a percentage of the contract's growth. The
contract's growth is account value less premiums net of withdrawals,
subject to a cap of 200% of premiums net of withdrawals.
[4] APB: the death benefit is the greater of current account value or MAV, not
to exceed current account value plus 25% times the greater of net premiums
and MAV (each adjusted for premiums in the past 12 months).
[5] Ratchet: the death benefit is the greatest of current account value, net
premiums paid and the highest account value on any specified anniversary
before age 85 (adjusted for withdrawals).
[6] Reset: the death benefit is the greatest of current account value, net
premiums paid and the most recent five to seven year anniversary account
value before age 80 (adjusted for withdrawals).
[7] Return of premium: the death benefit is the greater of current account
value and net premiums paid.
The Individual Life segment sells universal life-type contracts with and without
certain secondary guarantees, such as a guarantee that the policy will not
lapse, even if the account value is reduced to zero, as long as the policyholder
makes scheduled premium payments. The cumulative effect on net income upon
recording additional liabilities for universal life-type contracts and the
related secondary guarantees, in accordance with SOP 03-1, was not material.
6. SALES INDUCEMENTS
The Company currently offers enhanced crediting rates or bonus payments to
contractholders on certain of its individual and group annuity products. Through
December 31, 2003, the expense associated with offering certain of these bonuses
was deferred and amortized over the contingent deferred sales charge period.
Others were expensed as incurred. Effective January 1, 2004, upon the Company's
adoption of SOP 03-1, the expense associated with offering a bonus is deferred
and amortized over the life of the related contract in a pattern consistent with
the amortization of deferred policy acquisition costs. Also, effective January
1, 2004, amortization expense associated with expenses previously deferred is
recorded over the remaining life of the contract rather than over the contingent
deferred sales charge period. Changes in deferred sales inducement activity were
as follows:
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2004 SEPTEMBER 30, 2004
------------------ ------------------
Balance, beginning of period $ 249 $ 198
Sales inducements deferred 28 91
Amortization charged to income (7) (19)
----- ----------
Balance at September 30, 2004 $ 270 $ 270
The Company agreed to offer London Pacific Life and Annuity Company in
Liquidation ("London Pacific") deferred annuity customers the opportunity to
exchange to a Hartford Life Insurance Company ("HLIC") contract in the third
quarter of 2004. The Company assumed the contractual rights and liabilities
arising under approximately 5,500 immediate annuities in the third quarter of
2004 and expects to assume 2,000 universal life policies in the first quarter of
2005 from London Pacific pursuant to orders entered by the Wake County Superior
Court of North Carolina. During the third quarter, the Company completed the
assumption of the immediate annuity contracts. Also during the third quarter,
London Pacific deferred annuity contract holders with $566 of account value
elected to exchange their London Pacific contract for a Hartford Life contract.
Upon the exchange, which occurred in the fourth of quarter 2004, London Pacific
contract holders were given an immediate bonus. This sales inducement amounted
to $26 and will be deferred and amortized over the life of the contracts.
15
7. SEPARATE ACCOUNT PRESENTATION
The Hartford maintains separate account assets and liabilities, which are
reported at fair value. Separate account assets are segregated from other
investments. Investment income and gains and losses from those separate account
assets accrue directly to the policyholder. See Note 5 for a discussion of death
benefit guarantees offered in variable annuity contracts sold through separate
accounts. The fees earned for administrative and contractholder maintenance
services performed for these separate accounts are included in fee income.
During 2004, there were no gains or losses on transfers of assets from the
general account to the separate account. The Company had recorded certain market
value adjusted ("MVA") fixed annuity products and modified guarantee life
insurance (primarily the Company's Compound Rate Contract ("CRC") and associated
assets) as separate account assets and liabilities through December 31, 2003.
Notwithstanding the market value adjustment feature in this product, all of the
investment performance of the separate account assets is not being passed to the
contractholder. Therefore, it does not meet the conditions for separate account
reporting, under SOP 03-1. Separate account assets and liabilities related to
CRC of $11 billion were reclassified to and revalued in, the general account
upon adoption of SOP 03-1.
Prior to the adoption of SOP 03-1, the Company had also recorded its variable
annuity products offered in Japan in separate account assets and liabilities
through December 31, 2003. These assets are not legally insulated from general
creditors and therefore did not meet the conditions for separate account
reporting under SOP 03-1. On January 1, 2004, separate account assets and
liabilities in Japan of $6.2 billion were reclassified to the general account
with no change in value. The investment assets were recorded at fair value in a
trading securities portfolio. As of September 30, 2004, due to strong sales of
Japan variable annuity products and positive performance of the Japanese equity
markets these assets had increased to $11.1 billion.
8. COMMITMENTS AND CONTINGENCIES
LITIGATION
Hartford Life is or may become involved in various legal actions, some of which
assert claims for substantial amounts. These actions may include, among others,
putative state and federal class actions seeking certification of a state or
national class. Such putative class actions have alleged, for example, improper
sales practices in connection with the sale of life insurance and other
investment products, and improper fee arrangements in connection with mutual
funds. The Company also is involved in individual actions in which punitive
damages are sought, such as claims alleging bad faith in the handling of
insurance claims. Management expects that the ultimate liability, if any, with
respect to such lawsuits, after consideration of the provisions made for
potential losses and costs of defense, will not be material to the consolidated
financial position of the Company. Nonetheless, given the large or indeterminate
amounts sought in certain of these actions, and the inherent unpredictability of
litigation, it is possible that an adverse outcome in certain matters could,
from time to time, have a material adverse effect on the Company's consolidated
results of operations or cash flows in particular quarterly or annual periods.
Broker Compensation Litigation - On October 14, 2004, the New York Attorney
General's Office filed a civil complaint (the "NYAG Complaint") against Marsh
Inc. and Marsh & McLennan Companies, Inc. (collectively, "Marsh") alleging,
among other things, that certain insurance companies, including The Hartford,
participated with Marsh in arrangements to submit inflated bids for business
insurance and paid contingent commissions to ensure that Marsh would direct
business to them. The Hartford is not joined as a defendant in the action. Since
the filing of the NYAG Complaint, the Company has become aware of several
private actions against it asserting claims arising from the allegations of the
NYAG Complaint.
The Company is aware of two securities class actions filed in the United States
District Court for the District of Connecticut alleging claims against The
Hartford and five of its executive officers under Section 10(b) of the
Securities Exchange Act and SEC Rule 10b-5. The complaints allege on behalf of a
putative class of shareholders that The Hartford and the five named individual
defendants, as control persons of The Hartford, "disseminated false and
misleading financial statements" by concealing that "[The Hartford] was paying
illegal and concealed `contingent commissions' pursuant to illegal `contingent
commission agreements.'" The class period alleged is November 5, 2003 through
October 13, 2004, the day before the NYAG Complaint was filed. The complaints
seek damages and attorneys' fees. The Hartford and the individual defendants
dispute the allegations and intend to defend these actions vigorously.
In addition, the Company is aware of three putative class actions filed in the
same court on behalf of participants in The Hartford's 401(k) plan against The
Hartford, Hartford Fire Insurance Company, The Hartford's Pension Fund Trust and
Investment Committee, The Hartford's Pension Administration Committee, The
Hartford's Chief Financial Officer, and John/Jane Does 1-15. The suits assert
claims under the Employee Retirement Income Security Act of 1974, as amended
("ERISA"), alleging that The Hartford and the other named defendants breached
their fiduciary duties to plan participants by, among other things, failing to
inform them of the risk associated with investment in The Hartford's stock as a
result of the activity alleged in the NYAG Complaint. The class period alleged
is November 5, 2003 through the present. The complaints seek restitution of
losses to the plan, declaratory and injunctive relief, and attorneys' fees. All
defendants dispute the allegations and intend to defend these actions
vigorously.
The Company also is aware of two corporate derivative actions filed in the same
court. The complaints, brought in each case by a shareholder on behalf of The
Hartford against its directors and an executive officer, allege that the
16
defendants knew adverse non-public information about the activities alleged in
the NYAG Complaint and concealed and misappropriated that information to make
profitable stock trades, thereby breaching their fiduciary duties, abusing their
control, committing gross mismanagement, wasting corporate assets, and unjustly
enriching themselves. The complaints seek damages, injunctive relief,
disgorgement, and attorneys' fees. All defendants dispute the allegations and
intend to defend these actions vigorously.
The Company also is aware of an amended complaint filed on or about October 19,
2004 by OptiCare Health Systems, Inc., on behalf of a putative class of
policyholders, against Marsh, other brokers and consultants, and the insurers
named in the NYAG Complaint, including certain of their respective writing
companies. The putative class action was filed in August 2004 in the United
States District Court for the Southern District of New York and originally
asserted only claims against the broker/consultant defendants. The amended
complaint alleges additional claims against both the broker/consultant
defendants and the insurer defendants. These claims include a claim under the
Racketeer Influenced and Corrupt Organizations Act ("RICO") alleging that the
insurer defendants are co-liable with the broker/consultant defendants for
alleged misrepresentations or non-disclosures of contingent commission
agreements and the solicitation or submission of inflated bids. The amended
complaint also asserts claims under the Sherman Act and state antitrust and
unfair competition laws alleging that the insurer defendants acted in concert
with the broker/consultant defendants to restrain trade. The class period
alleged is August 26, 1994 through the date of class certification, which has
not yet occurred. The amended complaint seeks treble damages, injunctive and
declaratory relief, and attorneys' fees. The Hartford disputes the allegations
in the amended complaint and intends to defend the action vigorously.
Additional complaints may be filed against the Company and The Hartford in
various courts alleging claims under federal or state law arising from the
conduct alleged in the NYAG Complaint. The Company's ultimate liability, if any,
in the pending and possible future suits is highly uncertain and subject to
contingencies that are not yet known, such as how many suits will be filed, in
which courts they will be lodged, what claims they will assert, what the outcome
of investigations by the New York Attorney General's Office and other regulatory
agencies will be, the success of defenses that the Company may assert, and the
amount of recoverable damages if liability is established. In the opinion of
management, it is possible that an adverse outcome in one or more of these suits
could have a material adverse effect on the Company's consolidated results of
operations or cash flows in particular quarterly or annual periods.
REGULATORY DEVELOPMENTS
In June 2004, The Hartford received a subpoena from the New York Attorney
General's Office in connection with its inquiry into compensation arrangements
between brokers and carriers. On September 17, 2004, the New York Attorney
General's Office issued two additional subpoenas to The Hartford seeking
information about possible anti-competitive activity among brokers and insurers.
Subsequently, The Hartford has received additional subpoenas from the New York
Attorney General's Office, the Connecticut Attorney General's Office, the
Insurance Division of the Illinois Department of Financial and Professional
Regulation, the Massachusetts Attorney General's Office, the Minnesota
Department of Commerce, the Ohio Attorney General's Office and the Texas
Attorney General's Office regarding broker compensation and possible
anti-competitive activity. The Company and The Hartford may receive additional
subpoenas and other information requests from these or other regulatory agencies
regarding similar issues. The Company and The Hartford intend to continue
cooperating fully with these investigations, and have initiated an internal
review, with the assistance of outside counsel, regarding the issues under
investigation.
On October 14, 2004, the New York Attorney General's Office filed a civil
complaint against Marsh & McLennan Companies, Inc., and Marsh, Inc.
(collectively, "Marsh"). The complaint alleges, among other things, that certain
insurance companies, including The Hartford, participated with Marsh in
arrangements to submit inflated bids for business insurance and paid contingent
commissions to ensure that Marsh would direct business to them. The Hartford is
not joined as a defendant in the action. Although no regulatory action has been
initiated against The Hartford in connection with the allegations described in
the civil complaint, it is possible that the New York Attorney General's Office
or one or more other regulatory agencies may pursue action against The Hartford
or one or more of its employees in the future. The potential timing of any such
action is difficult to predict. If such an action is brought, it could have a
material adverse effect on the Company.
There continues to be significant federal and state regulatory activity relating
to financial services companies, particularly mutual funds companies. These
regulatory inquiries have focused on a number of mutual fund issues. The
Hartford has received requests for information and subpoenas from the Securities
and Exchange Commission ("SEC"), subpoenas from the New York Attorney General's
Office, and requests for information from the Connecticut Securities and
Investments Division of the Department of Banking, in each case requesting
documentation and other information regarding various mutual fund regulatory
issues. The Hartford continues to respond to requests for documents and
information from representatives from the SEC's Office of Compliance Inspections
and Examinations in connection with their ongoing compliance examinations
regarding market timing and late trading, revenue sharing and directed
brokerage, fees, fund service providers and transfer agents, and other mutual
fund-related issues. In addition, the SEC's Division of Enforcement and the New
York Attorney General's Office are investigating aspects of the Company's
variable annuity and mutual fund operations. The SEC's Division of Enforcement
recently commenced an investigation into the Company's use of directed
brokerage. The Hartford continues to cooperate fully with the SEC, the New York
Attorney General's Office and other regulatory agencies.
The Company's mutual funds are available for purchase by the separate accounts
of different variable life insurance policies, variable annuity products, and
funding agreements, and they are offered directly to certain qualified
retirement plans. Although existing products contain transfer restrictions
between subaccounts, some products, particularly older variable annuity
products, do not contain restrictions
17
on the frequency of transfers. In addition, as a result of the settlement of
litigation against the Company with respect to certain owners of older variable
annuity products, the Company's ability to restrict transfers by these owners is
limited.
A number of companies have announced settlements of enforcement actions with
various regulatory agencies, primarily the SEC and the New York Attorney
General's Office, which have included a range of monetary penalties and
restitution. While no such action has been initiated against the Company, it is
possible that the SEC, the New York Attorney General's Office or other
regulatory agencies may pursue action against the Company in the future. The
potential timing of any such action is difficult to predict. If such an action
is brought, it could have a material adverse effect on the Company.
TAX MATTERS
The Company's Federal income tax returns are routinely audited by the Internal
Revenue Service ("IRS"). During the third quarter of 2004, the IRS completed its
examination of the 1998-2001 tax years, and the IRS and the Company have agreed
upon all adjustments. As a result, during the third quarter of 2004 the Company
booked a $190 tax benefit to reflect the impact of the audit settlement on tax
years prior to 2004. The benefit relates primarily to the separate account
dividends-received deduction ("DRD") and interest. (For further discussion of
the Company's separate account DRD, see Note 16 of Notes to Consolidated
Financial Statements included in the Company's 2003 Form 10-K Annual Report.)
Management believes that adequate provision has been made in the financial
statements for any potential assessments that may result from future tax
examinations and other tax-related matters for all open tax years.
9. DEBT
SHORT-TERM DEBT September 30, 2004 December 31, 2003
Related Party Debt $ -- $ 305
Current maturities of long-term debt -- 200
TOTAL SHORT-TERM DEBT $ -- $ 505
LONG -TERM DEBT September 30, 2004 December 31, 2003
7.10% Notes, due 2007 $ 200 $ 200
7.65% Notes, due 2027 250 250
7.375% Notes, due 2031 400 400
JUNIOR SUBORDINATED DEBENTURES
7.20% Notes, due 2038 -- 250
7.625% Notes, due 2050 200 200
TOTAL LONG-TERM DEBT $ 1,050 $1,300
On January 30, 2004, the Company received a capital contribution in the form of
cash of $305 from The Hartford which was used by the Company to fund the payment
and settlement of the related party note agreements totaling $305 with The
Hartford.
In March 2004, the Company received a capital contribution of $200 from The
Hartford which was used, with additional available cash, to redeem, at par, on
March 15, 2004, $250 million aggregate principal amount of its 7.20 percent
Junior Subordinated Deferrable Interest Debentures, due June 30, 2038,
underlying the 7.20 percent Trust Preferred Securities, Series A, originally
issued by Hartford Life Capital Trust I. The redemption price was $25 per share,
plus accumulated and unpaid distributions thereon to March 15, 2004, in the
amount of $0.30 per share. The Company recorded a $7, before-tax, expense for
the unamortized costs associated with these preferred securities in the first
quarter of 2004.
On June 15, 2004, the Company received a capital contribution of $100 from The
Hartford which was used, with additional available cash, to repay $200 of 6.9%
senior notes at maturity.
SHELF REGISTRATION
On May 15, 2001, the Company filed with the SEC a shelf registration statement
(Registration No. 333-60944) for the potential offering and sale of up to $1.0
billion in debt and preferred securities. The registration statement was
declared effective on May 29, 2001. As of September 30, 2004, the Company had
$1.0 billion remaining on its shelf.
JUNIOR SUBORDINATED DEBENTURES
The Hartford and the Company have formed statutory business trusts ("The
Hartford Trusts "), which exist for the exclusive purposes of (i) issuing Trust
Securities representing undivided beneficial interests in the assets of the
Trust; (ii) investing the gross proceeds of the Trust Securities in Junior
Subordinated Deferrable Interest Debentures ("Junior Subordinated Debentures")
of The Hartford or the
18
Company; and (iii) engaging in only those activists necessary or incidental
thereto. The Hartford may enter into guarantees with respect to the preferred
securities of any of The Hartford Trusts.
COMMERCIAL PAPER
Hartford Life has a commercial paper program, which allows it to borrow up to a
maximum amount of $250 in short-term commercial paper notes. In addition, the
Company's Japanese subsidiary, Hartford Life Insurance KK, has an $18 line of
credit with a Japanese bank. As of September 30, 2004, the Company had no
outstanding borrowings under either facility.
10. TRANSACTIONS WITH AFFILIATES
For a description of transactions with affiliates, see Note 15 of Notes to
Consolidated Financial Statements included in Hartford Life's 2003 Form 10-K
Annual Report.
19
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
(Dollar amounts in millions, unless otherwise stated)
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") addresses the financial condition of Hartford Life, Inc. and
its subsidiaries ("Hartford Life" or the "Company") as of September 30, 2004,
compared with December 31, 2003, and its results of operations for the third
quarter and nine months ended September 30, 2004 compared with the equivalent
period in 2003. This discussion should be read in conjunction with the MD&A
included in the Company's 2003 Form 10-K Annual Report.
Certain of the statements contained herein are forward-looking statements. These
forward-looking statements are made pursuant to the safe harbor provisions of
the Private Securities Litigation Reform Act of 1995 and include estimates and
assumptions related to economic, competitive and legislative developments. These
forward-looking statements are subject to change and uncertainty which are, in
many instances, beyond the Company's control and have been made based upon
management's expectations and beliefs concerning future developments and their
potential effect upon the Company. There can be no assurance that future
developments will be in accordance with management's expectations or that the
effect of future developments on the Company will be those anticipated by
management. Actual results could differ materially from those expected by the
Company, depending on the outcome of various factors. These factors include: the
possible occurrence of terrorist attacks; the response of reinsurance companies
under reinsurance contracts and the availability, pricing and adequacy of
reinsurance to protect the Company against losses; changes in the stock markets,
interest rates or other financial markets, including the potential effect on the
Company's statutory capital levels; the inability to effectively mitigate the
impact of equity market volatility on the Company's financial position and
results of operations arising from obligations under annuity product guarantees;
the difficulty in predicting the Company's potential exposure arising out of
regulatory proceedings or private claims relating to incentive compensation or
payments made to brokers and alleged anti-competitive conduct; the uncertain
effect on the Company of regulatory and market-driven changes in practices
relating to the payment of incentive compensation to brokers and other
distribution intermediaries, including changes that have been announced and
those which may occur in the future; the uncertain effect on the Company of the
Jobs and Growth Tax Relief Reconciliation Act of 2003, in particular the
reduction in tax rates on long-term capital gains and most dividend
distributions; the possibility of more unfavorable loss experience than
anticipated; stronger than anticipated competitive activity; unfavorable
judicial or legislative developments, including the possibility that the
Terrorism Risk Insurance Act of 2002 is not extended beyond 2005; the potential
effect of domestic and foreign regulatory developments, which could increase the
Company's business costs and required capital levels; the possibility of general
economic and business conditions that are less favorable than anticipated; the
Company's ability to distribute its products through distribution channels, both
current and future; the uncertain effects of emerging claim and coverage issues;
the effect of assessments and other surcharges for guaranty funds; a downgrade
in the Company's claims-paying, financial strength or credit ratings; the
ability of the Company's subsidiaries to pay dividends to the Company; and other
factors described in such forward-looking statements.
Certain reclassifications have been made to prior year financial information to
conform to the current year presentation.
INDEX
Critical Accounting Estimates 20
Consolidated Results of Operations - Operating Summary 22
Retail Products Group 24
Institutional Solutions Group 25
Individual Life 26
Group Benefits 27
Investments 27
Investment Credit Risk 31
Capital Markets Risk Management 36
Capital Resources and Liquidity 37
Accounting Standards 42
CRITICAL ACOUNTING ESTIMATES
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States of America ("GAAP"), requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
The Company has identified the following estimates as critical in that they
involve a higher degree of judgment and are subject to a significant degree of
variability: deferred policy acquisition costs and present value of future
profits; investments; reserves and contingencies. In developing these estimates
management makes subjective and complex judgments that are inherently uncertain
and
20
subject to material change as facts and circumstances develop. Although
variability is inherent in these estimates, management believes the amounts
provided are appropriate based upon the facts available upon compilation of the
financial statements.
DEFERRED POLICY ACQUISITION COSTS AND PRESENT VALUE OF FUTURE PROFITS
Policy acquisition costs, which include commissions and certain other expenses
that vary with and are primarily associated with acquiring business, are
deferred and amortized over the estimated lives of the contracts, usually 20
years. These deferred costs, together with the present value of future profits
of acquired business, are recorded as an asset commonly referred to as deferred
policy acquisition costs and present value of future profits ("DAC"). At
September 30, 2004 and December 31, 2003, the carrying value of the Company's
DAC was $7.1 billion and $6.6 billion, respectively. For statutory accounting
purposes, such costs are expensed as incurred.
The Company has developed sophisticated modeling capabilities to evaluate its
DAC asset, which allowed it to run a large number of stochastically determined
scenarios of separate account fund performance. These scenarios were then
utilized to calculate a statistically significant range of reasonable estimates
of gross profits or "EGPs". This range was then compared to the present value of
EGPs currently utilized in the DAC amortization model. As of September 30, 2004,
the present value of the EGPs utilized in the DAC amortization model falls
within a reasonable range of statistically calculated present value of EGPs. As
a result, the Company does not believe there is evidence to suggest that a
revision to the EGPs (and therefore, a revision to the DAC) as of September 30,
2004 is necessary; however, if in the future the EGPs utilized in the DAC
amortization model were to exceed the margin of the reasonable range of
statistically calculated EGPs, a revision could be necessary. Furthermore, the
Company has estimated that the present value of the EGPs is likely to remain
within a reasonable range if overall separate account returns decline by 30% or
less from September 30 levels for the balance of 2004, or 20% or less over the
next twelve months, and if certain other assumptions that are implicit in the
computations of the EGPs are achieved. For further discussion of these
assumptions, see the Critical Accounting Estimates section of the Company's 2003
Form 10-K Annual Report under the heading "Deferred Policy Acquisition Costs and
Present Value of Future Profits".
Additionally, the Company continues to perform analyses with respect to the
potential impact of a revision to future EGPs. If such a revision to EGPs were
deemed necessary, the Company would adjust, as appropriate, all of its
assumptions for products accounted for in accordance with Statement of Financial
Accounting Standards No. 97, "Accounting and Reporting by Insurance Enterprises
for Certain Long-Duration Contracts and for Realized Gains and Losses from the
Sale of Investments", and reproject its future EGPs based on current account
values at the end of the quarter in which a revision is deemed to be necessary.
To illustrate the effects of this process, assume the Company had concluded that
a revision of the Company's EGPs was required at September 30, 2004. If the
Company assumed a 9% average long-term rate of growth from September 30, 2004
forward along with other appropriate assumption changes in determining the
revised EGPs, the Company estimates the cumulative increase to amortization
would be approximately $40-$50 after-tax. If instead the Company were to assume
a long-term growth rate of 8% in determining the revised EGPs, the adjustment
would be approximately $75-80, after-tax. Assuming that such an adjustment were
to have been required, the Company anticipates that there would have been
immaterial impacts on its DAC amortization for the 2004 and 2005 years exclusive
of the adjustment, and that there would have been positive earnings effects in
later years. Any such adjustment would not affect statutory income or surplus,
due to the prescribed accounting for such amounts that is discussed above.
The overall recoverability of the DAC asset is dependent on the future
profitability of the business. The Company tests the aggregate recoverability of
the DAC asset by comparing the amounts deferred to the present value of total
EGPs. In addition, the Company routinely stress tests its DAC asset for
recoverability against severe declines in its separate account assets, which
could occur if the equity markets experienced another significant sell-off, as
the majority of policyholders' funds in the separate accounts is invested in the
equity market. As of September 30, 2004, the Company believed variable annuity
separate account assets could fall by at least 45% before portions of its DAC
asset would be unrecoverable.
OTHER CRITICAL ACCOUNTING ESTIMATES
There have been no material changes to the identification of Company's critical
accounting estimates regarding reserves for future policy benefits and other
policyholder funds; investments; and commitments and contingencies since the
filing of the Company's 2003 Form 10-K Annual Report.
21
CONSOLIDATED RESULTS OF OPERATIONS
ORGANIZATIONAL STRUCTURE
The Company has changed its reportable operating segments from Investment
Products, Individual Life, Group Benefits and Corporate Owned Life Insurance
("COLI") to Retail Products Group ("Retail"), Institutional Solutions Group
("Institutional"), Individual Life and Group Benefits. Retail offers individual
variable and fixed annuities, mutual funds, retirement plan products and
services to corporations under Section 401(k) plans and other investment
products. Institutional primarily offers retirement plan products and services
to municipalities under Section 457 plans, other institutional investment
products and private placement life insurance. Individual Life sells a variety
of life insurance products, including variable universal life, universal life,
interest sensitive whole life and term life insurance. Group Benefits sells
group insurance products, including group life and group disability insurance as
well as other products, including medical 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. The Company also includes, in an Other category, its international
operations, which are primarily located in Japan and Brazil; net realized
capital gains and losses other than periodic net coupon settlements on
non-qualifying derivatives and net realized capital gains and losses related to
guaranteed minimum withdrawal benefits; corporate items not directly allocated
to any of its reportable operating segments; and intersegment eliminations.
Periodic net coupon settlements on non-qualifying derivatives and net realized
capital gains and losses related to guaranteed minimum withdrawal benefits are
reflected in each applicable segment in net realized capital gains and losses.
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------------- ---------------------------------
OPERATING SUMMARY 2004 2003 CHANGE 2004 2003 CHANGE
- ----------------------------------------------------- --------- ---------- ------ --------- -------- --------
Earned premiums $ 1,058 $ 981 8% $ 3,023 $ 2,370 28%
Fee income 805 716 12% 2,381 1,989 20%
Net investment income [1] 611 512 19% 2,670 1,519 76%
Other revenues - 35 (100%) - 99 (100%)
Net realized capital gains 28 4 NM 130 19 NM
--------- ---------- ---- --------- -------- ----
TOTAL REVENUES 2,502 2,248 11% 8,204 5,996 37%
--------- ---------- ---- --------- -------- ----
Benefits, claims and claim adjustment expenses [1] 1,325 1,375 (4%) 4,733 3,544 34%
Amortization of deferred policy acquisition costs and
present value of future profits 236 202 17% 702 540 30%
Insurance operating costs and other expenses 525 444 18% 1,566 1,197 31%
Interest expense 20 29 (31%) 77 87 (11%)
--------- ---------- ---- --------- -------- ----
TOTAL BENEFITS, CLAIMS AND EXPENSES 2,106 2,050 3% 7,078 5,368 32%
--------- ---------- ---- --------- -------- ----
INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT
OF ACCOUNTING CHANGE 396 198 100% 1,126 628 79%
Income tax (benefit) expense (103) 37 NM 91 98 (7%)
--------- ---------- ---- --------- -------- ----
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE
499 161 NM 1,035 530 95%
Cumulative effect of accounting change, net of tax [2] - - - (23) - -
--------- ---------- ---- --------- -------- ----
NET INCOME $ 499 $ 161 NM $ 1,012 $ 530 91%
========= ========== ==== ========= ======== ====
[1] With the adoption of SOP 03-1, certain annuity products were required to
be accounted for in the general account. This change in accounting
resulted in increases of $40 and $988 in net investment income and a
(decrease) increase of ($18) and $836 in benefits, claims and claim
adjustment expenses for the third quarter and nine months ended September
30, 2004, respectively.
[2] For the nine months ended September 30, 2004, represents the cumulative
impact of the Company's adoption of SOP 03-1.
Hartford Life defines "NM" as not meaningful for increases or decreases greater
than 200%, or changes from a net gain to a net loss position, or vice versa.
The Company's net income increased for the third quarter of 2004 compared to
2003 due primarily to lower income tax expense, increases in net income in all
lines of business and higher net realized capital gains. (See the Investments
section for further discussion of investment results and related realized
capital gains.) During the third quarter of 2004, the Internal Revenue Service
completed its examination of the 1998-2001 tax years. (For further discussion
see Note 8 of Notes to Condensed Consolidated Financial Standards under Tax
Matters). The Company recorded in the third quarter of 2004 an after-tax benefit
of $190, consisting primarily of a change in estimate of the dividends received
deduction ("DRD") tax benefit reported during 2003 and prior years and interest,
and changed the estimate of the after-tax benefit for the DRD benefit related to
the 2004 tax year. As a result of this change in estimate approximately $20 of
additional DRD benefit was recorded in the third quarter ended September 30,
2004 to reflect the change in estimate applicable to the first three quarters of
2004.
22
Net income in the Institutional segment was higher for the third quarter ended
September 30, 2004 as a result of a decrease in other expenses related to
private placement life insurance business compared to the respective prior year
period. The decrease in other expenses for the current year period is attributed
to a $40 after-tax charge, recorded in the third quarter ended September 30,
2003, associated with the settlement of the Bancorp Services, LLC ("Bancorp")
litigation. Net income in the Retail segment increased, principally driven by
growth in the variable annuity and mutual fund businesses as a result of
increasing assets under management. Partially offsetting the increase in the
Retail segment was lower spread income on market value adjusted ("MVA") fixed
annuities due to the adoption of SOP 03-1. Net income in the Group Benefits
segment increased due primarily to increased earned premiums and net investment
income growth, primarily resulting from the Company's acquisition of the group
life and accident, and short-term and long-term disability businesses of CNA
Financial Corporation ("CNA Acquisition"). In addition, the Group Benefits
segment was favorably impacted by a lower benefit ratio in the group life line.
Additionally, net income was higher for Individual Life and the international
operations. The increase in Individual Life earnings was primarily driven by
higher net investment income including the effects of prepayments, growth in
account values and life insurance in force. Net income for the international
operations, which is included in the other category, increased over the
comparable prior year period primarily driven by the increase in assets under
management of the Japan annuity business. Japan's assets under management have
grown to $11.1 billion at September 30, 2004 from $4.8 billion at September 30,
2003. During the quarter, the Company has also introduced MVA fixed annuity
products to provide a diversified product portfolio to customers in Japan.
For the nine months ended September 30, 2004 compared to 2003, net income
increased primarily due to higher net income in the Retail segment, Group
Benefits segment, Institutional segment and international operations as
discussed in the previous paragraph, higher net realized capital gains, and a
lower effective tax rate. The effective tax rate was 8% for the nine months
ended September 30, 2004 as compared to an effective tax rate of 16% for the
respective prior year period. The lower effective tax rate for the nine months
ended September 30, 2004 was attributed to tax related items, as discussed
above, of $190 and a year to date 2004 tax year benefit of $85, as compared to
tax related items of $30 and a year to date 2003 tax year DRD benefit of $65
reported for the nine months ended September 30, 2003, respectively. Partially
offsetting the positive earnings drivers for the nine months ended September 30,
2004 was the cumulative effect of accounting change from the Company's adoption
of SOP 03-1. The adoption of SOP 03-1 also resulted in certain changes in
presentation in the Company's financial statements, including reporting of the
spreads on the Company's MVA fixed annuities and variable annuity products
offered in Japan on a gross basis in net investment income and benefits expense.
Exclusive of the cumulative effect, overall application of SOP 03-1 resulted in
an immaterial reduction in net income. (For further discussion of the impact of
the Company's adoption of SOP 03-1, see Note 1 of Notes to Condensed
Consolidated Financial Statements).
As the Company has disclosed previously, The Hartford pays brokers and
independent agents commissions and other forms of incentive compensation in
connection with the sale of many of the Company's insurance products. Since the
New York Attorney General's Office filed a civil complaint against Marsh &
McLennan Companies, Inc. and Marsh, Inc. (collectively, "Marsh") on October 14,
2004, several of the largest national insurance brokers, including Marsh, have
announced their intention to discontinue the use of incentive compensation
arrangements. Other industry participants may make similar, or different,
determinations in the future. In addition, new regulations may require changes
to industry practices relating to incentive compensation. At this time, it is
not possible to predict the effect of these announced or potential changes on
the Company's business or distribution strategies.
23
RETAIL PRODUCTS GROUP
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ----------------------------------
OPERATING SUMMARY 2004 2003 CHANGE 2004 2003 CHANGE
- --------------------------------------------------------- ------ ------ ------ -------- -------- ------
Fee income and other $ 521 $ 448 16% $ 1,540 $ 1,213 27%
Earned premiums 50 (10) NM 19 (18) NM
Net investment income 272 125 118% 810 370 119%
Net realized capital (losses) gains (1) 3 NM - 12 (100%)
------ ------ ---- -------- -------- -----
TOTAL REVENUES 842 566 49% 2,369 1,577 50%
------ ------ ---- -------- -------- -----
Benefits, claims and claim adjustment expenses 336 140 140% 852 440 94%
Amortization of deferred policy acquisition costs
and present value of future profits 159 139 14% 486 356 37%
Insurance operating costs and other expenses 189 153 24% 544 434 25%
------ ------ ---- -------- -------- -----
TOTAL BENEFITS, CLAIMS AND EXPENSES 684 432 58% 1,882 1,230 53%
------ ------ ---- -------- -------- -----
INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF
ACCOUNTING CHANGE 158 134 18% 487 347 40%
Income tax expense 18 27 (33%) 93 42 121%
------ ------ ---- -------- -------- -----
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE
140 107 31% 394 305 29%
Cumulative effect of accounting change, net of tax [1] - - - (19) - -
------ ------ ---- -------- -------- -----
NET INCOME $ 140 $ 107 31% $ 375 $ 305 23%
------ ------ ---- -------- -------- -----
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 CHANGE
------------- ------------- ------
Individual variable annuity account values $ 92,079 $ 77,572 19%
Other individual annuity account values 11,471 10,939 5%
401K and specialty products account values 5,926 4,074 45%
---------- ---------- ----
TOTAL ACCOUNT VALUES [2] 109,476 92,585 18%
Retail mutual fund assets under management 22,694 17,208 32%
Other mutual fund assets under management 1,204 801 50%
---------- ---------- ----
TOTAL MUTUAL FUND ASSETS UNDER MANAGEMENT 23,898 18,009 33%
---------- ---------- ----
TOTAL ASSETS UNDER MANAGEMENT $ 133,374 $ 110,594 21%
---------- ---------- ----
S&P 500 INDEX VALUE AT END OF PERIOD 1,115 996 12%
========== ========== ====
[1] For the nine months ended September 30, 2004, represents the cumulative
impact of the Company's adoption of SOP 03-1.
[2] Includes policyholder balances for investment contracts and reserves for
future policy benefits for insurance contracts.
Net income in the Retail segment increased for the third quarter and nine months
ended September 30, 2004, principally driven by significant growth in the assets
under management within the variable annuity and mutual fund businesses. The
Company uses assets under management as an internal performance measure.
Relative profitability of the Retail segment is highly correlated to the growth
in assets under management since the segment generally earns fee income on a
daily basis on its assets under management. Assets under management are driven
by the performance of the equity markets and net flows. Net flows are comprised
of new sales less surrenders, death benefits and annuitizations of variable
annuity contracts. In the mutual fund business, net flows are known as net
sales. Net sales are comprised of new sales less redemptions of mutual fund
customers.
Fee income generated by the variable annuity operation increased, as average
account values were higher in the third quarter and nine months ended September
30, 2004 compared to the respective prior year periods. The increase in average
account values can be attributed to market appreciation of $8.0 billion and net
flows of $6.5 billion over the past four quarters. The Company uses the S&P 500
Index as an indicator for evaluating market returns of the underlying account
portfolios, more specifically the average daily value of the S&P 500, which rose
by approximately 10% from September 30, 2003 to September 30, 2004. Another
contributing factor to the increase in fee income was the mutual fund business.
Retail mutual fund assets under management increased 32% principally due to net
sales of $3.1 billion and market appreciation of $2.5 billion over the past four
quarters.
Additionally, for the third quarter ended September 30, 2004, the segment
experienced a lower effective tax rate, primarily attributed to additional DRD
benefit of $18 recorded in the third quarter ended September 30, 2004 to reflect
the change in estimate applicable to the first three quarters of 2004. The
effective tax rate for the third quarter ended September 30, 2004 was 11% as
compared to 20% for the comparable prior year period.
Partially offsetting the positive earnings drivers discussed above was a
decrease in net income in the individual fixed annuity business and higher
amortization of deferred policy acquisition costs for the third quarter and nine
months ended September 30, 2004 as
24
compared to the respective prior year periods. The decrease in net income in the
individual fixed annuity business was attributed to a lower investment spread
from the MVA fixed annuity product for the third quarter and nine months ended
September 30, 2004 as compared to the comparable prior year periods. In
addition, with the adoption of SOP 03-1, the Company includes the investment
return from the product in net investment income and includes interest credited
to contract holders in the benefits, claims and claim adjustment expenses line
in the operating summary rather than reporting the net spread in fee income and
other. The resulting cumulative effect of the accounting change from the
Company's adoption of SOP 03-1 recorded in the first quarter of 2004 also
provided an offset to the positive earnings growth for the nine months ended
September 30, 2004. Additionally, income tax expense was higher for the nine
months ended September 30, 2004 due primarily to higher income earned by the
segment and the $20 tax benefit recorded in the second quarter of 2003 related
to the change in estimate of the DRD reported during 2002. This increase was
largely offset by a higher DRD tax benefit of $77 related to the 2004 tax year
reported for the nine months ended September 30, 2004, as discussed above, as
compared to the DRD tax benefit of $59 related to the 2003 tax year reported in
the comparable prior year period.
INSTITUTIONAL SOLUTIONS GROUP
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- --------------------------------
OPERATING SUMMARY 2004 2003 CHANGE 2004 2003 CHANGE
- ------------------------------------------------------------ ------ ------ ------ -------- -------- ------
Fee income and other $ 77 $ 75 3% $ 227 $ 231 (2%)
Earned premiums 100 403 (75%) 304 645 (53%)
Net investment income 269 252 7% 788 740 6%
Net realized capital gains 2 3 (33%) 5 9 (44%)
------ ------ --- -------- -------- ---
TOTAL REVENUES 448 733 (39%) 1,324 1,625 (19%)
------ ------ --- -------- -------- ---
Benefits, claims and claim adjustment expenses 363 645 (44%) 1,075 1,354 (21%)
Amortization of deferred policy acquisition costs
and present value of future profits 9 6 50% 28 19 47%
Insurance operating costs and other expenses 29 98 (70%) 93 182 (49%)
------ ------ --- -------- -------- ---
TOTAL BENEFITS, CLAIMS AND EXPENSES 401 749 (46%) 1,196 1,555 (23%)
------ ------ --- -------- -------- ---
INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF
ACCOUNTING CHANGE 47 (16) NM 128 70 83%
Income tax expense (benefit) 14 (8) NM 38 18 111%
------ ------ --- -------- -------- ---
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE 33 (8) NM 90 52 73%
Cumulative effect of accounting change, net of tax [1] - - - (1) - -
------ ------ --- -------- -------- ---
NET INCOME $ 33 $ (8) NM $ 89 $ 52 71%
====== ====== === ======== ======== ===
SEPTEMBER 30, SEPTEMBER 30,
2004 2003 CHANGE
------------ ------------ ------
Institutional account values $ 14,011 $ 11,902 18%
Governmental account values 9,437 8,319 13%
Private Placement Life Insurance account values
Variable products 21,889 20,557 6%
Leveraged COLI 2,520 2,602 (3%)
---------- ---------- ----
TOTAL ACCOUNT VALUES [2] 47,857 43,380 10%
Mutual fund assets under management 1,300 891 46%
---------- ---------- ----
TOTAL ASSETS UNDER MANAGEMENT $ 49,157 $ 44,271 11%
========== ========== ====
[1] For the nine months ended September 30, 2004, represents the cumulative
impact of the Company's adoption of SOP 03-1.
[2] Includes policyholder balances for investment contracts and reserves for
future policy benefits for insurance contracts.
Net income for the third quarter and nine months ended September 30, 2004
increased primarily due to decreases in other expenses related to private
placement life insurance business compared to the respective prior year periods.
The decrease in other expenses for the current year period is attributed to a
$40 after-tax charge, recorded in the third quarter ended September 30, 2003,
associated with the settlement of the Bancorp litigation. In addition, the
governmental business contributed higher income for the third quarter and nine
months ended September 30, 2004. This increase was primarily attributable to
higher revenues earned from the growth in the average account values as a result
of positive net flows and market appreciation since the third quarter of 2003.
Partially offsetting this increase in net income for the third quarter and nine
months ended September 30, 2004 was lower income from the institutional
business, which includes structured settlements and institutional annuities.
Lower net income in the institutional business was due primarily to lower spread
income as a result of the lower interest rates and slightly higher insurance
operating costs for the third quarter and nine months ended September 30, 2004
as compared to the respective prior year periods. In addition, the institutional
business reported lower earnings for the third quarter and nine months ended
September 30, 2004 compared to the same periods in 2003 due to favorable
mortality experience in 2003. Private placement life insurance also experienced
lower revenues earned for the third quarter and nine months ended September 30,
2004 as compared to the prior year periods due to the declining leveraged COLI
account values, which
25
resulted from surrenders that occurred in 2003. Additionally, income tax expense
was higher for the nine months ended September 30, 2004 due primarily to
decreases in other expenses related to the private placement life insurance
business, as discussed above. This increase in income tax expense was partially
offset by a higher DRD tax benefit of $4 related to the 2004 tax year reported
for the nine months ended September 30, 2004, as discussed above, as compared to
the DRD tax benefit of $3 related to the 2003 tax year reported in the
comparable prior year period.
INDIVIDUAL LIFE
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------------- -----------------------------
OPERATING SUMMARY 2004 2003 CHANGE 2004 2003 CHANGE
- ----------------- --------- --------- ------ --------- ------ -------
Fee income and other $ 190 $ 190 - $ 557 $ 556 -
Earned premiums (6) (4) (50%) (16) (14) 14%
Net investment income 78 63 24% 227 192 18%
Net realized capital gains (losses) 1 - 100% 1 (1) NM
--------- --------- --- --------- -------- --
TOTAL REVENUES 263 249 6% 769 733 5%
--------- --------- --- --------- -------- --
Benefits, claims and claim adjustment expenses 115 117 (2%) 360 337 7%
Amortization of deferred policy acquisition costs and
present value of future profits 43 42 2% 122 131 (7%)
Insurance operating costs and other expenses 41 38 8% 120 116 3%
--------- --------- --- --------- -------- --
TOTAL BENEFITS, CLAIMS AND EXPENSES 199 197 1% 602 584 3%
--------- --------- --- --------- -------- --
INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF
ACCOUNTING CHANGE 64 52 23% 167 149 12%
Income tax expense 20 16 25% 52 45 16%
--------- --------- --- --------- -------- --
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE 44 36 22% 115 104 11%
Cumulative effect of accounting change, net of tax [1] - - - (1) - -
--------- --------- --- --------- -------- --
NET INCOME $ 44 $ 36 22% $ 114 $ 104 10%
--------- --------- --- --------- -------- --
Variable life account values $ 4,860 $ 4,284 13%
Total account values $ 8,943 $ 8,247 8%
--------- -------- --
Variable life insurance in force $ 68,051 $ 66,561 2%
Total life insurance in force $ 136,686 $128,462 6%
========= ======== ==
[1] For the nine months ended September 30, 2004, represents the cumulative
impact of the Company's adoption of SOP 03-1.
Net income in the Individual Life segment increased for the third quarter and
nine months ended September 30, 2004 as compared to the respective prior year
periods. These increases were primarily driven by higher net investment income
due to prepayments on bonds, growth in account values and life insurance in
force and reserve refinements. Net investment income increased for the third
quarter and nine months ended September 30, 2004 as compared to the prior year
periods primarily due to the adoption of SOP 03-1 and prepayments on bonds. The
adoption of SOP 03-1 also resulted in an increase in benefits, claims and claim
adjustment expenses and a decrease to fee income and other for the third quarter
and nine months ended September 30, 2004 as compared to the respective prior
year periods for the segment's Modified Guarantee Life Insurance product, which
was formerly classified as a separate account product. For the third quarter
ended September 30, 2004, the impact of SOP 03-1 on benefits, claims and claim
adjustment expenses was more than offset by lower mortality and morbidity costs.
The increase in overall benefits, claims and claim adjustment expenses for the
nine months ended September 30, 2004 also reflects higher mortality costs.
Increased insurance operating costs and expenses for the quarter and year to
date over the same periods last year reflect the impact of business growth.
Additionally, income tax expense was higher for the nine months ended September
30, 2004 due primarily to earnings growth, as discussed above. This increase in
income tax expense was partially offset by a higher DRD tax benefit of $4
related to the 2004 tax year reported for the nine months ended September 30,
2004, as discussed above, as compared to the DRD tax benefit of $3 related to
the 2003 tax year reported in the comparable prior year period.
26
GROUP BENEFITS
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
-------------------------- ---------------------------
OPERATING SUMMARY 2004 2003 CHANGE 2004 2003 CHANGE
- ----------------- ------- ------- ---- ------- ------- ------
Earned premiums and other $ 914 $ 597 53% $ 2,735 $ 1,772 54%
Net investment income 95 66 44% 277 198 41%
Net realized capital gains - - - 1 (2) NM
------- ------- ---- ------- ------- ----
TOTAL REVENUES 1,009 663 52% 3,013 1,968 53%
------- ------- ---- ------- ------- ----
Benefits, claims and claim adjustment expenses 671 472 42% 2,045 1,412 45%
Amortization of deferred policy acquisition costs 7 4 75% 18 13 38%
and present value of future profits
Insurance operating costs and other expenses 234 137 71% 726 406 79%
------- ------- ---- ------- ------- ----
TOTAL BENEFITS, CLAIMS AND EXPENSES 912 613 49% 2,789 1,831 52%
------- ------- ---- ------- ------- ----
INCOME BEFORE INCOME TAXES 97 50 94% 224 137 64%
Income tax expense 27 12 125% 59 30 97%
------- ------- ---- ------- ------- ----
NET INCOME $ 70 $ 38 84% $ 165 $ 107 54%
------- ------- ---- ------- ------- ----
Fully insured-ongoing premiums $ 904 $ 581 56% $ 2,706 $ 1,717 58%
Buyout premiums 1 11 (91%) 1 40 (98%)
Other 9 5 80% 28 15 87%
------- ------- ---- ------- ------- ----
Earned premiums and other $ 914 $ 597 53% $ 2,735 $ 1,772 54%
======= ======= ==== ======= ======= ====
Net income in the Group Benefits segment increased for the third quarter and
nine months ended September 30, 2004 as compared to the respective prior year
periods due to earned premium growth and net investment income growth, both in
the pre-acquisition Group Benefits business as well as the result of the CNA
Acquisition. The increase in earned premiums was driven by sales (excluding
buyouts) of $552 for the nine months ended September 30, 2004, representing an
increase of 33% over sales reported in the comparable prior year period, and
favorable persistency. Although benefits, claims and claim adjustment expenses
increased, the segment's loss ratio (defined as benefits, claims and claim
adjustment expenses as a percentage of premiums and other considerations
excluding buyouts) was 73% and 75% for the third quarter and nine months ended
September 30, 2004, respectively, down from 79% for both the comparable periods
of 2003, which contributed favorably to net income. The unusually low loss ratio
for the quarter was the result of improved mortality experience, as well as
favorable development in premium waiver reserves. Based on historical experience
trends and variability in the Group Benefits business, management expects the
loss ratio in future periods to be higher than 73%. Partially offsetting these
favorable items for the nine months ended September 30, 2004 as compared to the
prior year period were higher commissions due to higher sales and premiums
previously discussed. Additionally, operating costs increased due to the growth
in the segment and the CNA Acquisition. Consistent with the increase in
operating costs, the segment's ratio of insurance operating costs and other
expenses to premiums and other considerations (excluding buyouts) increased to
26% and 27% for the third quarter and nine months ended September 30, 2004,
respectively, from 24% for both the comparable prior year periods. As part of
the CNA Acquisition, a larger block of affinity business is now included in the
Group Benefits segment. This business typically has lower expected loss ratios
and higher expected commission ratios than other products within the business.
Due to this change in business mix in 2004, the segment, as expected, has a
lower loss ratio and higher commission ratio than in 2003.
INVESTMENTS
GENERAL
Hartford Life's investment portfolios are managed based on the underlying
characteristics and nature of each operating segment's respective liabilities
and within established risk parameters. (For further discussion of Hartford
Life's approach to managing risks, see the Investment Credit Risk section.)
Hartford Life's investment portfolios are managed by Hartford Investment
Management Company and its affiliates ("Hartford Investment Management"), a
wholly-owned subsidiary of The Hartford. Hartford Investment Management is
responsible for monitoring and managing the asset/liability profile,
establishing investment objectives and guidelines, and determining, within
specified risk tolerances and investment guidelines, the appropriate asset
allocation, duration, convexity and other characteristics of the portfolios.
Security selection and monitoring are performed by asset class specialists
working within dedicated portfolio management teams.
Pursuant to the adoption of SOP 03-1, as discussed in Note 7 of Notes to
Condensed Consolidated Financial Statements, on January 1, 2004, the Company
reclassified $17.9 billion of separate account assets to the general account. Of
this amount, $11.7 billion was associated with guaranteed separate accounts and
was primarily comprised of fixed maturities. These assets are classified as
available-for-sale securities with changes in fair value reported in other
comprehensive income. The remaining $6.2 billion is primarily comprised of
equity securities related to variable annuity products offered in Japan. These
assets are classified as trading securities with changes in fair value reported
in net investment income.
27
Return on invested assets is an important element of the Company'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. Net investment income and net realized capital gains accounted
for 26% and 23% of the Company's consolidated revenues for the third quarter
ended September 30, 2004 and 2003, respectively. For the nine months ended
September 30, 2004 and 2003, net investment income and net realized capital
gains accounted for approximately 34% and 26%, respectively, of the Company's
consolidated revenues. The increase in the percentage of consolidated revenues
for the third quarter and nine months ended September 30, 2004, as compared to
the respective prior year periods, is primarily due to income earned on separate
account assets reclassified to the general account as a result of the adoption
of SOP 03-1.
Fluctuations in interest rates and credit spreads affect the Company's return
on, and the fair value of, fixed maturity investments, which comprised
approximately 77% and 91% of the fair value of its invested assets as of
September 30, 2004 and December 31, 2003, 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.
The Company invests in private placement securities, mortgage loans and limited
partnership arrangements in order to further diversify its investment portfolio.
These investment types comprised approximately 18% and 19% of the fair value of
its invested assets as of September 30, 2004 and December 31, 2003,
respectively. These security types are typically less liquid than direct
investments in publicly traded fixed income or equity investments. However,
generally these securities have higher yields to compensate for the liquidity
risk.
A decrease in the fair value of any investment that is deemed
other-than-temporary would result in the Company's recognition of a net realized
capital loss in its financial results prior to the actual sale of the
investment. (For further discussion, see the Company's discussion of the
evaluation of other-than-temporary impairments in Critical Accounting Estimates
under the "Valuation of Investments and Derivative Instruments" section in
Hartford Life's 2003 Form 10-K Annual Report.)
The primary investment objective of the Company is to maximize after-tax returns
consistent with acceptable risk parameters, including the management of the
interest rate sensitivity of invested assets and the generation of sufficient
liquidity relative to that of policyholder and corporate obligations.
The following table identifies the Company's invested assets by type as of
September 30, 2004 and December 31, 2003.
COMPOSITION OF INVESTED ASSETS
SEPTEMBER 30, 2004 DECEMBER 31, 2003
-------------------- -------------------
AMOUNT PERCENT AMOUNT PERCENT
--------- ------- ---------- -------
Fixed maturities, available-for-sale, at fair value $ 50,200 76.9% $ 37,462 91.0%
Equity securities, available-for-sale, at fair value 449 0.7% 357 0.9%
Equity securities, held for trading, at fair value 10,685 16.4% -- --
Policy loans, at outstanding balance 2,665 4.0% 2,512 6.1%
Mortgage loans, at cost 783 1.2% 466 1.1%
Limited partnerships, at fair value 242 0.4% 177 0.4%
Other investments 262 0.4% 180 0.5%
--------- ------ ---------- -----
TOTAL INVESTMENTS $ 65,286 100.0% $ 41,154 100.0%
========= ====== ========== =====
Fixed maturity investments and equity securities held for trading increased 34%
and 100%, respectively, since December 31, 2003, primarily the result of fixed
maturities and equity securities that were reclassified from separate accounts
to the general account as a result of the adoption of SOP 03-1 coupled with
positive operating cash flow.
Mortgage loans increased $317, or 68%, since December 31, 2003 as a result of a
decision to increase the Company's investment in this asset class primarily due
to its attractive yields and diversification opportunities.
28
INVESTMENT RESULTS
The following table summarizes the Company's investment results.
THIRD QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------- -------------------
(before-tax) 2004 2003 2004 2003
- -------------------------------------------------------------------- ------- ------- ------- -------
Net investment income - excluding income on policy loans and trading
securities [1] $ 680 $ 461 $ 2,003 $ 1,356
Policy loan income 46 51 138 163
Trading securities (loss) income [2] (115) -- 529 --
------- ------- ------- -------
Net investment income - total [1] $ 611 $ 512 $ 2,670 $ 1,519
Yield on average invested assets [3] 5.8% 5.8% 5.8% 5.9%
------- ------- ------- -------
Gross gains on sale $ 74 $ 61 $ 258 $ 209
Gross losses on sale (24) (31) (112) (95)
Impairments (4) (27) (16) (111)
Periodic net coupon settlements on non-qualifying derivatives [1] 2 6 5 19
GMWB derivatives, net -- -- 4 --
Other, net [4] (20) (5) (9) (3)
------- ------- ------- -------
Net realized capital gains [1] $ 28 $ 4 $ 130 $ 19
======= ======= ======= =======
[1] The prior periods reflect the reclassification of periodic net coupon
settlements on non-qualifying derivatives from net investment income to
net realized capital gains to conform to the current year presentation.
[2] Represents the change in value of securities classified as trading.
[3] Represents annualized net investment income (excluding the change in fair
value of trading securities) divided by the monthly weighted average
invested assets at cost or amortized cost, as applicable, for the third
quarter and nine months ended September 30, 2004 and 2003, excluding
trading securities and collateral received associated with the securities
lending program.
[4] Primarily consists of changes in fair value on non-qualifying derivatives
and hedge ineffectiveness on qualifying derivative instruments as well as
the amortization of deferred policy acquisition costs associated with
realized capital gains.
For the third quarter and nine months ended September 30, 2004, net investment
income, excluding income on policy loans and trading securities, increased $219,
or 48%, and $647, or 48%, respectively, compared to the respective prior year
periods. The increases in net investment income were primarily due to income
earned on a higher average invested assets base, as compared to the respective
prior year periods, and an increase in income from prepayment penalties
primarily associated with commercial mortgage-backed securities ("CMBS") and
prepayment speed adjustments related to mortgage-backed securities ("MBS"). The
increase in the average invested assets base, as compared to the prior year
periods, was primarily the result of separate account assets reclassified to the
general account pursuant to the adoption of SOP 03-1 and, to a lesser extent,
assets acquired in the CNA acquisition and operating cash flows. Income earned
on separate account assets reclassified to the general account was $155 and $459
for the third quarter and nine months ended September 30, 2004, respectively.
Income earned on assets acquired in the CNA transaction was $30 and $85 for the
third quarter and nine months ended September 30, 2004, respectively.
For the nine months ended September 30, 2004, the yield on average invested
assets decreased slightly from the respective prior year period as a result of
new investment purchases at rates below the average portfolio yield due to the
continued low interest rate environment and decreased policy loan income. Since
the Company invests primarily in long-term fixed rate debt securities, current
period changes in long-term interest rates impact the yield on new asset
purchases and, therefore, have a gradual impact on the overall portfolio yield.
The weighted average yield on new invested asset purchases in the third quarter
and nine months ended September 30, 2004 of approximately 4.9%, before-tax,
continues to be below the average portfolio yield.
Net realized capital gains for the third quarter and nine months ended September
30, 2004 increased by $24 and $111, respectively, compared to the respective
prior year periods, primarily the result of higher net realized gains on sales
of fixed maturity securities in 2004 and lower other-than-temporary impairments.
(For further discussion of other-than-temporary impairments, see the
Other-Than-Temporary Impairments commentary in this section of the MD&A.)
Gross gains on sales for the third quarter and nine months ended September 30,
2004 were primarily within fixed maturities and were the result of decisions to
reposition the portfolio primarily due to the spread tightening in certain
sectors and changes in interest rates and foreign currency exchange rates. Gross
gains on sales of fixed maturity investments were concentrated in the corporate,
government, CMBS and asset-backed securities ("ABS") sectors. The majority of
the gains on sales in the corporate, CMBS and ABS sectors were the result of
divesting securities that had appreciated in value due to a decline in interest
rates and an improved corporate credit environment. Foreign government
securities were sold primarily to realize gains associated with the decline in
value of the U.S. Dollar against foreign currencies.
Gross losses on sales for the third quarter and nine months ended September 30,
2004 resulted predominantly from sales of U.S. government securities, corporate
securities, ABS and CMBS that were in an unrealized loss position primarily due
to changes in long-term interest rates.
29
Net realized capital gains on sales for the third quarter and nine months ended
September 30, 2003 primarily resulted from portfolio rebalancing of securities
that had appreciated in value due to historically low interest rates.
OTHER-THAN-TEMPORARY IMPAIRMENTS
For the third quarter and nine months ended September 30, 2004, total
other-than-temporary impairments were $4 and $16, respectively, as compared with
$27 and $111, respectively, for the comparable periods in 2003.
The following table identifies the Company's other-than-temporary impairments by
type for the nine months ended September 30, 2004 and 2003.
OTHER-THAN-TEMPORARY IMPAIRMENTS BY TYPE
NINE MONTHS ENDED
SEPTEMBER 30,
------------------
(before-tax) 2004 2003
- ----------------------------------------- ---- ----
ABS
Aircraft lease receivables $ 2 $ 15
Corporate debt obligations ("CDOs") 4 10
Credit card receivables -- 12
Other ABS -- 20
--- ----
Total ABS 6 57
Commercial mortgages 3 --
CMBS 3 4
Corporate
Consumer non-cyclical -- 7
Technology and communications -- 3
Transportation -- 7
Other corporate 3 5
--- ----
Total corporate 3 22
Equity -- 21
MBS - interest only securities 1 7
--- ----
TOTAL OTHER-THAN-TEMPORARY IMPAIRMENTS $16 $111
=== ====
The decrease in other-than-temporary impairments during the nine months ended
September 30, 2004, as compared to the respective prior year period, is due to
an improvement in general economic conditions and operating fundamentals and
improved pricing levels for ABS security types. In general, security issuers'
operating fundamentals have improved due to reduced company leverage, improved
liquidity and successfully implementing various cost cutting measures.
Improvement in pricing levels for ABS has been driven by a general stabilization
in the performance of the underlying collateral and an increase in demand for
these asset types due to improved economic and operating fundamentals of the
underlying security issuers, better market liquidity and attractive yields.
Impairments during the nine months ended September 30, 2003 were primarily
driven by increasing default rates and lower recovery rates on collateral
supporting certain ABS security types and the decline in value of several
corporate debt securities as a result of deteriorating earnings forecasts, debt
restructuring issues and accounting irregularities. Impairments were also
incurred as a result of the deterioration in the transportation sector,
specifically issuers of airline debt, due to a significant decline in airline
travel. Additionally, other-than-temporary impairments were recorded on various
diversified mutual funds and interest only securities.
The favorable other-than-temporary impairments trend will depend on continued
strong economic fundamentals, political stability and collateral performance. In
addition, as discussed in Note 1 of Notes to Condensed Consolidated Financial
Statements, the future adoption of EITF Issue No. 03-1, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain Investments",
could result in the recognition of additional other-than-temporary impairments.
While the ultimate impact of the adoption of this standard is still unknown,
depending on the nature of the ultimate guidance, adoption of this standard
could potentially result in the recognition of unrealized losses, including
those declines in value that are attributable to interest rate movements, as
other-than-temporary impairments, except those deemed to be minor in nature. As
of September 30, 2004, the Company had $219 of total gross unrealized losses.
The amount of impairments to be recognized, if any, will depend on the final
standard, market conditions and management's intent and ability to hold
securities with unrealized losses at the time of the impairment evaluation. (For
further discussion of risk factors associated with sectors with significant
unrealized loss positions, see the sector risk factor commentary under the Total
Available-for-Sale Securities with Unrealized Loss Greater than Six Months by
Type schedule in the Investment Credit Risk section of the MD&A.)
30
INVESTMENT CREDIT RISK
Hartford Life has established investment credit policies that focus on the
credit quality of obligors and counterparties, limit credit concentrations,
encourage diversification and require frequent creditworthiness reviews.
Investment activity, including setting of policy and defining acceptable risk
levels, is subject to regular review and approval by senior management and by
the Finance Committee of The Hartford's Board of Directors.
Please refer to the Investment Credit Risk section of the MD&A in Hartford
Life's 2003 Form 10-K Annual Report for a description of the Company's
objectives, policies and strategies, including the use of derivative
instruments.
The Company invests primarily in securities that 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. Hartford Life is not
exposed to any credit concentration risk of a single issuer greater than 10% of
the Company's stockholders' equity.
The following table identifies fixed maturity securities by type, as of
September 30, 2004 and December 31, 2003.
FIXED MATURITIES BY TYPE
- -----------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2004 DECEMBER 31, 2003
-------------------------------------------------- -----------------------------------------------------
PERCENT PERCENT
OF OF
TOTAL TOTAL
AMORTIZED UNREALIZED UNREALIZED FAIR FAIR AMORTIZED UNREALIZED UNREALIZED FAIR FAIR
COST GAINS LOSSES VALUE VALUE COST GAINS LOSSES VALUE VALUE
--------- ---------- ---------- --------- ------- --------- ---------- ---------- ---------- -------
ABS $ 5,897 $ 90 $ (79) $ 5,908 11.8% $ 5,397 $ 113 $ (101) $ 5,409 11.0%
CMBS 8,716 427 (16) 9,127 18.2% 7,757 432 (21) 8,168 16.6%
Collateralized mortgage
obligations ("CMOs") 972 13 (3) 982 2.0% 1,023 15 (3) 1,035 2.1%
Corporate
Basic industry 2,416 174 (8) 2,582 5.1% 2,509 176 (10) 2,675 5.4%
Capital goods 1,590 110 (6) 1,694 3.4% 1,555 113 (6) 1,662 3.4%
Consumer cyclical 2,405 142 (8) 2,539 5.0% 2,513 164 (6) 2,671 5.4%
Consumer non-cyclical 2,538 190 (6) 2,722 5.4% 2,735 198 (9) 2,924 5.9%
Energy 1,314 120 (1) 1,433 2.9% 1,485 118 (5) 1,598 3.2%
Financial services 6,295 442 (21) 6,716 13.3% 5,842 442 (28) 6,256 12.7%
Technology and
communications 3,569 321 (23) 3,867 7.7% 3,771 382 (11) 4,142 8.5%
Transportation 619 38 (4) 653 1.3% 633 43 (3) 673 1.4%
Utilities 2,271 180 (9) 2,442 4.9% 2,118 172 (11) 2,279 4.6%
Other 708 37 (1) 744 1.5% 638 36 (1) 673 1.4%
Government/Government
agencies
Foreign 726 61 (2) 785 1.6% 866 87 (1) 952 1.9%
United States 864 17 (4) 877 1.7% 1,100 30 (4) 1,126 2.3%
MBS - agency 1,617 20 (4) 1,633 3.3% 2,145 32 (2) 2,175 4.4%
Municipal
Taxable 660 27 (7) 680 1.4% 401 14 (7) 408 0.9%
Tax-exempt 2,079 186 (1) 2,264 4.4% 1,850 168 (1) 2,017 4.1%
Redeemable preferred stock 11 1 -- 12 -- 32 1 -- 33 0.1%
Short-term 2,540 -- -- 2,540 5.1% 2,319 2 -- 2,321 4.7%
--------- --------- ------- --------- ----- --------- --------- --------- ---------- -----
TOTAL FIXED MATURITIES $ 47,807 $ 2,596 $ (203) $ 50,200 100.0% $ 46,689 $ 2,738 $ (230) $ 49,197 100.0%
========= ========= ======= ========= ===== ========= ========= ========= ========== =====
Total general account fixed
maturities $ 35,569 $ 2,051 $ (158) $ 37,462 76.1%
Total guaranteed separate
account fixed
maturities [1] $ 11,120 $ 687 $ (72) $ 11,735 23.9%
======== ========= ========= ========== ====
[1] Effective January 1, 2004, guaranteed separate account assets were
included with general account assets as a result of adopting SOP 03-1.
The Company's fixed maturity portfolio gross unrealized gains and losses as of
September 30, 2004 in comparison to December 31, 2003 were primarily impacted by
changes in interest rates, credit spreads and security sales. The Company's
fixed maturity gross unrealized gains decreased $142 from December 31, 2003 to
September 30, 2004 due to sales of securities in a gain position and the
increase in short-term to five-year U.S. treasury rates partially offset by a
decrease in long-term (ten-year and beyond) U.S. treasury rates. The gross
unrealized loss amount decreased by $27 from December 31, 2003 to September 30,
2004 primarily due to credit spread tightening, improved pricing levels for
certain CDOs and credit card ABS, a decrease in long-term interest rates
(ten-year and beyond), security sales and, to a lesser extent,
other-than-temporary impairments.
31
At the September 21, 2004 Federal Open Market Committee policy meeting, the
overnight funds rate was raised a quarter-point for the third time in 2004 to
1.75%. The Fed members signaled that interest rates will continue to rise at a
measured pace as long as inflation risks remain stable. The pace of the Fed rate
increases has been widely anticipated by the market causing the U.S. interest
rate yield curve to flatten during the nine months ended September 30, 2004. The
five-year U.S. treasury rate increased approximately 12 basis points since
December 31, 2003 primarily due to the impact of short-term interest rate
increases while the ten-year U.S. treasury rate decreased 13 basis points since
December 31, 2003, largely the result of demand for higher yielding assets as
well as slower than expected economic growth, reduced inflationary concerns and
lack of significant job growth.
Investment allocations as a percentage of total fixed maturities have remained
materially consistent since December 31, 2003, except for CMBS and MBS-agency.
CMBS increased as a result of a decision to increase the Company's investment in
the asset class due to its stable spreads, high quality and attractive yields.
The decrease in MBS-agency holdings was the result of an effort to reduce
exposure to prepayment risk resulting from interest rates changes.
(For further discussion of risk factors associated with sectors with significant
unrealized loss positions, see the sector risk factor commentary under the Total
Available-for-Sale Securities with Unrealized Loss Greater than Six Months by
Type schedule in this section of the MD&A.)
The following table identifies fixed maturities by credit quality, as of
September 30, 2004 and December 31, 2003. The ratings referenced below are based
on the ratings of a nationally recognized rating organization or, if not rated,
assigned based on the Company's internal analysis of such securities.
FIXED MATURITIES BY CREDIT QUALITY
- ---------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2004 DECEMBER 31, 2003
----------------------------------- ------------------------------------
PERCENT OF PERCENT OF
AMORTIZED TOTAL FAIR AMORTIZED TOTAL FAIR
COST FAIR VALUE VALUE COST FAIR VALUE VALUE
----------- ----------- ---------- ----------- ----------- ----------
United States Government/Government agencies $ 3,474 $ 3,514 7.0% $ 4,291 $ 4,361 9.0%
AAA 10,149 10,554 21.0% 8,285 8,681 17.6%
AA 4,628 4,875 9.7% 4,243 4,486 9.1%
A 12,660 13,529 27.0% 13,015 13,901 28.3%
BBB 12,524 13,300 26.5% 12,277 13,061 26.5%
BB & below 1,832 1,888 3.8% 2,259 2,386 4.8%
Short-term 2,540 2,540 5.0% 2,319 2,321 4.7%
----------- ----------- ----- ----------- ----------- -----
TOTAL FIXED MATURITIES $ 47,807 $ 50,200 100.0% $ 46,689 $ 49,197 100.0%
=========== =========== ===== =========== =========== =====
Total general account fixed maturities $ 35,569 $ 37,462 76.1%
Total guaranteed separate account fixed
maturities [1] $ 11,120 $ 11,735 23.9%
=========== =========== =====
[1] Effective January 1, 2004, guaranteed separate account assets were
included with general account assets as a result of adopting SOP 03-1.
As of September 30, 2004 and December 31, 2003, greater than 95% of the fixed
maturity portfolio was invested in short-term securities or securities rated
investment grade (BBB and above).
32
The following table presents the Below Investment Grade ("BIG") fixed maturities
by type, as of September 30, 2004 and December 31, 2003.
BIG FIXED MATURITIES BY TYPE
- ------------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2004 DECEMBER 31, 2003
------------------------------------- ------------------------------------
PERCENT OF PERCENT OF
AMORTIZED TOTAL FAIR AMORTIZED TOTAL FAIR
COST FAIR VALUE VALUE COST FAIR VALUE VALUE
----------- ----------- ----------- ----------- ----------- ----------
ABS $ 198 $ 166 8.7% $ 259 $ 234 9.9%
CMBS 73 81 4.3% 117 120 5.0%
Corporate
Basic industry 198 212 11.2% 243 255 10.7%
Capital goods 83 85 4.5% 102 106 4.4%
Consumer cyclical 128 137 7.3% 273 295 12.3%
Consumer non-cyclical 177 186 9.9% 305 317 13.3%
Energy 61 65 3.4% 62 69 2.9%
Financial services 23 24 1.3% 20 21 0.9%
Technology and communications 343 355 18.8% 291 346 14.5%
Transportation 29 26 1.4% 38 40 1.7%
Utilities 302 317 16.8% 357 368 15.4%
Foreign government 193 210 11.1% 173 195 8.2%
Other 24 24 1.3% 19 20 0.8%
----------- ----------- ----- ----------- ----------- -----
TOTAL FIXED MATURITIES $ 1,832 $ 1,888 100.0% $ 2,259 $ 2,386 100.0%
=========== =========== ===== =========== =========== =====
Total general account fixed maturities $ 1,513 $ 1,604 67.2%
Total guaranteed separate account fixed maturities [1] $ 746 $ 782 32.8%
=========== =========== =====
[1] Effective January 1, 2004, guaranteed separate account assets were
included with general account assets as a result of adopting SOP 03-1.
As of September 30, 2004 and December 31, 2003, the Company held no issuer of a
BIG security with a fair value in excess of 5% and 4%, respectively, of the
total fair value for BIG securities. Total BIG securities decreased since
December 31, 2003 as a result of decisions to reduce exposure to lower credit
quality assets and re-invest in investment grade securities.
The following table presents the Company's unrealized loss aging for total fixed
maturity and equity securities classified as available-for-sale, as of September
30, 2004 and December 31, 2003, by length of time the security was in an
unrealized loss position.
UNREALIZED LOSS AGING OF TOTAL AVAILABLE-FOR-SALE SECURITIES
- ------------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2004 DECEMBER 31, 2003
---------------------------------- ------------------------------------
AMORTIZED FAIR UNREALIZED AMORTIZED FAIR UNREALIZED
COST VALUE LOSS COST VALUE LOSS
---------- ---------- ---------- ----------- ----------- ----------
Three months or less $ 2,601 $ 2,584 $ (17) $ 2,903 $ 2,878 $ (25)
Greater than three months to six months 3,874 3,813 (61) 1,943 1,882 (61)
Greater than six months to nine months 530 504 (26) 265 250 (15)
Greater than nine months to twelve months 46 43 (3) 138 130 (8)
Greater than twelve months 1,612 1,500 (112) 1,661 1,528 (133)
---------- ---------- -------- ---------- ---------- --------
TOTAL $ 8,663 $ 8,444 $ (219) $ 6,910 $ 6,668 $ (242)
========== ========== ======== ========== ========== ========
Total general account $ 4,887 $ 4,717 $ (170)
Total guaranteed separate accounts [1] $ 2,023 $ 1,951 $ (72)
========== ========== ========
[1] Effective January 1, 2004, guaranteed separate account assets were
included with general account assets as a result of adopting
SOP 03-1.
The decrease in the unrealized loss amount since December 31, 2003 is primarily
the result of credit spread tightening, a slight decrease in long-term interest
rates (ten-year and beyond), improved pricing levels for certain CDOs and credit
card ABS, asset sales, and, to a lesser extent, other-than-temporary
impairments. (For further discussion, see the economic commentary under the
Fixed Maturities by Type table in this section of the MD&A.)
As of September 30, 2004 and December 31, 2003, fixed maturities represented
$203, or 93%, and $230, or 95%, of the Company's total unrealized loss
associated with securities classified as available-for-sale, respectively. There
were no fixed maturities as of September 30, 2004 or December 31, 2003 with a
fair value less than 80% of the security's amortized cost basis for six
continuous months other than certain asset-backed and commercial mortgage-backed
securities. Other-than-temporary impairments for certain asset-backed and
commercial mortgage-backed securities are recognized if the fair value of the
security, as determined by external pricing sources, is less than its carrying
amount and there has been a decrease in the present value of the expected cash
flows since the last reporting period. There were no asset-backed or commercial
mortgage-backed securities included in the table above, as of September 30, 2004
and December 31, 2003, for which management's best estimate of future cash flows
adversely changed during the reporting period. As of
33
September 30, 2004 and December 31, 2003, no asset-backed or commercial
mortgage-backed securities had an unrealized loss in excess of $14 and $15,
respectively. (For further discussion of the other-than-temporary impairments
criteria, see "Valuation of Investments and Derivative Instruments" included in
the Critical Accounting Estimates section of the MD&A and in Note 2 of Notes to
Consolidated Financial Statements both of which are included in Hartford Life's
2003 Form 10-K Annual Report.)
The Company held no securities of a single issuer that were at an unrealized
loss position in excess of 8% and 7% of the total unrealized loss amount as of
September 30, 2004 and December 31, 2003, respectively.
The total securities classified as available-for-sale in an unrealized loss
position for longer than six months by type as of September 30, 2004 and
December 31, 2003 are presented in the following table.
TOTAL AVAILABLE-FOR-SALE SECURITIES WITH UNREALIZED LOSS GREATER THAN SIX MONTHS BY TYPE
- -------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2004 DECEMBER 31, 2003
------------------------------------------- ---------------------------------------------
PERCENT OF PERCENT OF
TOTAL TOTAL
AMORTIZED FAIR UNREALIZED UNREALIZED AMORTIZED FAIR UNREALIZED UNREALIZED
COST VALUE LOSS LOSS COST VALUE LOSS LOSS
---------- --------- ---------- ---------- ---------- -------- ---------- ----------
ABS and CMBS
Aircraft lease receivables $ 153 $ 97 $ (56) 39.7% $ 163 $ 108 $ (55) 35.3%
CDOs 72 67 (5) 3.5% 140 120 (20) 12.8%
Credit card receivables 33 32 (1) 0.7% 123 111 (12) 7.7%
Other ABS and CMBS 353 347 (6) 4.3% 616 602 (14) 9.0%
Corporate
Financial services 602 573 (29) 20.6% 678 646 (32) 20.5%
Technology and communications 163 150 (13) 9.2% 39 37 (2) 1.3%
Utilities 107 101 (6) 4.3% 85 79 (6) 3.8%
Other 463 446 (17) 12.0% 206 191 (15) 9.6%
Other securities 242 234 (8) 5.7% 14 14 -- --
---------- --------- --------- ----- ---------- -------- ---------- -----
TOTAL $ 2,188 $ 2,047 $ (141) 100.0% $ 2,064 $ 1,908 $ (156) 100.0%
========== ========= ========= ===== ========== ======== ========== =====
Total general accounts $ 1,425 $ 1,315 $ (110) 70.5%
Total guaranteed separate
accounts [1] $ 639 $ 593 $ (46) 29.5%
========== ======== ========== =====
[1] Effective January 1, 2004, guaranteed separate account assets were
included with general account assets as a result of adopting SOP 03-1.
The decrease in the September 30, 2004 total available-for-sale securities with
unrealized loss greater than six months amount in comparison to the December 31,
2003 amount was primarily due to improved pricing levels for certain CDOs and
credit card ABS and, to a lesser extent, other-than-temporary impairments taken
during 2004. The securities in an unrealized loss position for six months or
more as of September 30, 2004 and December 31, 2003, were primarily ABS
supported by aircraft lease receivables and corporate fixed maturities primarily
within the financial services sector. The Company's current view of risk factors
relative to these fixed maturity types is as follows:
AIRCRAFT LEASE RECEIVABLES -- The slight increase in the unrealized loss
position from December 31, 2003 to September 30, 2004 was primarily the result
of rating agency downgrades for certain issuers in this sector, partially offset
by other-than-temporary impairments taken during the year. In prior periods,
these securities had suffered a considerable decrease in value as a result of a
prolonged decline in airline travel and the uncertainty of a potential industry
recovery. Although uncertainty surrounding the stability of domestic airlines
continues to weigh heavily on this sector, worldwide travel and aircraft demand
appears to be improving. While the Company has seen modest price increases and
greater liquidity in this sector during 2004, any additional price recovery will
depend on continued improvement in economic fundamentals, political stability
and airline operating performance.
FINANCIAL SERVICES -- As of September 30, 2004, the Company held approximately
41 different securities in the financial services sector that had been in an
unrealized loss position for greater than six months. These securities are
primarily investment grade with the majority priced at or greater than 90% of
amortized cost as of September 30, 2004. These positions are a mixture of fixed
rate and variable rate securities with extended maturity dates, which have been
adversely impacted by changes in interest rates from the date of purchase.
Additional changes in fair value of these securities are primarily dependent on
future changes in interest rates.
As part of the Company's ongoing security monitoring process by a committee of
investment and accounting professionals, the Company has reviewed its investment
portfolio and concluded that there were no additional other-than-temporary
impairments as of September 30, 2004 and December 31, 2003. Due to the issuers'
continued satisfaction of the securities' obligations in accordance with their
contractual terms and the expectation that they will continue to do so,
management's intent and ability to hold these securities, as well as the
evaluation of the fundamentals of the issuers' financial condition and other
objective evidence, the Company believes that the prices of the securities in
the sectors identified above were temporarily depressed.
34
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. ABS and CMBS),
projections of expected future cash flows may change based upon new information
regarding the performance of the underlying collateral. As of September 30, 2004
and December 31, 2003, management's expectation of the discounted future cash
flows on these securities was in excess of the associated securities' amortized
cost. (For further discussion, see "Valuation of Investments and Derivative
Instruments" included in the Critical Accounting Estimates section of MD&A and
in Note 2 of Notes to Consolidated Financial Statements both of which are
included in Hartford Life's 2003 Form 10-K Annual Report.)
The following table presents the Company's unrealized loss aging for BIG and
equity securities classified as available-for-sale, as of September 30, 2004 and
December 31, 2003.
UNREALIZED LOSS AGING OF AVAILABLE-FOR-SALE BIG AND EQUITY SECURITIES
- ------------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2004 DECEMBER 31, 2003
------------------------------------ ------------------------------------
AMORTIZED FAIR UNREALIZED AMORTIZED FAIR UNREALIZED
COST VALUE LOSS COST VALUE LOSS
---------- --------- ---------- ---------- --------- ----------
Three months or less $ 142 $ 134 $ (8) $ 57 $ 55 $ (2)
Greater than three months to six months 203 192 (11) 91 87 (4)
Greater than six months to nine months 102 91 (11) 60 54 (6)
Greater than nine months to twelve months 8 6 (2) 18 17 (1)
Greater than twelve months 281 232 (49) 361 302 (59)
---------- --------- ------- ---------- --------- --------
TOTAL $ 736 $ 655 $ (81) $ 587 $ 515 $ (72)
========== ========= ======= ========== ========= ========
Total general accounts $ 467 $ 411 $ (56)
Total guaranteed separate accounts [1] $ 120 $ 104 $ (16)
========== ========= ========
[1] Effective January 1, 2004, guaranteed separate account assets were
included with general account assets as a result of adopting SOP 03-1.
The increase in the BIG and equity security unrealized loss amount for
securities classified as available-for-sale from December 31, 2003 to September
30, 2004 was primarily the result of recent rating agency downgrades for certain
issuers, and the impact of short-term interest rate increases on certain
variable rate perpetual preferred securities, partially offset by
other-than-temporary impairments taken during the year, and, to a lesser extent,
slightly improved pricing levels for ABS securities and asset sales. (For
further discussion, see the economic commentary under the Fixed Maturities by
Type table in this section of the MD&A.)
The BIG and equity securities classified as available-for-sale in an unrealized
loss position for longer than six months by type as of September 30, 2004 and
December 31, 2003 are presented in the following table.
AVAILABLE-FOR-SALE BIG AND EQUITY SECURITIES WITH UNREALIZED LOSS GREATER THAN SIX MONTHS BY TYPE
- ------------------------------------------------------------------------------------------------------------------------------------
SEPTEMBER 30, 2004 DECEMBER 31, 2003
--------------------------------------------- ------------------------------------------------
PERCENT OF PERCENT OF
TOTAL TOTAL
AMORTIZED FAIR UNREALIZED UNREALIZED AMORTIZED FAIR UNREALIZED UNREALIZED
COST VALUE LOSS LOSS COST VALUE LOSS LOSS
---------- --------- --------- ---------- ---------- ------- ---------- ----------
ABS and CMBS
Aircraft lease receivables $ 63 $ 33 $ (30) 48.4% $ 52 $ 34 $ (18) 27.3%
CDOs 39 35 (4) 6.5% 42 32 (10) 15.1%
Credit card receivables 18 18 -- -- 45 34 (11) 16.7%
Other ABS and CMBS 6 5 (1) 1.6% 49 42 (7) 10.6%
Corporate
Financial services 120 105 (15) 24.2% 113 101 (12) 18.2%
Technology and communications 39 33 (6) 9.6% 5 5 -- --
Utilities 59 55 (4) 6.5% 71 65 (6) 9.1%
Other 45 43 (2) 3.2% 57 55 (2) 3.0%
Other securities 2 2 -- -- 5 5 -- --
---------- --------- --------- ----- ---------- ------- ---------- -----
TOTAL $ 391 $ 329 $ (62) 100.0% $ 439 $ 373 $ (66) 100.0%
========== ========= ========= ===== ========== ======= ========== =====
Total general accounts $ 340 $ 289 $ (51) 77.3%
Total guaranteed separate
accounts [1] $ 99 $ 84 $ (15) 22.7%
========== ======= ========== =====
[1] Effective January 1, 2004, guaranteed separate account assets were
included with general account assets as a result of adopting SOP 03-1.
The decrease in the available-for-sale BIG and equity securities greater than
six months unrealized loss amount since December 31, 2003 was primarily the
result of improved pricing levels for certain CDOs and credit card ABS,
other-than-temporary impairments taken during the year and, to a lesser extent,
asset sales. This decrease was partially offset by rating agency downgrades for
certain issuers in
35
the aircraft lease receivables sector and the impact of short-term interest rate
increases on certain variable rate perpetual preferred securities.
For additional discussion of the Company's current view of risk factors relative
to certain security types listed above, please refer to the Total
Available-for-Sale Securities with Unrealized Loss Greater Than Six Months by
Type table in this section of the MD&A.
CAPITAL MARKETS RISK MANAGEMENT
Hartford Life 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 operations. Derivative instruments
are utilized in compliance with established Company policy and regulatory
requirements and are monitored internally and reviewed by senior management.
MARKET RISK
Hartford Life 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.
(For further discussion of market risk, see the Capital Markets Risk Management
section of MD&A in Hartford Life's 2003 Form 10-K Annual Report.) There have
been no material changes in market risk exposures from December 31, 2003.
DERIVATIVE INSTRUMENTS
Hartford Life 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 designed to achieve one of four
Company approved objectives: to hedge risk arising from interest rate, price or
currency exchange rate volatility; to manage liquidity; to control transaction
costs; or to enter into replication transactions. 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 Hartford Life's use of
derivative instruments, refer to Note 3 of Notes to Condensed Consolidated
Financial Statements.)
EQUITY RISK
The Company's 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. Prolonged and precipitous declines in the equity markets can have a
significant impact on the Company's operations, as sales of variable products
may decline and surrender activity may increase, and as customer sentiment
towards the equity market turns negative. Lower assets under management will
have a negative impact on the Company's financial results, primarily due to
lower fee income related to the Retail Products Group and Institutional
Solutions Group and, to a lesser extent, 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.
The Company sells variable annuity contracts that offer various guaranteed death
benefits. The Company maintains a liability for the death benefit costs, net of
reinsurance, of $132, as of September 30, 2004. Declines in the equity market
may increase the Company's net exposure to death benefits under these contracts.
The majority of the contracts with the guaranteed death benefit feature are sold
by the Retail segment. For certain guaranteed death benefits, the Retail segment
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. For certain guaranteed death
benefits sold with variable annuity contracts beginning in June of 2003, the
Retail segment pays the greater of (1) the account value at death; or (2) the
maximum anniversary value; not to exceed the account value plus the greater of
(a) 25% of premium payments, or (b) 25% of the maximum anniversary value of the
contract. The Retail segment currently reinsures a significant portion of these
death benefit guarantees associated with its in-force block of business.
36
The Retail segment's total gross exposure (i.e. before reinsurance) to these
guaranteed death benefits as of September 30, 2004 is $10.8 billion. Due to the
fact that 80% of this amount is reinsured, the net exposure is $2.2 billion.
This amount is often referred to as the net amount at risk. However, the Retail
segment will incur these guaranteed death benefit payments in the future only if
the policyholder has an in-the-money guaranteed death benefit at their time of
death.
In addition, the Company offers certain variable annuity products with a GMWB
rider. Declines in the equity market may increase the Company's exposure to
benefits under the GMWB contracts. For all contracts in effect through July 6,
2003, the Company entered into a reinsurance arrangement to offset its exposure
to the GMWB for the remaining lives of those contracts. As of July 6, 2003, the
Company exhausted all but a small portion of the reinsurance capacity for new
business under the current arrangement and will be ceding only a very small
number of new contracts subsequent to July 6, 2003. Substantially all new
contracts with the GMWB are not covered by reinsurance. These unreinsured
contracts are expected to generate volatility in net income as the underlying
embedded derivative liabilities are recorded at fair value each reporting
period, resulting in the recognition of net realized capital gains or losses in
response to changes in certain critical factors including capital market
conditions and policyholder behavior. In order to minimize the volatility
associated with the unreinsured GMWB liabilities, the Company established an
alternative risk management strategy. During the third quarter of 2003, the
Company began hedging its unreinsured GMWB exposure using interest rate futures,
Standard and Poor's ("S&P") 500 and NASDAQ index options and futures contracts.
During the first quarter of 2004, the Company entered into Europe, Australasia
and Far East ("EAFE") Index swaps to hedge GMWB exposure to international equity
markets. The hedging program involves a detailed monitoring of policyholder
behavior and capital markets conditions on a daily basis and rebalancing of the
hedge position as needed. While the Company actively manages this hedge
position, hedge ineffectiveness may result due to factors including, but not
limited to, policyholder behavior, capital markets dislocation or discontinuity
and divergence between the performance of the underlying funds and the hedging
indices.
The net impact of the change in value of the embedded derivative, net of the
results of the hedging program was a $4 gain before deferred policy acquisition
costs and tax effects for the nine months ended September 30, 2004.
INTEREST RATE RISK
The Company believes that a moderate increase in interest rates from the current
levels is generally a favorable development for the Company. Rate increases are
expected to provide additional net investment income, increased sales of fixed
rate investment products, reduce the cost of the GMWB hedging program, limit the
potential risk of margin erosion due to minimum guaranteed crediting rates in
certain products and, if sustained through the end of 2004, could reduce the
Company's prospective pension expense. Conversely, a rise in interest rates will
reduce the net unrealized gain position of the investment portfolio, increase
interest expense on the Company's variable rate debt obligations and, if
long-term interest rates rise dramatically within a six to twelve month time
period, certain Life businesses may be exposed to disintermediation risk.
Disintermediation risk refers to the risk that policyholders will surrender
their contracts in a rising interest rate environment requiring the Company to
liquidate assets in an unrealized loss position. The Company analyzes interest
rate risk using various models including multi-scenario cash flow projections
that forecast cash flows of the liabilities and their supporting investments,
including derivative instruments and adjusts the asset/liability profile to help
mitigate disintermediation risk. Measures used by the Company to quantify its
exposure to interest rate risk inherent in its invested assets and interest rate
sensitive liabilities are duration and key rate duration. In conjunction with
the interest rate risk measurement and management techniques, significant
portions of fixed income product offerings have market value adjustment
provisions at contract surrender.
The Company believes that a gradual rise in interest rates should increase net
investment income and sales of fixed rate investment products while the
potential adverse consequences of increased rates, primarily the reduction of
the investment portfolio's net unrealized gain and disintermediation risk, is
mitigated by the Company's disciplined asset/liability management techniques and
product design.
CAPITAL RESOURCES AND LIQUIDITY
Capital resources and liquidity represent the overall financial strength of the
Company and its ability to generate strong cash flows from each of the business
segments, borrow funds at competitive rates and raise new capital to meet
operating and growth needs.
LIQUIDITY REQUIREMENTS
The liquidity requirements of the Company have been and will continue to be met
by funds from operations as well as the issuance of commercial paper, debt
securities and borrowings from its credit facilities. The principal sources of
operating funds are premiums and investment income, while investing cash flows
originate from maturities and sales of invested assets.
The Company 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 (see the Ratings
section below for further discussion), and strong shareholder returns. As a
result, the Company may from time to time raise capital from the issuance of
debt or other capital securities. The issuance of debt or other capital
securities could result in the dilution of shareholder interests or reduced net
income due to additional interest expense.
37
Hartford Life is a holding company which relies upon operating cash flow in the
form of dividends from its subsidiaries, which enables the Company to service
debt, pay dividends to its parent, and pay certain business expenses.
Dividends to Hartford Life, Inc. from its direct subsidiary, Hartford Life and
Accident Insurance Company ("HLA"), are restricted. The payment of dividends by
Connecticut-domiciled insurers is limited under the insurance holding company
laws of Connecticut. Under these laws, the insurance subsidiaries may only make
their dividend payments out of unassigned surplus. These laws require notice to
and approval by the state insurance commissioner for the declaration or payment
of any dividend, which, together with other dividends or distributions made
within the preceding twelve months, exceeds the greater of (i) 10% of the
insurer's policyholder surplus as of December 31 of the preceding year or (ii)
net income (or net gain from operations, if such company is a life insurance
company) for the twelve-month period ending on the thirty-first day of December
last preceding, in each case determined under statutory insurance accounting
policies. In addition, if any dividend of a Connecticut-domiciled insurer
exceeds the insurer's earned surplus, it requires the prior approval of the
Connecticut Insurance Commissioner. The insurance holding company laws of the
other jurisdictions in which the Company's insurance subsidiaries are
incorporated (or deemed commercially domiciled) generally contain similar
(although in certain instances somewhat more restrictive) limitations on the
payment of dividends. Through October 31, 2004, the Company's insurance
subsidiaries had paid $332 to the Company and are permitted to pay up to a
maximum of approximately $115 in dividends to the Company for the remainder of
2004 without prior approval from the applicable insurance commissioner.
The primary uses of funds are to pay claims, policy benefits, operating expenses
and commissions and to purchase new investments. The Company has a policy of
carrying a significant short-term investment position and accordingly does not
anticipate selling intermediate and long-term fixed maturity investments to meet
its liquidity needs. (For a discussion of the Company's investment objectives
and strategies, see the Investments and Capital Markets Risk Management
sections.)
SOURCES OF LIQUIDITY
Shelf Registrations
On May 15, 2001, the Company filed with the SEC a shelf registration statement
(Registration No. 333-60944) for the potential offering and sale of up to $1.0
billion in debt and preferred securities. The registration statement was
declared effective on May 29, 2001. As of September 30, 2004, the Company had
$1.0 billion remaining on its shelf.
Commercial Paper
Hartford Life has a commercial paper program, which allows it to borrow up to a
maximum amount of $250 in short term commercial paper notes. In addition, the
Company's Japanese subsidiary, Hartford Life Insurance KK, has a $18 line of
credit with a Japanese bank. As of September 30, 2004, the Company had no
outstanding borrowings under either facility.
OFF-BALANCE SHEET ARRANGEMENTS AND AGGREGATE CONTRACTUAL OBLIGATIONS
There have been no material changes to the Company's off-balance sheet
arrangements and aggregate contractual obligations since the filing of the
Company's 2003 Form 10-K Annual Report.
CAPITALIZATION
The capital structure of Hartford Life as of September 30, 2004 and December 31,
2003 consisted of debt and equity, summarized as follows:
SEPTEMBER 30, 2004 DECEMBER 31, 2003
------------------ -----------------
Short-term debt $ - $ 505
Long-term debt [1] 1,050 1,300
-------------- ---------------
TOTAL DEBT $ 1,050 $ 1,805
-------------- ---------------
Equity excluding net unrealized gains on securities, net of tax $ 7,654 $ 6,156
Net unrealized capital gains on securities, net of tax 1,161 903
-------------- ---------------
TOTAL STOCKHOLDER'S EQUITY $ 8,815 $ 7,059
-------------- ---------------
TOTAL CAPITALIZATION $ 9,865 $ 8,864
-------------- ---------------
Debt to equity 12% 26%
Debt to capitalization 11% 20%
-------------- ---------------
[1] Includes junior subordinated debentures.
The Company's total capitalization increased $1.0 billion, or 11%, as of
September 30, 2004, as compared to December 31, 2003. The increase was primarily
the result of an increase in stockholder's equity partially offset by a decrease
in debt. The increase in stockholder's equity, excluding net unrealized gains on
securities, was primarily due to net income of $1.0 billion and capital
contributions of $605, partially offset by dividends of $121. Net unrealized
capital gains on securities, net of tax, increased $258, or
38
29%, as of September 30, 2004 as compared to December 31, 2003. The decrease in
unrealized gains is due primarily to the Company's adoption of SOP 03-1, which
resulted in a $292 cumulative effect on unrealized gains on securities for the
nine months ended September 30, 2004 related to the reclassification of
investments from separate account assets to general account assets partially
offset by an increase in interest rates and credit spreads.
DEBT
The following discussion describes the Company's debt financing activities for
the nine months ended September 30, 2004.
On June 15, 2004, the Company repaid $200 of 6.9% senior notes at maturity.
On March 15, 2004, the Company redeemed its 7.2% junior subordinated debentures
underlying the trust preferred securities issued by Hartford Life Capital I.
On January 30, 2004, the Company paid and settled the related party note
agreements totaling $305 with The Hartford.
For additional information regarding debt, see Note 8 of Notes to Consolidated
Financial Statements in Hartford Life's 2003 Form 10-K Annual Report.
DIVIDENDS
The Company declared $121 in dividends to Hartford Holdings, Inc. for the nine
months ended September 30, 2004. Future dividend decisions will be based on, and
affected by, a number of factors, including the operating results and financial
requirements of the Company on a stand-alone basis and the impact of regulatory
restrictions.
CASH FLOWS
NINE MONTHS ENDED
SEPTEMBER 30,
-----------------
2004 2003
------- -------
Net Cash provided by operating activities $ 1,286 $ 1,056
Net Cash used for investing activities (1,260) (3,516)
Net Cash provided by financing activities 332 2,577
------- -------
Cash - end of period 625 293
------- -------
The increase in cash provided by operating activities was primarily the result
of the timing of funds received for policyholder accounts, net of the activity
in the equity securities, held for trading purposes, and timing of the
settlement of receivables and payables for the nine months ended September 30,
2004. The increase in cash used for investing activities for the nine months
ended September 30, 2004 as compared to the prior year period was primarily due
to higher sales and maturities of investments, partially offset by higher
purchases of investments. The decrease in net cash provided by financing
activities was primarily due to a decrease in net receipts from policyholders
accounts related to investment and universal life contracts, the shift in
capital structure associated with debt repayments, and increased dividends to
shareholders, partially offset by capital contributions. Operating cash flows in
both periods have been more than adequate to meet liquidity requirements.
EQUITY MARKETS
For a discussion of the equity markets impact to capital and liquidity, see the
Capital Markets Risk Management.
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.
On August 4, 2004, Moody's affirmed Hartford Life, Inc.'s A3 senior debt ratings
as well as the Aa3 insurance financial strength ratings of its life insurance
operating subsidiaries. In addition, Moody's changed the outlook for all of
these ratings from negative to stable.
Since the announcement of the suit filed by the New York Attorney General's
Office against Marsh & McLennan Companies, Inc., and Marsh, Inc. on October 14,
2004, the major independent ratings agencies have indicated that they continue
to monitor developments relating to the suit. On October 22, 2004, Standard &
Poor's revised its outlook on the U.S. property/casualty commercial lines sector
to negative from stable. On October 29, 2004, Standard & Poor's revised its
outlook on the counterparty credit ratings of American
39
International Group, Inc. and ACE Ltd. to negative from stable. It is not
possible to predict whether Standard & Poor's or any other agency will take
similar action with respect to the Company's ratings outlook.
The following table summarizes Hartford Life's significant member companies'
financial ratings from the major independent rating organizations as November 1,
2004:
STANDARD &
A.M. BEST FITCH POOR'S MOODY'S
INSURANCE RATINGS
Hartford Life Insurance Company A+ AA AA- Aa3
Hartford Life and Accident A+ AA AA- Aa3
Hartford Life Group Insurance Company A+ AA -- --
Hartford Life and Annuity A+ AA AA- Aa3
Hartford Life Insurance KK (Japan) -- -- AA- --
OTHER RATINGS
Hartford Life, Inc.:
Senior debt a- A A- A3
Commercial paper -- F1 A-2 P-2
Hartford Life, Inc.:
Capital II trust preferred securities bbb A- BBB Baa1
Hartford Life Insurance Company:
Short Term Rating -- -- A-1+ P-1
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. Statutory
Surplus as of September 30, 2004 and December 31, 2003 was $4.7 billion and $4.5
billion, respectively.
REGULATORY DEVELOPMENTS
Contingencies -- In June 2004, The Hartford received a subpoena from the New
York Attorney General's Office in connection with its inquiry into compensation
arrangements between brokers and carriers. On September 17, 2004, the New York
Attorney General's Office issued two additional subpoenas to the Company seeking
information about possible anti-competitive activity among brokers and insurers.
Subsequently, The Hartford has received additional subpoenas from the New York
Attorney General's Office, the Connecticut Attorney General's Office, the
Insurance Division of the Illinois Department of Financial and Professional
Regulation, the Massachusetts Attorney General's Office, the Minnesota
Department of Commerce, the Ohio Attorney General's Office and the Texas
Attorney General's Office regarding broker compensation and possible
anti-competitive activity. The Hartford may receive additional subpoenas and
other information requests from these or other regulatory agencies regarding
similar issues. The Hartford intends to continue cooperating fully with these
investigations, and has initiated an internal review, with the assistance of
outside counsel, regarding the issues under investigation.
On October 14, 2004, the New York Attorney General's Office filed a civil
complaint against Marsh & McLennan Companies, Inc., and Marsh, Inc.
(collectively, "Marsh"). The complaint alleges, among other things, that certain
insurance companies, including The Hartford, participated with Marsh in
arrangements to submit inflated bids for business insurance and paid contingent
commissions to ensure that Marsh would direct business to them. The Hartford is
not joined as a defendant in the action. Although no regulatory action has been
initiated against The Hartford in connection with the allegations described in
the civil complaint, it is possible that the New York Attorney General's Office
or one or more other regulatory agencies may pursue action against The Hartford
or one or more of its employees in the future. The potential timing of any such
action is difficult to predict. If such an action is brought, it could have a
material adverse effect on the Company.
On October 29, 2004, the New York Attorney General's Office informed The
Hartford that the Attorney General is conducting an investigation with respect
to the timing of the previously disclosed sale by Thomas Marra, a director and
executive officer of The Hartford and the Company, of 217,074 shares of The
Hartford's common stock on September 21, 2004. The sale occurred shortly after
the issuance of the additional subpoenas dated September 17, 2004 by the New
York Attorney General's Office. The Hartford has engaged outside counsel to
review the circumstances related to the transaction and is fully cooperating
with the New York Attorney General's Office. On the basis of the review, The
Hartford has determined that Mr. Marra complied with The Hartford's applicable
internal trading procedures and has found no indication that Mr. Marra was aware
of the additional subpoenas at the time of the sale.
40
There continues to be significant federal and state regulatory activity relating
to financial services companies, particularly mutual funds companies. These
regulatory inquiries have focused on a number of mutual fund issues. The
Hartford has received requests for information and subpoenas from the Securities
and Exchange Commission ("SEC"), subpoenas from the New York Attorney General's
Office, and requests for information from the Connecticut Securities and
Investments Division of the Department of Banking, in each case requesting
documentation and other information regarding various mutual fund regulatory
issues. The Hartford continues to respond to requests for documents and
information from representatives from the SEC's Office of Compliance Inspections
and Examinations in connection with their ongoing compliance examinations
regarding market timing and late trading, revenue sharing and directed
brokerage, fees, fund service providers and transfer agents, and other mutual
fund-related issues. In addition, the SEC's Division of Enforcement and the New
York Attorney General's Office are investigating aspects of the Company's
variable annuity and mutual fund operations. The SEC's Division of Enforcement
recently commenced an investigation into the Company's use of directed
brokerage. The Hartford continues to cooperate
fully with the SEC, the New York Attorney General's Office and other regulatory
agencies.
The Company's mutual funds are available for purchase by the separate accounts
of different variable life insurance policies, variable annuity products, and
funding agreements, and they are offered directly to certain qualified
retirement plans. Although existing products contain transfer restrictions
between subaccounts, some products, particularly older variable annuity
products, do not contain restrictions on the frequency of transfers. In
addition, as a result of the settlement of litigation against the Company with
respect to certain owners of older variable annuity products, the Company's
ability to restrict transfers by these owners is limited.
A number of companies have announced settlements of enforcement actions with
various regulatory agencies, primarily the SEC and the New York Attorney
General's Office, which have included a range of monetary penalties and
restitution. While no such action has been initiated against the Company, it is
possible that the SEC, the New York Attorney General's Office or other
regulatory agencies may pursue action against the Company in the future. The
potential timing of any such action is difficult to predict. If such an action
is brought, it could have a material adverse effect on the Company.
On October 21, 2004, the Financial Services Agency ("FSA"), the Company's
primary regulator in Japan, issued regulations concerning new reserving
methodologies and Solvency Margin Ratio ("SMR") standards for variable annuity
contracts. The regulations are scheduled to become effective on April 1, 2005.
The regulations propose a "Standard" methodology and allow for an "Alternative"
methodology to determine required reserve levels and SMR standards. The FSA
plans to issue detailed administrative guidelines by the end of 2004 that will
describe the requirements for the permissible "Alternative" methodology.
The Company through the American Council of Life Insurers (ACLI), along with the
European Business Community, and the Canadian Life and Health Insurance
Association Inc. (CLHIA), has presented a joint proposal for adoption as the
"Alternative" methodology to the FSA. The proposal reflects the methodologies
already adopted in Canada and forthcoming in the United States. The proposal
recognizes the complexity of principal guarantees offered in variable annuities
and encourages insurance companies to conduct risk management in a more precise
and comprehensive manner based on each product's unique features and changing
market risk. The joint proposal requires significantly less capital than the
Standard Methodology in many situations but, depending on product design and
economic conditions, the joint proposal may require additional capital in other
situations.
Although the new reserve methodologies and SMR standards would only apply to
capital requirements for Japanese regulatory purposes, and are not directly
related to results under accounting principles generally accepted in the United
States of America, it is likely that the Company will need to provide additional
capital to support its Japanese operations, which would lower the Company's
return on invested capital for this business. Management is still evaluating the
impact of the regulations on the Company's Japanese operations. At this point in
time, based on the Company's preliminary assessment, the Standard methodology
would require $400-$650 of additional capital during 2005. This estimate assumes
the Company employs various capital strategies which may include but not be
limited to product re-filing, hedging and other capital management strategies.
Adoption of an "Alternative" methodology based on the joint proposal described
above would require significantly less capital in most scenarios.
Any additional capital required will be obtained by redeploying capital from the
Company's domestic Life operating companies to the Company's Japanese
subsidiary, Hartford Life Insurance, KK. Based on preliminary estimates under
the "Standard" methodology and current circumstances, the impact on the capital
adequacy of the domestic life operating companies for U.S. regulatory and rating
agency risk based capital would be between $100 and $275.
The Company, industry organizations and Institute of Actuaries of Japan ("IAJ")
have been consulting with the regulators on the development of the "Alternative"
methodology and SMR standards. The final guidelines may or may not reflect
recommendations by the industry, the IAJ or others. Since the administrative
guidelines for the "Standard" and the "Alternative" methodologies have not yet
been specified, at this time it is not possible to predict the final form of any
reserve methodology or SMR standard change. Participants in the Japanese market,
including the Company, may need to reassess certain product terms and features
depending on outcome of the final guidelines. This could have an impact on the
Company's sales.
For further information on other contingencies, see Note 14 of Notes to
Consolidated Financial Statements included in the Company's 2003 Form 10-K
Annual Report.
41
Tax Matters -- Prior to the Tax Reform Act of 1984, the Life Insurance Company
Income Tax Act of 1959 permitted the deferral from taxation of a portion of
statutory income under certain circumstances. In these situations, the deferred
income was accumulated in a "Policyholders' Surplus Account" and, would be
taxable only under conditions which management considered to be remote;
therefore, no federal income taxes have been provided on the balance in this
account, which for tax return purposes was $104 as of September 30, 2004. In
October 2004, the American Jobs Creation Act of 2004 was passed by the Congress,
and the bill was signed by the President on October 22, 2004. This legislation
allows distributions to be made from the Policyholders' Surplus Account free of
tax in 2005 and 2006. The Company anticipates that, based on currently available
information, this change will permanently eliminate the tax of $37 on this
deferred income.
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-15(e)) 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-15(e) as of
September 30, 2004.
CHANGE IN INTERNAL CONTROL OVER FINANCIAL REPORTING
There was no change in the Company's internal control over financial reporting
that occurred during the third quarter of 2004 that has materially affected, or
is reasonably likely to materially affect, the Company's internal control over
financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Hartford Life is or may become involved in various legal actions, in the normal
course of its business, in which claims for alleged economic and punitive
damages have been or may be asserted, some for substantial amounts. Some of the
pending litigation has been filed as purported class actions and some actions
have been filed in certain jurisdictions that permit punitive damage awards that
are disproportionate to the actual damages incurred. Although there can be no
assurances, at the present time, the Company does not anticipate that the
ultimate liability arising from potential, pending or threatened legal actions,
after consideration of provisions made for estimated losses and costs of
defense, will have a material adverse effect on the financial condition or
operating results of the Company. Nonetheless, given the large or indeterminate
amounts sought in certain of these actions, and the inherent unpredictability of
litigation, it is possible that an adverse outcome in certain matters could,
from time to time, have a material adverse effect on the Company's consolidated
results of operations or cash flows in particular quarterly or annual periods.
Broker Compensation Litigation - On October 14, 2004, the New York Attorney
General's Office filed a civil complaint (the "NYAG Complaint") against Marsh
Inc. and Marsh & McLennan Companies, Inc. (collectively, "Marsh") alleging,
among other things, that certain insurance companies, including The Hartford,
participated with Marsh in arrangements to submit inflated bids for business
insurance and paid contingent commissions to ensure that Marsh would direct
business to them. The Hartford is not joined as a defendant in the action. Since
the filing of the NYAG Complaint, the Company has become aware of several
private actions against it asserting claims arising from the allegations of the
NYAG Complaint.
The Company is aware of two securities class actions filed in the United States
District Court for the District of Connecticut alleging claims against The
Hartford and five of its executive officers under Section 10(b) of the
Securities Exchange Act and SEC Rule 10b-5. The complaints allege on behalf of a
putative class of shareholders that The Hartford and the five named individual
defendants, as control persons of the Company, "disseminated false and
misleading financial statements" by concealing that "[The Hartford] was paying
illegal and concealed `contingent commissions' pursuant to illegal `contingent
commission agreements.'" The class period alleged is November 5, 2003 through
October 13, 2004, the day before the NYAG Complaint was filed. The complaints
seek damages and attorneys' fees. The Hartford and the individual defendants
dispute the allegations and intend to defend these actions vigorously.
42
In addition, the Company is aware of three putative class actions filed in the
same court on behalf of participants in the Company's 401(k) plan against The
Hartford, Hartford Fire Insurance Company, The Hartford's Pension Fund Trust and
Investment Committee, The Hartford's Pension Administration Committee, The
Hartford's Chief Financial Officer, and John/Jane Does 1-15. The suits assert
claims under the Employee Retirement Income Security Act of 1974, as amended
("ERISA"), alleging that The Hartford and the other named defendants breached
their fiduciary duties to plan participants by, among other things, failing to
inform them of the risk associated with investment in The Hartford's stock as a
result of the activity alleged in the NYAG Complaint. The class period alleged
is November 5, 2003 through the present. The complaints seek restitution of
losses to the plan, declaratory and injunctive relief, and attorneys' fees. All
defendants dispute the allegations and intend to defend these actions
vigorously.
The Company also is aware of two corporate derivative actions filed in the same
court. The complaints, brought in each case by a shareholder on behalf of The
Hartford against its directors and an executive officer, allege that the
defendants knew adverse non-public information about the activities alleged in
the NYAG Complaint and concealed and misappropriated that information to make
profitable stock trades, thereby breaching their fiduciary duties, abusing their
control, committing gross mismanagement, wasting corporate assets, and unjustly
enriching themselves. The complaints seek damages, injunctive relief,
disgorgement, and attorneys' fees. All defendants dispute the allegations and
intend to defend these actions vigorously.
The Company also is aware of an amended complaint filed on or about October 19,
2004 by OptiCare Health Systems, Inc., on behalf of a putative class of
policyholders, against Marsh, other brokers and consultants, and the insurers
named in the NYAG Complaint, including certain of their respective writing
companies. The putative class action was filed in August 2004 in the United
States District Court for the Southern District of New York and originally
asserted only claims against the broker/consultant defendants. The amended
complaint alleges additional claims against both the broker/consultant
defendants and the insurer defendants. These claims include a claim under the
Racketeer Influenced and Corrupt Organizations Act ("RICO") alleging that the
insurer defendants are co-liable with the broker/consultant defendants for
alleged misrepresentations or non-disclosures of contingent commission
agreements and the solicitation or submission of inflated bids. The amended
complaint also asserts claims under the Sherman Act and state antitrust and
unfair competition laws alleging that the insurer defendants acted in concert
with the broker/consultant defendants to restrain trade. The class period
alleged is August 26, 1994 through the date of class certification, which has
not yet occurred. The amended complaint seeks treble damages, injunctive and
declaratory relief, and attorneys' fees. The Hartford disputes the allegations
in the amended complaint and intends to defend the action vigorously.
Additional complaints may be filed against the Company in various courts
alleging claims under federal or state law arising from the conduct alleged in
the NYAG Complaint. The Company's ultimate liability, if any, in the pending and
possible future suits is highly uncertain and subject to contingencies that are
not yet known, such as how many suits will be filed, in which courts they will
be lodged, what claims they will assert, what the outcome of investigations by
the New York Attorney General's Office and other regulatory agencies will be,
the success of defenses that the Company may assert, and the amount of
recoverable damages if liability is established. In the opinion of management,
it is possible that an adverse outcome in one or more of these suits could have
a material adverse effect on the Company's consolidated results of operations or
cash flows in particular quarterly or annual periods.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits - See Exhibit Index.
(b) Reports on Form 8-K: None
43
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HARTFORD LIFE, INC.
/s/ Ernest M. McNeill Jr.
---------------------------------------------
Ernest M. McNeill Jr.
Vice President and Chief Accounting Officer
November 10, 2004
44
HARTFORD LIFE, INC. AND SUBSIDIARIES
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004
EXHIBITS INDEX
EXHIBIT #
- ---------
15.01 Deloitte & Touche LLP Letter of Awareness
31.01 Section 302 Certification of Thomas M. Marra
31.02 Section 302 Certification of Lizabeth H. Zlatkus
32.01 Section 906 Certification of Thomas M. Marra
32.02 Section 906 Certification of Lizabeth H. Zlatkus
45