Attached files
file | filename |
---|---|
EX-32.01 - EX-32.01 - TALCOTT RESOLUTION LIFE INSURANCE CO | y85874exv32w01.htm |
EX-31.01 - EX-31.01 - TALCOTT RESOLUTION LIFE INSURANCE CO | y85874exv31w01.htm |
EX-15.01 - EX-15.01 - TALCOTT RESOLUTION LIFE INSURANCE CO | y85874exv15w01.htm |
EX-32.02 - EX-32.02 - TALCOTT RESOLUTION LIFE INSURANCE CO | y85874exv32w02.htm |
EX-12.01 - EX-12.01 - TALCOTT RESOLUTION LIFE INSURANCE CO | y85874exv12w01.htm |
EX-31.02 - EX-31.02 - TALCOTT RESOLUTION LIFE INSURANCE CO | y85874exv31w02.htm |
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
þ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended June 30, 2010
OR
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from
to
Commission file number 001-32293
HARTFORD LIFE INSURANCE COMPANY
(Exact name of registrant as specified in its charter)
Connecticut | 06-0974148 | |
(State or other jurisdiction of | (I.R.S. Employer | |
Incorporation or organization) | Identification No.) |
200 Hopmeadow Street, Simsbury, Connecticut 06089
(Address of principal executive offices)
(Address of principal executive offices)
(860) 547-5000
(Registrants telephone number, including area code)
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and (2) has been
subject to such filing requirements for the past 90 days.
Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its
corporate Web site, if any, every Interactive Data File required to be submitted and posted
pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files).
Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated filer, or a smaller reporting company. See the definitions of large accelerated
filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.
(Check one):
Large accelerated filer o | Accelerated filer o | Non-accelerated filer þ | Smaller reporting company o | |||
(Do not check if a smaller reporting company) |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act)
Yes o No þ
As of July 30, 2010 there were outstanding 1,000 shares of Common Stock, $5,690 par value per
share, of the registrant, all of which were directly owned by Hartford Life and Accident Insurance
Company. The Hartford Financial Services Group, Inc. is the ultimate parent of the registrant.
The registrant meets the conditions set forth in General Instruction H (1) (a) and (b) of Form 10-Q
and is therefore filing this form with the reduced disclosure format
INDEX
Page | ||||||||
PART I. FINANCIAL INFORMATION |
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EX-12.01 | ||||||||
EX-15.01 | ||||||||
EX-31.01 | ||||||||
EX-31.02 | ||||||||
EX-32.01 | ||||||||
EX-32.02 |
2
Table of Contents
Forward
- Looking Statements
Certain of the statements contained herein are forward-looking statements made pursuant to the safe
harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking
statements can be identified by words such as anticipates, intends, plans, seeks,
believes, estimates, expects, projects, and similar references to future periods.
Forward-looking statements are based on our current expectations and assumptions regarding
economic, competitive and legislative developments. Because forward-looking statements relate to
the future, they are subject to inherent uncertainties, risks and changes in circumstances that are
difficult to predict. They have been made based upon managements expectations and beliefs
concerning future developments and their potential effect upon Hartford Life Insurance Company
(the Company). Future developments may not be in line with managements expectations or have
unanticipated effects. Actual results could differ materially from expectations, depending on the
evolution of various factors, including those set forth in Part I, Item 1A, Risk Factors in the
Companys 2009 Form 10-K Annual Report, Part II, Item 1A, Risk Factors of the Companys Quarterly
Report on Form 10-Q for the quarter ended March 31, 2010, as well as in Part II, Item 1A Risk
Factors of this Form 10-Q. These important risks and uncertainties include:
| risks and uncertainties related to the Companys current operating environment, which reflects continued volatility in financial markets, constrained capital and credit markets and uncertainty about the strength of an economic recovery and the impact of U.S. and other governmental stimulus, budgetary and legislative initiatives, and whether managements efforts to identify and address these risks will be timely and effective; | |
| risks associated with our continued execution of steps to realign our business and reposition our investment portfolio, including the potential need to take other actions, such as divestitures; | |
| market risks associated with our business, including changes in interest rates, credit spreads, equity prices, and foreign exchange rates, as well as challenging or deteriorating conditions in key sectors such as the commercial real estate market, that have pressured our results and have continued to do so in 2010; | |
| volatility in our earnings resulting from our adjustment of our risk management program to emphasize protection of statutory surplus; | |
| the impact on our statutory capital of various factors, including many that are outside the Companys control, which can in turn affect our credit and financial strength ratings, cost of capital, regulatory compliance and other aspects of our business and results; | |
| risks to our business, financial position, prospects and results associated with negative ratings actions or downgrades in the Companys financial strength and credit ratings or negative rating actions or downgrades relating to our investments; | |
| the potential for differing interpretations of the methodologies, estimations and assumptions that underlie the valuation of the Companys financial instruments that could result in changes to investment valuations; | |
| the subjective determinations that underlie the Companys evaluation of other-than-temporary impairments on available-for-sale securities; | |
| losses due to nonperformance or defaults by others; | |
| the potential for further acceleration of deferred policy acquisition cost amortization; | |
| the potential for further impairments of our goodwill or the potential for establishing valuation allowances against deferred tax assets; | |
| the possible occurrence of terrorist attacks and the Companys ability to contain its exposure, including the effect of the absence or insufficiency of applicable terrorism legislation on coverage; | |
| the possibility of a pandemic or man-made disaster that may adversely affect the financial condition of the Companys businesses and cost and availability of reinsurance; | |
| weather and other natural physical events, including the severity and frequency of storms, hail, snowfall and other winter conditions, natural disasters such as hurricanes and earthquakes, as well as climate change, including effects on weather patterns, greenhouse gases, sea, land and air temperatures, sea levels, rain and snow; |
3
Table of Contents
| the response of reinsurance companies under reinsurance contracts and the availability, pricing and adequacy of reinsurance to protect the Company against losses; | |
| the possibility of unfavorable loss development; | |
| actions by our competitors, many of which are larger or have greater financial resources than we do; | |
| the restrictions, oversight, costs and other consequences of our parent, The Hartford Financial Services Group, Inc. (The Hartford), being a savings and loan holding company, including from the supervision, regulation and examination by the Office of Thrift Supervision (the OTS), and in the future, as a result of the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act), The Federal Reserve and the Office of the Controller of the Currency as regulator of Federal Trust Bank, and arising from our participation in the Capital Purchase Program (the CPP), under the Emergency Economic Stabilization Act of 2008, certain elements of which will continue to apply to The Hartford for so long as the U.S. Department of the Treasury (Treasury), holds the warrant or shares of The Hartfords common stock received on exercise of the warrant that The Hartford issued as part of its participation in the CPP; | |
| the potential effect of domestic and foreign regulatory developments, including those that could adversely impact the demand for the Companys products, operating costs and required capital levels, including changes to statutory reserves and/or risk-based capital requirements related to secondary guarantees under universal life and variable annuity products; | |
| the cost and other effects of increased regulation as a result of the enactment of the Dodd-Frank Act, which will, among other effects, vest a newly created Financial Services Oversight Council with the power to designate systemically important institutions, require central clearing of, and/or impose new margin and capital requirements on, derivatives transactions, and as a savings and loan holding company, may affect The Hartfords ability to manage our general account by limiting or eliminating investments in certain private equity and hedge funds; | |
| the Companys ability to distribute its products through distribution channels, both current and future; | |
| the uncertain effects of emerging claim and coverage issues; | |
| the ability of the Companys subsidiaries to pay dividends to the Company; | |
| the risk that our framework for managing business risks may not be effective in mitigating risk and loss to us that could adversely affect our business; | |
| the Companys ability to maintain the availability of its systems and safeguard the security of its data in the event of a disaster or other unanticipated events; | |
| the potential for difficulties arising from outsourcing relationships; | |
| the impact of potential changes in federal or state tax laws, including changes affecting the availability of the separate account dividend received deduction; | |
| the impact of potential changes in accounting principles and related financial reporting requirements; | |
| the Companys ability to protect its intellectual property and defend against claims of infringement; | |
| unfavorable judicial or legislative developments; | |
| other factors described in such forward-looking statements. |
Any forward-looking statement made by us in this document speaks only as of the date of the filing
of this Form 10-Q. Factors or events that could cause our actual results to differ may emerge from
time to time, and it is not possible for us to predict all of them. We undertake no obligation to
publicly update any forward-looking statement, whether as a result of new information, future
developments or otherwise.
4
Table of Contents
Item I. FINANCIAL STATEMENTS
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholder of
Hartford Life Insurance Company
Hartford, Connecticut
Hartford Life Insurance Company
Hartford, Connecticut
We have reviewed the accompanying condensed consolidated balance sheet of Hartford Life Insurance
Company and subsidiaries (the Company) as of June 30, 2010, and the related condensed
consolidated statements of operations for the three-month and six-month periods ended June 30, 2010
and 2009, and changes in stockholders equity and cash flows for the six-month periods ended June
30, 2010 and 2009. These interim financial statements are the responsibility of the Companys
management.
We conducted our reviews in accordance with the standards of the Public Company Accounting
Oversight Board (United States). A review of interim financial information consists principally of
applying analytical procedures and making inquiries of persons responsible for financial and
accounting matters. It is substantially less in scope than an audit conducted in accordance with
the standards of the Public Company Accounting Oversight Board (United States), the objective of
which is the expression of an opinion regarding the financial statements taken as a whole.
Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should be made to such
condensed consolidated interim financial statements for them to be in conformity with accounting
principles generally accepted in the United States of America.
We have previously audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheet of the Company as of December 31,
2009, and the related consolidated statements of operations, changes in stockholders equity, and
cash flows for the year then ended (not presented herein); and in our report dated February 23,
2010, (which report includes an explanatory paragraph relating to the Companys change in its
method of accounting and reporting for other-than-temporary impairments in 2009 and for the fair
value measurement of financial instruments in 2008), we expressed an unqualified opinion on those
consolidated financial statements. In our opinion, the information set forth in the accompanying
condensed consolidated balance sheet as of December 31, 2009 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
August 4, 2010
5
Table of Contents
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
Three Months ended | Six Months ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
(In millions) | 2010 | 2009 | 2010 | 2009 | ||||||||||||
(Unaudited) | (Unaudited) | |||||||||||||||
Revenues |
||||||||||||||||
Fee income and other |
$ | 960 | $ | 823 | $ | 1,920 | $ | 1,787 | ||||||||
Earned premiums |
62 | 96 | 117 | 336 | ||||||||||||
Net investment income (loss) |
||||||||||||||||
Securities available-for-sale and other |
690 | 644 | 1,327 | 1,237 | ||||||||||||
Equity securities, trading |
(105 | ) | 120 | 13 | 9 | |||||||||||
Total net investment income |
585 | 764 | 1,340 | 1,246 | ||||||||||||
Net realized capital gains (losses): |
||||||||||||||||
Total other-than-temporary impairment (OTTI) losses |
(247 | ) | (411 | ) | (563 | ) | (590 | ) | ||||||||
OTTI losses recognized in other comprehensive income |
158 | 157 | 337 | 157 | ||||||||||||
Net OTTI losses recognized in earnings |
(89 | ) | (254 | ) | (226 | ) | (433 | ) | ||||||||
Net realized capital gains (losses), excluding net OTTI losses
recognized in earnings |
694 | 285 | 317 | 1,927 | ||||||||||||
Total net realized capital gains (losses) |
605 | 31 | 91 | 1,494 | ||||||||||||
Total revenues |
2,212 | 1,714 | 3,468 | 4,863 | ||||||||||||
Benefits, losses and expenses |
||||||||||||||||
Benefits, losses and loss adjustment expenses |
851 | 662 | 1,578 | 2,325 | ||||||||||||
Benefits, loss and loss adjustment expenses returns credited on
International unit-linked bonds and pension products |
(105 | ) | 120 | 13 | 9 | |||||||||||
Insurance operating costs and other expenses |
1,518 | 449 | 1,851 | 888 | ||||||||||||
Amortization of deferred policy acquisition costs and present value
of future profits |
134 | 167 | 202 | 1,699 | ||||||||||||
Dividends to policyholders |
5 | 5 | 7 | 11 | ||||||||||||
Total benefits, losses and expenses |
2,403 | 1,403 | 3,651 | 4,932 | ||||||||||||
Income (loss) before income tax expense (benefit) |
(191 | ) | 311 | (183 | ) | (69 | ) | |||||||||
Income tax expense (benefit) |
(106 | ) | 94 | (90 | ) | (78 | ) | |||||||||
Net income (loss) |
(85 | ) | 217 | (93 | ) | 9 | ||||||||||
Less: Net (income) loss attributable to the noncontrolling interest |
(3 | ) | (1 | ) | (5 | ) | (6 | ) | ||||||||
Net income (loss) attributable to shareholder |
$ | (88 | ) | $ | 216 | $ | (98 | ) | $ | 3 | ||||||
See Notes to Condensed Consolidated Financial Statements
6
Table of Contents
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
June 30, | December 31, | |||||||
(In millions, except for share data) | 2010 | 2009 | ||||||
(Unaudited) | ||||||||
Assets |
||||||||
Investments |
||||||||
Fixed maturities, available for sale, at fair value (amortized cost of $46,388 and $44,284)
(includes variable interest entity assets , at fair value, of $842 as of June 30, 2010) |
$ | 45,011 | $ | 40,403 | ||||
Equity securities, trading, at fair value (cost of $2,063 and $2,359) |
2,101 | 2,443 | ||||||
Equity securities, available-for-sale, at fair value (cost of $400 and $447) |
372 | 419 | ||||||
Mortgage loans (net of allowance for loan losses of $88 and $260) |
3,325 | 4,304 | ||||||
Policy loans, at outstanding balance |
2,129 | 2,120 | ||||||
Limited partnership and other alternative investments (includes variable entity assets of $22
as of June 30, 2010) |
782 | 759 | ||||||
Other investments |
2,098 | 338 | ||||||
Short-term investments |
4,545 | 5,128 | ||||||
Total investments |
60,363 | 55,914 | ||||||
Cash |
476 | 793 | ||||||
Premiums receivable and agents balances |
68 | 69 | ||||||
Reinsurance recoverables |
4,543 | 3,140 | ||||||
Deferred policy acquisition costs and present value of future profits |
5,045 | 5,779 | ||||||
Deferred income taxes, net |
2,805 | 3,066 | ||||||
Goodwill |
470 | 470 | ||||||
Other assets |
2,860 | 1,709 | ||||||
Separate account assets |
154,870 | 150,380 | ||||||
Total assets |
$ | 231,500 | $ | 221,320 | ||||
Liabilities |
||||||||
Reserve for future policy benefits and unpaid losses and loss adjustment expenses |
11,680 | 11,318 | ||||||
Other policyholder funds and benefits payable |
44,467 | 43,526 | ||||||
Other policyholder funds and benefits payable International unit-linked bonds and pension
products |
2,078 | 2,419 | ||||||
Consumer notes |
452 | 1,136 | ||||||
Other liabilities (including variable interest entity liabilities of $470 as of June 30, 2010) |
10,604 | 6,245 | ||||||
Separate account liabilities |
154,870 | 150,380 | ||||||
Total liabilities |
$ | 224,151 | $ | 215,024 | ||||
Commitments and Contingencies (Note 9) |
||||||||
Equity |
||||||||
Common stock - 1,000 shares authorized, issued and outstanding, par value $5,690 |
6 | 6 | ||||||
Capital surplus |
8,459 | 8,457 | ||||||
Accumulated other comprehensive loss, net of tax |
(757 | ) | (1,941 | ) | ||||
Retained earnings |
(359 | ) | (287 | ) | ||||
Total stockholders equity |
7,349 | 6,235 | ||||||
Noncontrolling interest |
| 61 | ||||||
Total equity |
7,349 | 6,296 | ||||||
Total liabilities and stockholders equity |
$ | 231,500 | $ | 221,320 | ||||
See Notes to Condensed Consolidated Financial Statements
7
Table of Contents
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
Condensed Consolidated Statements Of Changes in Stockholders Equity
Accumulated Other | ||||||||||||||||||||||||||||||||||||
Comprehensive Income (Loss) | ||||||||||||||||||||||||||||||||||||
Net | ||||||||||||||||||||||||||||||||||||
Unrealized | ||||||||||||||||||||||||||||||||||||
Capital | Net (Loss) | |||||||||||||||||||||||||||||||||||
Gains | Gain On | |||||||||||||||||||||||||||||||||||
(Losses) | Cash Flow | Foreign | ||||||||||||||||||||||||||||||||||
Additional | On | Hedging | Currency | Non- | ||||||||||||||||||||||||||||||||
(Unaudited) | Common | Paid In | Securities, | Instruments, | Translation | Retained | Total | Controlling | Total | |||||||||||||||||||||||||||
(In millions) | Stock | Capital | Net of Tax | Net of Tax | Adjustments | Earnings | S.E. | Interest | Equity | |||||||||||||||||||||||||||
Six months ended June 30, 2010 |
||||||||||||||||||||||||||||||||||||
Balance, December 31, 2009 |
$ | 6 | $ | 8,457 | $ | (2,039 | ) | $ | 148 | $ | (50 | ) | $ | (287 | ) | $ | 6,235 | $ | 61 | $ | 6,296 | |||||||||||||||
Comprehensive income |
||||||||||||||||||||||||||||||||||||
Net income (loss) |
(98 | ) | (98 | ) | (98 | ) | ||||||||||||||||||||||||||||||
Other comprehensive income, net
of tax (1) |
||||||||||||||||||||||||||||||||||||
Net change in unrealized capital
losses on securities (2) |
1,058 | 1,058 | 1,058 | |||||||||||||||||||||||||||||||||
Net gains (losses) on cash flow
hedging instruments |
185 | 185 | 185 | |||||||||||||||||||||||||||||||||
Cumulative translation
adjustments |
(59 | ) | (59 | ) | (59 | ) | ||||||||||||||||||||||||||||||
Total other comprehensive income
(loss) |
1,184 | 1,184 | ||||||||||||||||||||||||||||||||||
Total comprehensive income (loss) |
1,086 | 1,086 | ||||||||||||||||||||||||||||||||||
Capital contribution from parent |
2 | 2 | 2 | |||||||||||||||||||||||||||||||||
Dividends declared |
| | | |||||||||||||||||||||||||||||||||
Cumulative effect of accounting
changes, net of DAC and tax |
26 | 26 | 26 | |||||||||||||||||||||||||||||||||
Change in noncontrolling
interest ownership |
(66 | ) | (66 | ) | ||||||||||||||||||||||||||||||||
Noncontrolling income (loss) |
5 | 5 | ||||||||||||||||||||||||||||||||||
Balance, June 30, 2010 |
$ | 6 | $ | 8,459 | $ | (981 | ) | $ | 333 | $ | (109 | ) | $ | (359 | ) | $ | 7,349 | $ | 0 | $ | 7,349 | |||||||||||||||
Six months ended June 30, 2009 |
||||||||||||||||||||||||||||||||||||
Balance, December 31, 2008 |
$ | 6 | $ | 6,157 | $ | (4,806 | ) | $ | 440 | $ | (165 | ) | $ | 1,446 | $ | 3,078 | $ | 165 | $ | 3,243 | ||||||||||||||||
Comprehensive income |
||||||||||||||||||||||||||||||||||||
Net income (loss) |
3 | 3 | 3 | |||||||||||||||||||||||||||||||||
Other comprehensive income, net
of tax (1) |
||||||||||||||||||||||||||||||||||||
Net change in unrealized capital
gains on securities (2) |
1,163 | 1,163 | 1,163 | |||||||||||||||||||||||||||||||||
Net losses on cash flow hedging
instruments |
(273 | ) | (273 | ) | (273 | ) | ||||||||||||||||||||||||||||||
Cumulative translation
adjustments |
117 | 117 | 117 | |||||||||||||||||||||||||||||||||
Total other comprehensive income
(loss) |
1,007 | 1,007 | ||||||||||||||||||||||||||||||||||
Total comprehensive income (loss) |
1,010 | 1,010 | ||||||||||||||||||||||||||||||||||
Capital contribution from parent |
908 | 908 | 908 | |||||||||||||||||||||||||||||||||
Dividends declared |
(39 | ) | (39 | ) | (39 | ) | ||||||||||||||||||||||||||||||
Cumulative effect of accounting
changes, net of tax |
(462 | ) | 462 | | | |||||||||||||||||||||||||||||||
Change in noncontrolling
interest ownership |
(84 | ) | (84 | ) | ||||||||||||||||||||||||||||||||
Noncontrolling income (loss) |
6 | 6 | ||||||||||||||||||||||||||||||||||
Balance, June 30, 2009 |
$ | 6 | $ | 7,065 | $ | (4,105 | ) | $ | 167 | $ | (48 | ) | $ | 1,872 | $ | 4,957 | $ | 87 | $ | 5,044 | ||||||||||||||||
(1) | Net change in unrealized capital gains on securities is reflected net of tax benefit and other items of $(570) and $(626) for the six months ended June 30, 2010 and 2009, respectively. There is no tax effect on cumulative translation adjustments. | |
(2) | There were reclassification adjustments for after-tax gains (losses) realized in net income of $(23) and $(443) for the six months ended June 30, 2010 and 2009, respectively. |
See Notes to Condensed Consolidated Financial Statements
8
Table of Contents
HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
Six months ended June 30, | ||||||||
(In millions) | 2010 | 2009 | ||||||
(Unaudited) | ||||||||
Operating Activities |
||||||||
Net income (loss) |
$ | (93 | ) | $ | 9 | |||
Adjustments to reconcile net income to net cash provided by operating activities |
||||||||
Amortization of deferred policy acquisition costs and present value of future profits |
202 | 1,699 | ||||||
Additions to deferred policy acquisition costs and present value of future profits |
(254 | ) | (366 | ) | ||||
Change in: |
||||||||
Reserve for future policy benefits and unpaid losses and loss adjustment expenses |
109 | 1,012 | ||||||
Reinsurance recoverables |
(6 | ) | (300 | ) | ||||
Receivables and other assets |
(84 | ) | 4 | |||||
Payables and accruals |
1,087 | (380 | ) | |||||
Accrued and deferred income taxes |
68 | 513 | ||||||
Net realized capital losses |
(91 | ) | (1,494 | ) | ||||
Net receipts from investment contracts related to policyholder funds International unit-linked
bonds and pension products |
(342 | ) | 357 | |||||
Net increase in equity securities held for trading |
342 | (365 | ) | |||||
Depreciation and amortization |
111 | 95 | ||||||
Other, net |
(101 | ) | 35 | |||||
Net cash provided by operating activities |
948 | 819 | ||||||
Investing Activities |
||||||||
Proceeds from the sale/maturity/prepayment of: |
||||||||
Fixed maturities and short-term investments, available-for-sale |
11,871 | 25,703 | ||||||
Equity securities, available-for-sale |
99 | 100 | ||||||
Mortgage loans |
1,020 | 255 | ||||||
Partnerships |
90 | 111 | ||||||
Proceeds from business sold |
130 | | ||||||
Payments for the purchase of: |
||||||||
Fixed maturities and short-term investments, available-for-sale |
(12,976 | ) | (25,507 | ) | ||||
Equity securities, available-for-sale |
(84 | ) | (32 | ) | ||||
Mortgage loans |
(29 | ) | (183 | ) | ||||
Partnerships |
(66 | ) | (70 | ) | ||||
Purchase price of business acquired |
| (8 | ) | |||||
Change in policy loans, net |
(9 | ) | 3 | |||||
Change in payables for collateral under securities lending, net |
(46 | ) | (1,142 | ) | ||||
Derivatives, net |
484 | 24 | ||||||
Change in all other, net |
3 | 120 | ||||||
Net cash provided by (used for) investing activities |
487 | (626 | ) | |||||
Financing Activities |
||||||||
Deposits and other additions to investment and universal life-type contracts |
8,769 | 5,742 | ||||||
Withdrawals and other deductions from investment and universal life-type contracts |
(13,848 | ) | (9,685 | ) | ||||
Net transfers from (to) separate accounts related to investment and universal life-type contracts |
4,010 | 3,249 | ||||||
Capital Contributions (1) |
| 821 | ||||||
Dividends paid (1) |
| (39 | ) | |||||
Net issuances/(Repayments) at maturity or settlement of consumer notes |
(683 | ) | (11 | ) | ||||
Net cash provided by (used for) financing activities |
(1,752 | ) | 77 | |||||
Impact of foreign exchange |
| 60 | ||||||
Net increase (decrease) in cash |
(317 | ) | 330 | |||||
Cash beginning of period |
793 | 661 | ||||||
Cash end of period |
$ | 476 | $ | 991 | ||||
Supplemental Disclosure of Cash Flow Information: |
||||||||
Net Cash Paid (Received) During the Period For: |
||||||||
Income taxes |
$ | (153 | ) | $ | (574 | ) |
Supplemental schedule of noncash operating and financing activities:
(1) | For the six months ended June 30, 2010, there were no noncash net dividends or capital contributions made or received. For the six months ended June 30, 2009, the Company made noncash net dividends of $6 to its parent company related to the guaranteed minimum income and accumulation benefit reinsurance agreements with Hartford Life Insurance K.K. (HLIKK) and received a noncash asset capital contribution of $87 from its parent during the Six months ended June 30, 2009. |
See Notes to Condensed Consolidated Financial Statements
9
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HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in millions, unless otherwise stated)
(unaudited)
(unaudited)
1. Basis of Presentation and Accounting Policies
Basis of Presentation
Hartford Life Insurance Company (together with its subsidiaries, HLIC, Company, we or our)
is a provider of insurance and investment products in the United States (U.S.) and is an indirect
wholly-owned subsidiary of The Hartford Financial Services Group, Inc. (The Hartford).
The Consolidated Financial Statements have been prepared on the basis of accounting principles
generally accepted in the United States of America (U.S. GAAP), which differ materially from the
accounting practices prescribed by various insurance regulatory authorities.
The accompanying condensed consolidated financial statements and notes as of June 30, 2010, and for
the three and six months ended June 30, 2010 and 2009 are unaudited. These financial statements
reflect all adjustments (consisting only of normal accruals) which are, in the opinion of
management, necessary for the fair presentation of the financial position, results of operations,
and cash flows for the interim periods. These condensed consolidated financial statements and notes
should be read in conjunction with the consolidated financial statements and notes thereto included
in The Companys 2009 Form 10-K Annual Report. The results of operations for the interim periods
should not be considered indicative of the results to be expected for the full year.
Consolidation
The Condensed Consolidated Financial Statements include the accounts of Hartford Life Insurance
Company, companies in which the Company directly or indirectly has a controlling financial interest
and those variable interest entities (VIEs) in which the Company is required to consolidate.
Entities in which HLIC has significant influence over the operating and financing decisions but are
not required to consolidate are reported using the equity method. For further information on VIEs,
see Note 4. Material intercompany transactions and balances between HLIC and its subsidiaries have
been eliminated.
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 U.S. GAAP, requires management to make
estimates and assumptions that affect the reported amounts of assets and liabilities and the
disclosure of contingent assets and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual results could differ
from those estimates.
The most significant estimates include those used in determining estimated gross profits used in
the valuation and amortization of assets and liabilities associated with variable annuity and other
universal life-type contracts; evaluation of other-than-temporary impairments on available-for-sale
securities and valuation allowances on investments; living benefits required to be fair valued;
goodwill impairment; valuation of investments and derivative instruments, valuation allowance on
deferred tax assets; and contingencies relating to corporate litigation and regulatory matters.
Certain of these estimates are particularly sensitive to market conditions, and deterioration
and/or volatility in the worldwide debt or equity markets could have a material impact on the
Consolidated Financial Statements.
Significant Accounting Policies
For a description of significant accounting policies, see Note 1 of the Notes to Consolidated
Financial Statements included in HLICs 2009 Form 10-K Annual Report, which should be read in
conjunction with these accompanying Condensed Consolidated Financial Statements.
10
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Adoption of New Accounting Standards
Variable Interest Entities
In June 2009, the Financial Accounting Standards Board (FASB) updated the guidance which amends
the consolidation requirements applicable to variable interest entities (VIE). Under this new
guidance, an entity would consolidate a VIE when the entity has both (a) the power to direct the
activities of a VIE that most significantly impact the entitys economic performance and (b) the
obligation to absorb losses of the entity that could potentially be significant to the VIE or the
right to receive benefits from the entity that could potentially be significant to the VIE. The
FASB also issued an amendment to this guidance in February 2010 which defers application of this
guidance to certain entities that apply specialized accounting guidance for investment companies.
The Company adopted this guidance on January 1, 2010. As a result of adoption, in addition to those
VIEs the Company consolidates under the previous guidance, the Company consolidated a Company
sponsored Collateralized Debt Obligation (CDO) electing the fair value option, and a Company
sponsored Collateralized Loan Obligation, at carrying values carried forward as if the Company had
been the primary beneficiary from the date the Company entered into the VIE arrangement. The impact
on the Companys Condensed Consolidated Balance Sheet as a result of adopting this new guidance was
an increase in assets of $432, an increase in liabilities of $406, and an increase in January 1,
2010 retained earnings, net of tax, of $26. The Company has investments in mutual funds, limited
partnerships and other alternative investments including hedge funds, mortgage and real estate
funds, mezzanine debt funds, and private equity and other funds which may be VIEs. The accounting
for these investments will remain unchanged as they fall within the scope of the deferral of this
new consolidation guidance. See Note 4 for further discussion.
Future Adoption of New Accounting Standards
Embedded Credit Derivatives
In March 2010, the FASB issued guidance clarifying the scope exception for credit derivatives
embedded within structured securities which may result in bifurcation of these credit derivatives.
Embedded credit derivatives resulting only from subordination of one financial instrument to
another continue to qualify for the exemption. As a result, investments with an embedded credit
derivative in a form other than the above mentioned subordination may need to be separately
accounted for as an embedded credit derivative, meaning that in changes in the fair value of the
embedded credit derivative are recorded in current period earnings. Upon adoption, an entity may
elect the fair value option, with changes in fair value of the investment in its entirety
recognized in earnings, rather than bifurcate the embedded credit derivative. The guidance is
effective, on a prospective basis only, for fiscal years and interim periods within those fiscal
years, beginning on or after June 15, 2010. The Company adopted this guidance on July 1, 2010, and
reclassified approximately $175, after-tax, of unrealized capital losses recorded in Accumulated
Other Comprehensive Income, to Retained Earnings.
Income Taxes
A reconciliation of the tax provision at the U.S. Federal statutory rate to the provision (benefit)
for income taxes is as follows:
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Tax expense (benefit) at the U.S. federal statutory rate |
$ | (67 | ) | $ | 109 | $ | (64 | ) | $ | (24 | ) | |||||
Dividends received deduction |
(39 | ) | (37 | ) | (78 | ) | (75 | ) | ||||||||
Foreign related investments |
| 20 | (3 | ) | 26 | |||||||||||
Investment valuation allowance |
| | 56 | | ||||||||||||
Other |
| 2 | (1 | ) | (5 | ) | ||||||||||
Income tax expense (benefit) |
(106 | ) | 94 | (90 | ) | (78 | ) | |||||||||
The separate account dividends received deduction (DRD) is estimated for the current year using information from the prior
year-end, adjusted for current year equity market performance and other appropriate factors,
including estimated levels of corporate dividend payments. The actual current year DRD can vary
from estimates based on, but not limited to, changes in eligible dividends received by the mutual
funds, amounts of distribution from these mutual funds, amounts of short-term capital gains at the
mutual fund level and the Companys taxable income before the DRD. Given recent financial markets
volatility, the Company is reviewing its DRD computations on a quarterly basis.
The Companys federal income tax returns are routinely audited by the Internal Revenue Service
(IRS) as part of the Hartfords consolidated tax return. Audits have been concluded for all
years through 2006. The audit of 2007 and 2008 commenced in the second quarter of 2010. In
addition, the Company is working with the IRS on a possible settlement of a DRD issue related to
prior periods which, if settled, may result in the booking of tax benefits. Such benefits are not
expected to be material to the statement of operations.
The Company has recorded a deferred tax asset valuation allowance that is adequate to reduce the
total deferred tax asset to an amount that will more likely than not be realized. The deferred tax
asset valuation allowance as of June 30, 2010 was approximately $137, which has not materially
changed from the first quarter of 2010. In assessing the need for a valuation allowance,
management considered future reversals of existing taxable temporary differences, future taxable
income exclusive of reversing temporary differences and carryforwards, and taxable income in prior
carry back years, as well as tax planning strategies that include holding debt
11
Table of Contents
securities with
market value losses until recovery, selling appreciated securities to offset capital losses, and
sales of certain corporate assets, including subsidiaries. Such tax planning strategies are viewed
by management as prudent and feasible and will be implemented
if necessary to realize the deferred tax asset. An increase in interest rates can adversely impact
the Companys tax planning strategies and in particular the Companys ability to utilize tax
benefits to offset certain previously recognized realized capital losses. Even under a separate
entity approach, the Company would not record an additional valuation allowance relating to
realized capital losses. Under a separate entity approach, the current tax benefit related to
any of the Companys tax attributes realized by virtue of its inclusion in The Hartfords
consolidated tax return would have been recorded directly to surplus rather than income. These
benefits would have been $0 and $79 for the six months ended June 30, 2010 and 2009, respectively.
2. Segment Information
Effective for first quarter 2010 reporting, Life made changes to its segments as described below.
Life changed its reporting structure to realign mutual funds businesses into Retirement from Global
Annuity U.S (formerly the Retail Products Group or Retail). In addition, certain fee revenue
and commission expenses associated with sales of non-proprietary products by a subsidiary
broker-dealer have been moved from Global Annuity U.S. to Other, with no impact on net income in
either Global Annuity U.S. or Other. The impact of these changes on the annual periods presented
in Hartford Life Insurance Companys 2009 Annual Report Form 10-K, which annual periods are not
contained in the accompanying interim financial statements, is disclosed in the following tables:
Revenues
Total earned premiums, fees and other considerations
As Reported in the | Realignment of | Movement of | Segment | |||||||||||||
2009 Annual Report | Mutual Fund | Non-Proprietary | Results, | |||||||||||||
on Form 10-K | Businesses | Product Results | As Revised | |||||||||||||
For the year ended December 31, 2009 |
||||||||||||||||
Global
Annuity U.S. (formerly Retail) |
$ | 2,110 | $ | (437 | ) | $ | (124 | ) | $ | 1,549 | ||||||
Retirement |
324 | 437 | | 761 | ||||||||||||
Life- Other |
292 | | 124 | 416 | ||||||||||||
For the year ended December 31, 2008 |
||||||||||||||||
Global
Annuity U.S. (formerly Retail) |
$ | 2,677 | $ | (589 | ) | $ | (150 | ) | $ | 1,938 | ||||||
Retirement |
338 | 589 | | 927 | ||||||||||||
Life- Other |
285 | | 150 | 435 | ||||||||||||
For the year ended December 31, 2007 |
||||||||||||||||
Global
Annuity U.S. (formerly Retail) |
$ | 2,977 | $ | (611 | ) | $ | (140 | ) | $ | 2,226 | ||||||
Retirement |
242 | 611 | | 853 | ||||||||||||
Life-Other |
221 | | 140 | 361 |
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Net Income (loss)
As Reported in the | Realignment of | Segment | ||||||||||
2009 Annual Report | Mutual Fund | Results, | ||||||||||
on Form 10-K | Businesses | As Revised | ||||||||||
For the year ended December 31, 2009 |
||||||||||||
Global
Annuity U.S. (formerly Retail) |
$ | (1,929 | ) | $ | (33 | ) | $ | (1,962 | ) | |||
Retirement |
(222 | ) | 33 | (189 | ) | |||||||
For the year ended December 31, 2008 |
||||||||||||
Global
Annuity U.S. (formerly Retail) |
$ | (1,248 | ) | $ | (36 | ) | $ | (1,284 | ) | |||
Retirement |
(157 | ) | 36 | (121 | ) | |||||||
For the year ended December 31, 2007 |
||||||||||||
Global
Annuity U.S. (formerly Retail) |
$ | 809 | $ | (64 | ) | $ | 745 | |||||
Retirement |
61 | 64 | 125 |
The
Company is organized into four reporting segments: Global Annuity U.S., Individual Life,
Retirement and Institutional. Lifes Other category includes: corporate items not directly
allocated to any of its reportable operating segments; intersegment eliminations; assumed and ceded
reinsurance of death and living benefits from The Hartfords Japan operations; certain direct group
life and group disability insurance that is ceded to an affiliate; as well as revenues and expenses
related to the sale of non-proprietary insurance and investment products by the Companys
broker-dealer subsidiaries; as well as other International operations.
Global
Annuity U.S. offers individual variable, fixed market value adjusted (MVA), and single
premium immediate annuities.
Retirement provides products and services to corporations pursuant to Section 401(k) and products
and services to municipalities and not-for-profit organizations under Section 457 and 403(b) of the
IRS code, as well as Retail mutual funds, Insurance Product mutual
funds, Investment only mutual
funds and 529 college savings plans.
Institutional, primarily offers institutional liability products, such as variable Private
Placement Life Insurance (PPLI) owned by corporations and high net worth individuals and stable
value products. Institutional continues to service existing customers of its suspended businesses,
which includes Leveraged PPLI, structured settlements and institutional annuities (primarily
terminal funding cases).
Individual Life sells a variety of life insurance products, including variable universal life,
universal life and term life.
The accounting policies of the reportable operating segments are the same as those described in the
summary of significant accounting policies in Note 1. The Company primarily evaluates performance
of its segments based on revenues, net income and the segments return on allocated capital. Each
operating segment is allocated corporate surplus as needed to support its business.
The Company charge direct operating expenses to the appropriate segment and allocates the majority
of indirect expenses to the segments under an intercompany expense arrangement. Inter-segment
revenues primarily occur between the Companys Other category and the reporting segments. These
amounts primarily include interest income on allocated surplus and interest charges on excess
separate account surplus. Consolidated net investment income is unaffected by such transactions.
For further discussion of the types of products offered by each segment, see Note 2 of Notes to the
Consolidated Financial Statements included in the Companys 2009 Form 10-K Annual Report filed on
February 23, 2010.
13
Table of Contents
The following tables represent summarized financial information concerning the Companys segments.
Three Months ended June 30, | Six Months ended June 30, | |||||||||||||||
Revenues by product line | 2010 | 2009 | 2010 | 2009 | ||||||||||||
Revenues |
||||||||||||||||
Life |
||||||||||||||||
Earned premiums, fees and other considerations |
||||||||||||||||
Global
Annuity U.S. |
||||||||||||||||
Individual Annuity: |
||||||||||||||||
Individual Variable Annuity |
$ | 429 | 313 | $ | 833 | 727 | ||||||||||
Fixed/MVA Annuity [1] |
2 | 2 | 5 | 1 | ||||||||||||
Total Global
Annuity U.S. |
431 | 315 | 838 | 728 | ||||||||||||
Individual Life |
||||||||||||||||
Variable Life |
101 | 109 | 203 | 273 | ||||||||||||
Universal Life |
97 | 91 | 196 | 180 | ||||||||||||
Term Life |
9 | 9 | 19 | 19 | ||||||||||||
Total Individual Life |
207 | 209 | 418 | 472 | ||||||||||||
Retirement |
||||||||||||||||
401(k) |
80 | 71 | 156 | 134 | ||||||||||||
403(b)/457 |
9 | 9 | 20 | 19 | ||||||||||||
Mutual funds |
121 | 102 | 242 | 189 | ||||||||||||
Other [2] |
33 | 3 | 64 | 6 | ||||||||||||
Total Retirement Division |
243 | 185 | 482 | 348 | ||||||||||||
Institutional |
||||||||||||||||
Institutional investment products |
5 | 81 | 20 | 298 | ||||||||||||
PPLI [3] |
41 | 31 | 82 | 65 | ||||||||||||
Total Institutional |
46 | 112 | 102 | 363 | ||||||||||||
Other |
95 | 98 | 197 | 212 | ||||||||||||
Total Life premiums, fees and considerations |
1,022 | 919 | 2,037 | 2,123 | ||||||||||||
Net investment income |
585 | 764 | 1,340 | 1,246 | ||||||||||||
Net realized capital gains (losses) |
605 | 31 | 91 | 1,494 | ||||||||||||
Total Life [4] |
$ | 2,212 | 1,714 | $ | 3,468 | 4,863 | ||||||||||
Three Months ended June 30, | Six Months ended June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Net Income (Loss) |
||||||||||||||||
Global
Annuity U.S. |
$ | (213 | ) | 187 | $ | (107 | ) | (559 | ) | |||||||
Individual Life |
80 | 14 | 96 | (7 | ) | |||||||||||
Retirement |
36 | (35 | ) | 55 | (122 | ) | ||||||||||
Institutional |
(3 | ) | (69 | ) | (94 | ) | (246 | ) | ||||||||
Other [4],[5] |
12 | 119 | (48 | ) | 937 | |||||||||||
Total net income (loss) |
$ | (88 | ) | 216 | $ | (98 | ) | 3 | ||||||||
[1] | Single premium immediate annuities were transferred from Institutional to Global Annuity U.S. effective January 1, 2010. | |
[2] | Includes Insurance Product, Investment Only, and Canadian mutual funds and 529 plan assets. | |
[3] | Includes leveraged PPLI transferred from Other effective January 1, 2010. | |
[4] | As of June 30, 2010 Other segment contains the free standing derivative associated with the GMIB, GMWB and GMAB reinsurance from the Companys affiliate, HLIKK. Effective October 1, 2009, HLAI entered into a modified coinsurance and coinsurance with funds withheld reinsurance agreement with an affiliated captive reinsurer, which passed this economic risk and reward related to the reinsured business to the affiliated captive reinsurer through modco adjustments | |
[5] | As of June 30, 2009, Other segment contains the free standing derivative associated with the GMIB, GMWB and GMAB reinsurance from the Companys affiliate, HLIKK. The reinsurance agreement is the primary driver of the revenue and net income (loss) for the Other segment. |
14
Table of Contents
3. Fair Value Measurements
Fair Value Disclosures
The following financial instruments are carried at fair value in the Companys Condensed
Consolidated Financial Statements: fixed maturities and equity securities, available-for-sale
(AFS), equity securities, trading, short-term investments, freestanding and embedded derivatives,
separate account assets and certain other liabilities.
The following section applies the fair value hierarchy and disclosure requirements for the
Companys financial instruments that are carried at fair value. The fair value hierarchy
prioritizes the inputs in the valuation techniques used to measure fair value into three broad
Levels (Level 1, 2 and 3).
Level 1
|
Observable inputs that reflect quoted prices for identical assets or liabilities in active markets that the Company has the ability to access at the measurement date. Level 1 securities include highly liquid U.S. Treasuries, money market funds and exchange traded equity and derivative securities. | |
Level 2
|
Observable inputs, other than quoted prices included in Level 1, for the asset or liability or prices for similar assets and liabilities. Most fixed maturities and preferred stocks are model priced by vendors using observable inputs and are classified within Level 2. Also included in the Level 2 category are derivative instruments that are priced using models with observable market inputs, including interest rate, foreign currency and certain credit default swap contracts and have no significant unobservable market inputs. | |
Level 3
|
Valuations that are derived from techniques in which one or more of the significant inputs are unobservable (including assumptions about risk). Level 3 securities include less liquid securities such as highly structured and/or lower quality asset-backed securities (ABS), commercial mortgage-backed securities (CMBS), commercial real estate (CRE) collateralized debt obligations (CDOs), residential mortgage-backed securities (RMBS) primarily backed by below-prime loans, and private placement securities. Also included in Level 3 are guaranteed product embedded and reinsurance derivatives and other complex derivative securities, including customized GMWB hedging derivatives, equity derivatives, long dated derivatives, swaps with optionality, certain complex credit derivatives and certain other liabilities. Because Level 3 fair values, by their nature, contain unobservable market inputs as there is little or no observable market for these assets and liabilities, considerable judgment is used to determine the Level 3 fair values. Level 3 fair values represent the Companys best estimate of an amount that could be realized in a current market exchange absent actual market exchanges. |
In many situations, inputs used to measure the fair value of an asset or liability position may
fall into different levels of the fair value hierarchy. In these situations, the Company will
determine the level in which the fair value falls based upon the lowest level input that is
significant to the determination of the fair value. Transfers of securities among the levels occur
at the beginning of the reporting period. Transfers between Level 1 and Level 2 were not material
for the three and six months ended June 30, 2010. In most cases, both observable (e.g., changes in
interest rates) and unobservable (e.g., changes in risk assumptions) inputs are used in the
determination of fair values that the Company has classified within Level 3. Consequently, these
values and the related gains and losses are based upon both observable and unobservable inputs. The
Companys fixed maturities included in Level 3 are classified as such as they are primarily priced
by independent brokers and/or within illiquid markets (i.e., below-prime RMBS).
15
Table of Contents
These disclosures provide information as to the extent to which the Company uses fair value to
measure financial instruments and information about the inputs used to value those financial
instruments to allow users to assess the relative reliability of the measurements. The following
tables present assets and (liabilities) carried at fair value by hierarchy level.
June 30, 2010 | ||||||||||||||||
Quoted Prices | ||||||||||||||||
in Active | Significant | Significant | ||||||||||||||
Markets for | Observable | Unobservable | ||||||||||||||
Identical Assets | Inputs | Inputs | ||||||||||||||
Total | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Assets accounted for at fair value on a recurring basis |
||||||||||||||||
Fixed maturities, AFS |
||||||||||||||||
ABS |
$ | 2,136 | $ | | $ | 1,666 | $ | 470 | ||||||||
CDOs |
2,078 | | 46 | 2,032 | ||||||||||||
CMBS |
5,553 | | 5,053 | 500 | ||||||||||||
Corporate |
26,152 | | 20,387 | 5,765 | ||||||||||||
Foreign government/government agencies |
1,110 | | 1,069 | 41 | ||||||||||||
States, municipalities and political subdivisions (Municipal) |
928 | | 656 | 272 | ||||||||||||
RMBS |
3,541 | | 2,322 | 1,219 | ||||||||||||
U.S. Treasuries |
3,513 | 1,181 | 2,332 | | ||||||||||||
Total fixed maturities. AFS |
45,011 | 1,181 | 33,531 | 10,299 | ||||||||||||
Equity securities, trading |
2,101 | 2,101 | | | ||||||||||||
Equity securities, AFS |
372 | 160 | 169 | 43 | ||||||||||||
Derivative assets |
||||||||||||||||
Credit derivatives |
(26 | ) | | (4 | ) | (22 | ) | |||||||||
Equity derivatives |
(1 | ) | | | (1 | ) | ||||||||||
Foreign exchange |
441 | | 441 | | ||||||||||||
Interest rate derivatives |
(9 | ) | | 7 | (16 | ) | ||||||||||
Variable annuity hedging derivatives and macro hedge program |
1,703 | 4 | 139 | 1,560 | ||||||||||||
Total derivatives assets [1] |
2,108 | 4 | 583 | 1,521 | ||||||||||||
Short-term investments |
4,545 | 942 | 3,603 | | ||||||||||||
Reinsurance recoverable for U.S. GMWB and Japan GMWB, GMIB, and GMAB |
2,446 | | | 2,446 | ||||||||||||
Separate account assets [2] |
139,459 | 103,505 | 35,017 | 937 | ||||||||||||
Total assets accounted for at fair value on a recurring basis |
$ | 196,042 | $ | 107,893 | $ | 72,903 | $ | 15,246 | ||||||||
Liabilities accounted for at fair value on a recurring basis |
||||||||||||||||
Other policyholder funds and benefits payable |
||||||||||||||||
Guaranteed living benefits |
$ | (5,345 | ) | $ | $ | $ | (5,345 | ) | ||||||||
Institutional notes |
2 | | | 2 | ||||||||||||
Equity linked notes |
(7 | ) | | | (7 | ) | ||||||||||
Total other policyholder funds and benefits payable |
(5,350 | ) | | | (5,350 | ) | ||||||||||
Derivative liabilities |
||||||||||||||||
Credit derivatives |
(490 | ) | | (43 | ) | (447 | ) | |||||||||
Equity derivatives |
1 | | | 1 | ||||||||||||
Foreign exchange |
(44 | ) | | (44 | ) | | ||||||||||
Interest rate derivatives |
(46 | ) | | (13 | ) | (33 | ) | |||||||||
Variable annuity hedging derivatives and macro hedge program |
(13 | ) | (1 | ) | (43 | ) | 31 | |||||||||
Total derivative liabilities [3] |
(592 | ) | (1 | ) | (143 | ) | (448 | ) | ||||||||
Other liabilities |
(16 | ) | | | (16 | ) | ||||||||||
Consumer notes [4] |
(4 | ) | | | (4 | ) | ||||||||||
Total liabilities accounted for at fair value on a recurring basis |
$ | (5,962 | ) | $ | (1 | ) | $ | (143 | ) | $ | (5,818 | ) | ||||
[1] | Includes over-the-counter derivative instruments in a net asset value position which may require the counterparty to pledge collateral to the Company. As of June 30, 2010, $1.5 billion of a cash collateral liability was netted against the derivative asset value in the Condensed Consolidated Balance Sheet and is excluded from the table above. See footnote 3 below for derivative liabilities. | |
[2] | As June 30, 2010, excludes approximately $15 billion of investment sales receivable that are not subject to fair value accounting. | |
[3] | Includes over-the-counter derivative instruments in a net negative market value (derivative liability). In the Level 3 roll forward table included below in this Note 3, the derivative asset and liability are referred to as freestanding derivatives and are presented on a net basis. | |
[4] | Represents embedded derivatives associated with non-funding agreement-backed consumer equity-linked notes. |
16
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December 31, 2009 | ||||||||||||||||
Quoted Prices | ||||||||||||||||
in Active | Significant | Significant | ||||||||||||||
Markets for | Observable | Unobservable | ||||||||||||||
Identical Assets | Inputs | Inputs | ||||||||||||||
Total | (Level 1) | (Level 2) | (Level 3) | |||||||||||||
Assets accounted for at fair value on a recurring basis |
||||||||||||||||
Fixed maturities, AFS |
||||||||||||||||
ABS |
$ | 1,903 | $ | | $ | 1,406 | $ | 497 | ||||||||
CDOs |
2,165 | | 56 | 2,109 | ||||||||||||
CMBS |
5,365 | | 5,096 | 269 | ||||||||||||
Corporate |
23,667 | | 18,428 | 5,239 | ||||||||||||
Foreign government/government agencies |
846 | | 766 | 80 | ||||||||||||
Municipal |
780 | | 562 | 218 | ||||||||||||
RMBS |
3,336 | | 2,341 | 995 | ||||||||||||
U.S. Treasuries |
2,341 | 325 | 2,016 | | ||||||||||||
Total fixed maturities, AFS |
40,403 | 325 | 30,671 | 9,407 | ||||||||||||
Equity securities, trading |
2,443 | 2,443 | | | ||||||||||||
Equity securities, AFS |
419 | 113 | 274 | 32 | ||||||||||||
Other investments |
||||||||||||||||
Variable annuity hedging derivatives and macro hedge program |
212 | 8 | 16 | 188 | ||||||||||||
Other derivatives [1] |
8 | | (4 | ) | 12 | |||||||||||
Total other investments |
220 | 8 | 12 | 200 | ||||||||||||
Short-term investments |
5,128 | 3,785 | 1,343 | | ||||||||||||
Reinsurance recoverable for U.S. GMWB and Japan GMWB, GMIB, and GMAB [2] |
1,108 | | | 1,108 | ||||||||||||
Separate account assets [3] |
147,418 | 112,863 | 33,593 | 962 | ||||||||||||
Total assets accounted for at fair value on a recurring basis |
$ | 197,139 | $ | 119,537 | $ | 65,893 | $ | 11,709 | ||||||||
Liabilities accounted for at fair value on a recurring basis |
||||||||||||||||
Other policyholder funds and benefits payable |
||||||||||||||||
Guaranteed living benefits |
$ | (3,439 | ) | $ | | $ | | $ | (3,439 | ) | ||||||
Institutional notes |
(2 | ) | | | (2 | ) | ||||||||||
Equity linked notes |
(10 | ) | | | (10 | ) | ||||||||||
Total other policyholder funds and benefits payable |
(3,451 | ) | | | (3,451 | ) | ||||||||||
Other liabilities [4] |
||||||||||||||||
Variable annuity hedging derivatives and macro hedge program |
158 | (2 | ) | (178 | ) | 338 | ||||||||||
Other derivative liabilities |
(45 | ) | | 125 | (170 | ) | ||||||||||
Total other liabilities |
113 | (2 | ) | (53 | ) | 168 | ||||||||||
Consumer notes [5] |
(5 | ) | | | (5 | ) | ||||||||||
Total liabilities accounted for at fair value on a recurring basis |
$ | (3,343 | ) | $ | (2 | ) | $ | (53 | ) | $ | (3,288 | ) | ||||
[1] | Includes over-the-counter derivative instruments in a net asset value position which may require the counterparty to pledge collateral to the Company. At December 31, 2009, $104 of a cash collateral liability was netted against the derivative asset value on the Consolidated Balance Sheet, and is excluded from the table above. See footnote 3 below for derivative liabilities. | |
[2] | Includes fair value of reinsurance recoverables from an affiliated reinsurer of approximately $761. | |
[3] | As of December 31, 2009, excludes approximately $3 billion of investment sales receivable that are not subject to fair value accounting. | |
[4] | Includes over-the-counter derivative instruments in a net negative market value position (derivative liability). In the Level 3 roll forward table included below in this Note, the derivative asset and liability are referred to as freestanding derivatives and are presented on a net basis. | |
[5] | Represents embedded derivatives associated with non-funding agreement-backed consumer equity-linked notes. |
Determination of Fair Values
The valuation methodologies used to determine the fair values of assets and liabilities under the
exit price notion reflect market-participant objectives and are based on the application of the
fair value hierarchy that prioritizes relevant observable market inputs over unobservable inputs.
The Company determines the fair values of certain financial assets and financial liabilities based
on quoted market prices, where available and where prices represent a reasonable estimate of fair
value. The Company also determines fair value based on future cash flows discounted at the
appropriate current market rate. Fair values reflect adjustments for counterparty credit quality,
the Companys default spreads, and liquidity and, where appropriate, risk margins on unobservable
parameters. The following is a discussion of the methodologies used to determine fair values for
the financial instruments listed in the above tables.
17
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Available-for-Sale Securities, Equity Securities, Trading, and Short-term Investments
The fair value of AFS securities, equity securities, trading, and short-term investments in an
active and orderly market (e.g. not distressed or forced liquidation) is determined by management
after considering one of three primary sources of information: third party pricing services,
independent broker quotations or pricing matrices. Security pricing is applied using a waterfall
approach whereby publicly available prices are first sought from third party pricing services, the
remaining unpriced securities are submitted to independent brokers for prices, or lastly,
securities are priced using a pricing matrix. Based on the typical trading volumes and the lack of
quoted market prices for fixed maturities, third party pricing services will normally derive the
security prices from recent reported trades for identical or similar securities making adjustments
through the reporting date based upon available market observable information as outlined above.
If there are no recently reported trades, the third-party pricing services and independent brokers
may use matrix or model processes to develop a security price where future cash flow expectations
are developed based upon collateral performance and discounted at an estimated market rate.
Included in the pricing of ABS and RMBS are estimates of the rate of future prepayments of
principal over the remaining life of the securities. Such estimates are derived based on the
characteristics of the underlying structure and prepayment speeds previously experienced at the
interest rate levels projected for the underlying collateral. Actual prepayment experience may
vary from these estimates.
Prices from third party pricing services are often unavailable for securities that are rarely
traded or are traded only in privately negotiated transactions. As a result, certain securities
are priced via independent broker quotations which utilize inputs that may be difficult to
corroborate with observable market based data. Additionally, the majority of these independent
broker quotations are non-binding. A pricing matrix is used to price securities for which the
Company is unable to obtain either a price from a third party pricing service or an independent
broker quotation by discounting the expected future cash flows from the security by a developed
market discount rate utilizing current credit spreads. Credit spreads are developed each month
using market based data for public securities adjusted for credit spread differentials between
public and private securities which are obtained from a survey of multiple private placement
brokers.
The Company performs a monthly analysis of the prices and credit spreads received from third
parties to ensure that the prices represent a reasonable estimate of the fair value. As a part of
this analysis, the Company considers trading volume and other factors to determine whether the
decline in market activity is significant when compared to normal activity in an active market, and
if so, whether transactions may not be orderly considering the weight of available evidence. If
the available evidence indicates that pricing is based upon transactions that are stale or not
orderly, the Company places little, if any, weight on the transaction price and will estimate fair
value utilizing
an internal pricing model. This process involves quantitative and qualitative analysis and is
overseen by investment and accounting professionals. Examples of procedures performed include, but
are not limited to, initial and on-going review of third-party pricing services methodologies,
review of pricing statistics and trends, back testing recent trades, and monitoring of trading
volumes, new issuance activity and other market activities. In addition, the Company ensures that
prices received from independent brokers represent a reasonable estimate of fair value through the
use of internal and external cash flow models developed based on spreads, and when available,
market indices. As a result of this analysis, if the Company determines that there is a more
appropriate fair value based upon the available market data, the price received from the third
party is adjusted accordingly. The Companys internal pricing model utilizes the Companys best
estimate of expected future cash flows discounted at a rate of return that a market participant
would require. The significant inputs to the model include, but are not limited to, current market
inputs, such as credit loss assumptions, estimated prepayment speeds and market risk premiums.
The Company has analyzed the third party pricing services valuation methodologies and related
inputs, and has also evaluated the various types of securities in its investment portfolio to
determine an appropriate fair value hierarchy level based upon trading activity and the
observability of market inputs. Most prices provided by third-party pricing services are
classified into Level 2 because the inputs used in pricing the securities are market observable.
Due to a general lack of transparency in the process that brokers use to develop prices, most
valuations that are based on brokers prices are classified as Level 3. Some valuations may be
classified as Level 2 if the price can be corroborated. Internal matrix priced securities,
primarily consisting of certain private placement securities, are also classified as Level 3 due to
significant non-observable inputs.
Derivative Instruments, including embedded derivatives within investments
Derivative instruments are fair valued using pricing valuation models; that utilize independent
market data inputs, quoted market prices for exchange-traded derivatives, or independent broker
quotations. Excluding embedded and reinsurance related derivatives, as of June 30, 2010 and
December 31, 2009, 98% and 96%, respectively, of derivatives, based upon notional values, were
priced by valuation models or quoted market prices. The remaining derivatives were priced by
broker quotations. The Company performs a monthly analysis on derivative valuations which includes
both quantitative and qualitative analysis. Examples of procedures performed include, but are not
limited to, review of pricing statistics and trends, back testing recent trades, analyzing the
impacts of changes in the market environment, and review of changes in market value for each
derivative including those derivatives priced by brokers.
The Company utilizes derivative instruments to manage the risk associated with certain assets and
liabilities. However, the derivative instrument may not be classified with the same fair value
hierarchy level as the associated assets and liabilities. Therefore the realized
18
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and unrealized
gains and losses on derivatives reported in Level 3 may not reflect the offsetting impact of the
realized and unrealized gains and losses of the associated assets and liabilities.
Valuation techniques and inputs for investments
Generally, the Company determines the estimated fair value of its AFS securities and short-term
investments using the market approach. The income approach is used for securities priced using a
pricing matrix as well as for derivative instruments. For Level 1 investments, which are comprised
of U.S. Treasuries, equity securities, short-term investments, and exchange traded futures and
option contracts, valuations are based on observable inputs that reflect quoted prices for
identical assets in active markets that the Company has the ability to access at the measurement
date.
For most of the Companys debt securities, the following inputs are typically used in the Companys
pricing methods: reported trades, benchmark yields, bids, offers and/or estimated cash flows. For
securities except U.S. Treasuries, inputs also include issuer spreads, which may utilize credit
default swaps. Derivative instruments are valued using mid-market inputs that are predominantly
observable in the market.
A description of additional inputs used in the Companys Level 2 and Level 3 measurements is listed below:
Level 2 | The fair values of most of the Companys Level 2 investments are determined by management after considering prices received from third party pricing services. These investments include most fixed maturities and preferred stocks, including those reported in separate account assets. |
| ABS, CDOs, CMBS and RMBS Primary inputs also include monthly payment information, collateral performance, which varies by vintage year and includes delinquency rates, collateral valuation loss severity rates, collateral refinancing assumptions, credit default swap indices and, for RMBS, estimated prepayment rates. | ||
| Corporates - Primary inputs also include observations of equity and credit default swap curves related to the issuer. | ||
| Foreign government/government agencies - Primary inputs also include observations of equity and credit default swap curves related to the issuer and political events in emerging markets. | ||
| Municipals - Primary inputs also include Municipal Securities Rulemaking Board reported trades and material event notices, and issuer financial statements. | ||
| Short-term investments Primary inputs also include material event notices and new issue money market rates. | ||
| Equity securities, trading Consist of investments in mutual funds. Primary inputs include net asset values obtained from third party pricing services. | ||
| Credit derivatives- Significant inputs primarily include the swap yield curve and credit curves. | ||
| Foreign exchange derivatives- Significant inputs primarily include the swap yield curve, currency spot and forward rates, and cross currency basis curves. | ||
| Interest rate derivatives- Significant input is primarily the swap yield curve. |
Level 3 | Most of the Companys securities classified as Level 3 are valued based on brokers prices. Certain long-dated securities are priced based on third party pricing services, including municipal securities and foreign government/government agencies, as well as bank loans. Primary inputs for these long-dated securities are consistent with the typical inputs used in Level 1 and Level 2 measurements noted above, but include benchmark interest rate or credit spread assumptions that are not observable in the marketplace. Also included in Level 3 are certain derivative instruments that either have significant unobservable inputs or are valued based on broker quotations. Significant inputs for these derivative contracts primarily include the typical inputs used in the Level 1 and Level 2 measurements noted above, but also may include the following: |
| Credit derivatives- Significant unobservable inputs may include credit correlation and swap yield curve and credit curve extrapolation beyond observable limits. | ||
| Equity derivatives Significant unobservable inputs may include equity volatility. | ||
| Interest rate contracts Significant unobservable inputs may include swap yield curve extrapolation beyond observable limits and interest rate volatility. |
19
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Product Derivatives
The
Company currently offers certain variable annuity products with a
GMWB riders in the U.S., and formerly offered such products in the U.K. The Company has also
assumed, through reinsurance, from HLIKK GMIB, GMWB and GMAB. As of October 1, 2009 the Company has
subsequently ceded the GMWB and assumed reinsurance from HLIKK to an affiliated captive reinsurer.
The GMWB represents an embedded derivative in the variable annuity contract. When it is determined
that (1) the embedded derivative possesses economic characteristics that are not clearly and
closely related to the economic characteristics of the host contract, and (2) a separate instrument
with the same terms would qualify as a derivative instrument, the embedded derivative is bifurcated
from the host for measurement purposes. The embedded derivative, which is reported with the host
instrument in the Condensed Consolidated Balance Sheets, is carried at fair value with changes in
fair value reported in net realized capital gains and losses. The Companys GMWB liability is
carried at fair value and reported in other policyholder funds.
In valuing
the embedded derivative, the Company attributes to the derivative a
portion of the expected fees to be collected over the expected life
of the contract from the contract holder equal to the present value of future GMWB claims (the
Attributed Fees). All changes in the fair value of the embedded derivative are recorded in net
realized capital gains and losses. The excess of fees collected from
the contract holder in the current period over the current periods
Attributed Fees are associated with the host variable annuity contract reported in fee income.
The reinsurance assumed on the HLIK.K. GMIB, GMWB, and GMAB and ceded to an affiliated captive
reinsurer meet the characteristics of a free-standing derivative instrument. As a result, the
derivative asset or liability is recorded at fair value with changes in the fair value reported in
net realized capital gains and losses.
U.S. GMWB Ceded Reinsurance Derivative
The fair value of the U.S. GMWB reinsurance derivative is calculated as an aggregation of the
components described in the Living Benefits Required to be Fair Valued discussion below and is
modeled using significant unobservable policyholder behavior inputs, identical to those used in
calculating the underlying liability, such as lapses, fund selection, resets and withdrawal
utilization and risk margins.
During 2009, the Company entered into a reinsurance arrangement with an affiliated captive
reinsurer to transfer a portion of its risk of loss associated with direct US GMWB and assumed
HLIKK GMIB, GMWB, and GMAB. This arrangement is recognized as a derivative and carried at fair
value in reinsurance recoverables. Changes in the fair value of the reinsurance agreement are
reported in net realized capital gains and losses. Please see Note 10 for more information on this
transaction.
Separate Account Assets
Separate account assets are primarily invested in mutual funds but also have investments in fixed
maturity and equity securities. The separate account investments are valued in the same manner,
and using the same pricing sources and inputs, as the fixed maturity, equity security, and
short-term investments of the Company.
Living Benefits Required to be Fair Valued (in Other Policyholder Funds and Benefits Payable)
Fair values for GMWB and guaranteed minimum accumulation benefit (GMAB) contracts are calculated
using the income approach based upon internally developed models because active, observable markets
do not exist for those items. The fair value of the Companys guaranteed benefit liabilities,
classified as embedded derivatives, and the related reinsurance and customized freestanding
derivatives is calculated as an aggregation of the following
components: Best Estimate Claim Payments; Credit Standing Adjustment; and Margins representing an amount that
market participants would require for the risk that the Companys assumptions about policyholder
behavior could differ from actual experience. The resulting aggregation is reconciled or
calibrated, if necessary, to market information that is, or may be, available to the Company, but
may not be observable by other market participants, including reinsurance discussions and
transactions. The Company believes the aggregation of these components, as necessary and as
reconciled or calibrated to the market information available to the Company, results in an amount
that the Company would be required to transfer or receive, for an asset, to or from market
participants in an active liquid market, if one existed, for those market participants to assume
the risks associated with the guaranteed minimum benefits and the related reinsurance and
customized derivatives. The fair value is likely to materially diverge from the ultimate
settlement of the liability as the Company believes settlement will be based on our best estimate
assumptions rather than those best estimate assumptions plus risk margins. In the absence of any
transfer of the guaranteed benefit liability to a third party, the release of risk margins is
likely to be reflected as realized gains in future periods net income. Each component described
below is unobservable in the marketplace and requires subjectivity by the Company in determining
their value.
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Best
Estimate Claim Payments
The Best
Estimate Claim Payments is calculated based on actuarial and capital market assumptions
related to projected cash flows, including the present value of benefits and related contract
charges, over the lives of the contracts, incorporating expectations concerning policyholder
behavior such as lapses, fund selection, resets and withdrawal
utilization. For the customized
derivatives, policyholder behavior is prescribed in the derivative contract. Because of the
dynamic and complex nature of these cash flows, best estimate assumptions and a Monte Carlo
stochastic process used in valuation. The Monte Carlo
stochastic process involves the generation of thousands of scenarios that assume risk neutral
returns consistent with swap rates and a blend of observable implied index volatility levels.
Estimating these cash flows involves numerous estimates and
subjective judgments regarding a number of variables including expected markets rates of return, market volatility, correlations of market index
returns to funds, fund performance, discount rates and assumptions
about policyholder behavior which emerge over time.
At each valuation date, the Company assumes expected returns based on:
| risk-free rates as represented by the Eurodollar futures, LIBOR deposits and swap rates to derive forward curve rates. | ||
| market implied volatility assumptions for each underlying index based primarily on a blend of observed market implied volatility data. | ||
| correlations of historical returns across underlying well known market indices based on actual observed returns over the ten years preceding the valuation date; and | ||
| three years of history for fund indexes compared to separate account fund regression |
As many guaranteed benefit obligations are relatively new in the marketplace, actual policyholder
behavior experience is limited. As a result, estimates of future policyholder behavior are
subjective and based on analogous internal and external data. As markets change, mature and evolve
and actual policyholder behavior emerges, management continually evaluates the appropriateness of
its assumptions for this component of the fair value model.
On a daily basis, the Company updates capital market assumptions used in the GMWB liability model
such as interest rates and equity indices. On a weekly basis, the blends of implied equity index
volatilities are updated. The Company continually monitors various aspects of policyholder
behavior and may modify certain of its assumptions, including living benefit lapses and withdrawal
rates, if credible emerging data indicates that changes are warranted. At a minimum, all
policyholder behavior assumptions are reviewed and updated, as appropriate, in conjunction with the
completion of the Companys comprehensive study to refine its estimate of future gross profits
during the third quarter of each year.
Credit Standing Adjustment
This
assumption makes an adjustment that market participants would make,
in determining fair value, to reflect the risk that
guaranteed benefit obligations or the GMWB reinsurance recoverables will not be fulfilled
(nonperformance risk). As a result of sustained volatility in the Companys credit default
spreads, during 2009 the Company changed its estimate of the Credit Standing Adjustment to
incorporate a blend of observable Company and reinsurer credit default spreads from capital
markets, adjusted for market recoverability. Prior to the first quarter of 2009, the Company
calculated the Credit Standing Adjustment by using default rates published by rating agencies,
adjusted for market recoverability. For the three months ended June 30, 2010 and 2009, the credit
standing adjustment assumption net of reinsurance resulted in pre-tax realized gains /(losses) of
$(206) and $11 respectively and $(172) and $233 for the six months ended June 30, 2010 and 2009,
respectively.
Margins
The
behavior risk margin adds a margin that market participants would
require, in determining fair value, for the risk that the
Companys assumptions about policyholder behavior could differ from actual experience. The
behavior risk margin is calculated by taking the difference between adverse policyholder behavior
assumptions and best estimate assumptions.
Assumption updates, including policyholder behavior assumptions, affected best estimates and
margins for total pre-tax realized gains of approximately of $0 and $118 for the three months ended
June 30, 2010 and 2009, respectively, and $0 and $432 for the six months ended June, 30, 2010 and
2009, respectively.
In addition to the non-market-based updates described above, the Company recognized
non-market-based updates driven by the relative outperformance (underperformance) of the underlying
actively managed funds as compared to their respective indices resulting in before-tax realized
gains of approximately $5 and $239 for the three months ended June 30, 2010 and 2009, respectively,
and $13 and $391 for the six months ended June 30, 2010 and 2009, respectively.
21
Table of Contents
Assets and Liabilities Measured at Fair Value on a Recurring Basis Using Significant Unobservable
Inputs (Level 3)
The tables below provide a fair value roll forward for the three months ending June 30, 2010 and
2009, for the financial instruments classified as Level 3.
Roll-forward of Financial Instruments Measured at Fair Value on a Recurring Basis Using Significant
Unobservable Inputs (Level 3) for the three months ended June 30, 2010:
Changes in unrealized | ||||||||||||||||||||||||||||||||
Fair value | Total realized/unrealized | Purchases, | Fair value | gains (losses) included in | ||||||||||||||||||||||||||||
as of | gains (losses) included in: | issuances, | Transfers | Transfers | as of | net income related to | ||||||||||||||||||||||||||
March 31, | Net | and | in to | out of | June 30, | financial instruments still | ||||||||||||||||||||||||||
Asset (liability) | 2010 | income [1], [2] | OCI [3] | settlements [4] | Level 3 [5] | Level 3 [5] | 2010 | held at June 30, 2010 [2] | ||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||||||||||
Fixed maturities, AFS |
||||||||||||||||||||||||||||||||
ABS |
$ | 446 | $ | (3 | ) | $ | 9 | $ | (2 | ) | $ | 28 | $ | (8 | ) | $ | 470 | $ | (4 | ) | ||||||||||||
CDO |
2,007 | (20 | ) | 94 | (43 | ) | 11 | (17 | ) | 2,032 | (26 | ) | ||||||||||||||||||||
CMBS |
339 | (33 | ) | 159 | (14 | ) | 99 | (50 | ) | 500 | (30 | ) | ||||||||||||||||||||
Corporate |
5,733 | 6 | 43 | (17 | ) | 104 | (104 | ) | 5,765 | 3 | ||||||||||||||||||||||
Foreign govt./govt. agencies |
41 | | | | | | 41 | | ||||||||||||||||||||||||
Municipal |
264 | | 16 | (8 | ) | | | 272 | | |||||||||||||||||||||||
RMBS |
1,027 | (17 | ) | 66 | 143 | | | 1,219 | (15 | ) | ||||||||||||||||||||||
Fixed maturities, AFS |
9,857 | (67 | ) | 387 | 59 | 242 | (179 | ) | 10,299 | (72 | ) | |||||||||||||||||||||
Equity securities, AFS |
37 | (2 | ) | 4 | 4 | | | 43 | (4 | ) | ||||||||||||||||||||||
Derivatives |
||||||||||||||||||||||||||||||||
Credit derivatives |
(429 | ) | (43 | ) | | 3 | | | (469 | ) | (43 | ) | ||||||||||||||||||||
Equity derivatives |
(1 | ) | 1 | | | | | | 1 | |||||||||||||||||||||||
Interest rate derivatives |
(6 | ) | 1 | | (44 | ) | | | (49 | ) | (20 | ) | ||||||||||||||||||||
Variable annuity hedging
derivatives and macro hedge
program |
462 | 897 | | 232 | | | 1,591 | 917 | ||||||||||||||||||||||||
Total derivatives [6] |
26 | 856 | | 191 | | | 1,073 | 855 | ||||||||||||||||||||||||
Reinsurance recoverable for
U.S. GMWB and Japan GMWB, GMIB,
and GMAB [1] |
780 | 1,468 | 89 | 109 | | | 2,446 | 1,468 | ||||||||||||||||||||||||
Separate accounts [7] |
955 | (2 | ) | | 5 | (2 | ) | (19 | ) | 937 | 9 | |||||||||||||||||||||
Liabilities |
||||||||||||||||||||||||||||||||
Other policyholder funds and benefits payable [1] |
||||||||||||||||||||||||||||||||
Guaranteed living benefits [8] |
$ | (3,033 | ) | $ | (2,147 | ) | $ | (103 | ) | $ | (62 | ) | $ | | | $ | (5,345 | ) | $ | (2,147 | ) | |||||||||||
Institutional notes |
(7 | ) | 9 | | | | | 2 | 9 | |||||||||||||||||||||||
Equity linked notes |
(9 | ) | 2 | | | | | (7 | ) | 2 | ||||||||||||||||||||||
Total other policyholder funds
and benefits payable [1] |
(3,049 | ) | (2,136 | ) | (103 | ) | (62 | ) | (5,350 | ) | (2,136 | ) | ||||||||||||||||||||
Other derivative liabilities |
||||||||||||||||||||||||||||||||
Other liabilities |
(22 | ) | 6 | | | | | (16 | ) | | ||||||||||||||||||||||
Consumer notes |
(5 | ) | 1 | | | | | (4 | ) | 1 | ||||||||||||||||||||||
[1] | The Company classifies gains and losses on GMWB reinsurance derivatives and Guaranteed Living Benefit embedded derivatives as unrealized gains (losses) for purposes of disclosure in this table because it is impracticable to track on a contract-by-contract basis the realized gains (losses) for these derivatives and embedded derivatives. | |
[2] | All amounts in these columns are reported in net realized capital gains (losses) except for less than $1, which is reported in benefits, losses and loss adjustment expenses. All amounts are before income taxes and amortization of DAC. | |
[3] | All amounts are before income taxes and amortization of DAC. | |
[4] | The Purchases, issuances, and settlements primarily relates to the receipt of cash on futures and option contracts classified as Level 1 and interest rate, currency and credit default swaps classified as Level 2. For GMWB reinsurance and guaranteed withdrawal benefits, purchases, issuances and settlements represent the reinsurance premium paid and the attributed fees collected, respectively. | |
[5] | Transfers in and/or (out) of Level 3 are primarily attributable to changes in the availability of market observable information and re-evaluation of the observability of pricing inputs. | |
[6] | Derivative instruments are reported in this table on a net basis for asset/(liability) positions and reported in the Condensed Consolidated Balance Sheet in other investments and other liabilities. | |
[7] | The realized/unrealized gains (losses) included in net income for separate account assets are offset by an equal amount for separate account liabilities, which results in a net zero impact on net income for the Company. | |
[8] | The net loss on U.S. GMWB since March 31, 2010 was primarily due to the lower equity market valuation, lower interest rates and higher implied market volatility. |
22
Table of Contents
Roll-forward of Financial Instruments Measured at Fair Value on a Recurring Basis Using Significant
Unobservable Inputs (Level 3) for the six months ended June 30, 2010:
Changes in unrealized | ||||||||||||||||||||||||||||||||
Fair value | Total realized/unrealized | Purchases, | Fair value | gains (losses) included in | ||||||||||||||||||||||||||||
as of | gains (losses) included in: | issuances, | Transfers | Transfers | as of | net income related to | ||||||||||||||||||||||||||
January 1, | Net | and | in to | out of | June 30, | financial instruments still | ||||||||||||||||||||||||||
Asset (liability) | 2010 | income [1], [2] | OCI [3] | settlements [4] | Level 3 [5] | Level 3 [5] | 2010 | held at June 30, 2010 [2] | ||||||||||||||||||||||||
Assets |
||||||||||||||||||||||||||||||||
Fixed maturities, AFS |
||||||||||||||||||||||||||||||||
ABS |
$ | 497 | $ | (3 | ) | $ | 32 | $ | (11 | ) | $ | 28 | $ | (73 | ) | $ | 470 | $ | (4 | ) | ||||||||||||
CDO |
2,109 | (83 | ) | 286 | (55 | ) | 27 | (252 | ) | 2,032 | (88 | ) | ||||||||||||||||||||
CMBS |
269 | (93 | ) | 227 | (19 | ) | 166 | (50 | ) | 500 | (89 | ) | ||||||||||||||||||||
Corporate |
5,239 | 8 | 148 | 89 | 440 | (159 | ) | 5,765 | 3 | |||||||||||||||||||||||
Foreign govt./govt. agencies |
80 | | | (6 | ) | | (33 | ) | 41 | | ||||||||||||||||||||||
Municipal |
218 | | 35 | 23 | | (4 | ) | 272 | | |||||||||||||||||||||||
RMBS |
995 | (29 | ) | 146 | 119 | | (12 | ) | 1,219 | (27 | ) | |||||||||||||||||||||
Fixed maturities, AFS |
9,407 | (200 | ) | 874 | 140 | 661 | (583 | ) | 10,299 | (205 | ) | |||||||||||||||||||||
Equity securities, AFS |
32 | (2 | ) | 8 | 5 | | | 43 | (5 | ) | ||||||||||||||||||||||
Derivatives |
||||||||||||||||||||||||||||||||
Credit derivatives |
(161 | ) | (21 | ) | | 3 | (290 | ) | | (469 | ) | (20 | ) | |||||||||||||||||||
Equity derivatives |
(2 | ) | 2 | | | | | | 2 | |||||||||||||||||||||||
Interest rate derivatives |
5 | 1 | | (44 | ) | | (11 | ) | (49 | ) | (20 | ) | ||||||||||||||||||||
Variable annuity hedging
derivatives and macro hedge
program |
526 | 680 | | 385 | | | 1,591 | 663 | ||||||||||||||||||||||||
Total derivatives [6] |
368 | 662 | | 344 | (290 | ) | (11 | ) | 1,073 | 625 | ||||||||||||||||||||||
Reinsurance recoverable for
U.S. GMWB and Japan GMWB, GMIB,
and GMAB [1] |
1,108 | 1,028 | 87 | 223 | | | 2,446 | 1,028 | ||||||||||||||||||||||||
Separate accounts [7] |
962 | 16 | | 82 | 4 | (127 | ) | 937 | 13 | |||||||||||||||||||||||
Liabilities |
||||||||||||||||||||||||||||||||
Other policyholder funds and
benefits payable [1] |
||||||||||||||||||||||||||||||||
Guaranteed living benefits [8] |
$ | (3,439 | ) | $ | (1,686 | ) | $ | (98 | ) | $ | (122 | ) | $ | | $ | | $ | (5,345 | ) | $ | (1,686 | ) | ||||||||||
Institutional notes |
(2 | ) | 4 | | | | | 2 | 4 | |||||||||||||||||||||||
Equity linked notes |
(10 | ) | 3 | | | | | (7 | ) | 3 | ||||||||||||||||||||||
Total other policyholder funds
and benefits payable [1] |
$ | (3,451 | ) | $ | (1,679 | ) | $ | (98 | ) | $ | (122 | ) | $ | | $ | | $ | (5,350 | ) | $ | (1,679 | ) | ||||||||||
Other derivative liabilities |
||||||||||||||||||||||||||||||||
Other liabilities |
| (5 | ) | | | (11 | ) | | (16 | ) | | |||||||||||||||||||||
Consumer notes |
(5 | ) | 1 | | | | | (4 | ) | 1 | ||||||||||||||||||||||
[1] | The Company classifies gains and losses on GMWB reinsurance derivatives and Guaranteed Living Benefit embedded derivatives as unrealized gains (losses) for purposes of disclosure in this table because it is impracticable to track on a contract-by-contract basis the realized gains (losses) for these derivatives and embedded derivatives. | |
[2] | All amounts in these columns are reported in net realized capital gains (losses) except for less than $1, which is reported in benefits, losses and loss adjustment expenses. All amounts are before income taxes and amortization of DAC. | |
[3] | All amounts are before income taxes and amortization of DAC. | |
[4] | The Purchases, issuances, and settlements primarily relates to the receipt of cash on futures and option contracts classified as Level 1 and interest rate, currency and credit default swaps classified as Level 2. For GMWB reinsurance and guaranteed withdrawal benefits, purchases, issuances and settlements represent the reinsurance premium paid and the attributed fees collected, respectively. | |
[5] | Transfers in and/or (out) of Level 3 are primarily attributable to changes in the availability of market observable information and re-evaluation of the observability of pricing inputs. Transfers in also include the consolidation of additional VIEs due to the adoption of new accounting guidance on January 1, 2010, as well as the election of fair value option for one of these VIEs. | |
[6] | Derivative instruments are reported in this table on a net basis for asset/(liability) positions and reported in the Condensed Consolidated Balance Sheet in other investments and other liabilities. | |
[7] | The realized/unrealized gains (losses) included in net income for separate account assets are offset by an equal amount for separate account liabilities, which results in a net zero impact on net income for the Company. | |
[8] | The net loss on U.S. GMWB since January 1, 2010 was primarily due to the lower equity market valuation, lower interest rates and higher implied market volatility. |
23
Table of Contents
Roll-forward of Financial Instruments Measured at Fair Value on a Recurring Basis Using Significant
Unobservable Inputs (Level 3) for the three months ended June 30, 2009
Changes in unrealized | ||||||||||||||||||||||||||||
gains (losses) | ||||||||||||||||||||||||||||
Fair value | Total realized/unrealized | Purchases, | included in net income | |||||||||||||||||||||||||
as of | gains (losses) included in: | issuances, | Transfers in | Fair value | related to financial | |||||||||||||||||||||||
March 31, | Net income | and | and/or (out) | as of | instruments still held at | |||||||||||||||||||||||
Asset (Liability) | 2009 | [1], [2] | OCI [2] | Settlements [8] | of Level 3 [6] | June 30, 2009 | June 30, 2009 [1] | |||||||||||||||||||||
Assets |
||||||||||||||||||||||||||||
Fixed maturities, AFS |
||||||||||||||||||||||||||||
ABS |
$ | 436 | $ | (3 | ) | $ | 58 | $ | (29 | ) | $ | (61 | ) | $ | 401 | $ | (5 | ) | ||||||||||
CDO |
1,819 | (72 | ) | 204 | (29 | ) | | 1,922 | (79 | ) | ||||||||||||||||||
CMBS |
159 | (18 | ) | 19 | (2 | ) | 4 | 162 | (8 | ) | ||||||||||||||||||
Corporate |
4,544 | 6 | 313 | (26 | ) | (451 | ) | 4,386 | (20 | ) | ||||||||||||||||||
Foreign govt./govt. agencies |
52 | | 1 | (1 | ) | | 52 | | ||||||||||||||||||||
Municipal |
172 | | 2 | (1 | ) | 6 | 179 | | ||||||||||||||||||||
RMBS |
1,089 | (45 | ) | (34 | ) | 49 | 3 | 1,062 | (78 | ) | ||||||||||||||||||
Fixed maturities, AFS |
8,271 | (132 | ) | 563 | (39 | ) | (499 | ) | 8,164 | (190 | ) | |||||||||||||||||
Equity securities, AFS |
59 | | | (1 | ) | (33 | ) | 25 | | |||||||||||||||||||
Derivatives [3] |
||||||||||||||||||||||||||||
Variable annuity hedging derivatives and macro
hedge program |
2,552 | (1,201 | ) | | (216 | ) | | 1,135 | (1,133 | ) | ||||||||||||||||||
Other freestanding derivatives |
(318 | ) | 71 | (5 | ) | 14 | (3 | ) | (241 | ) | 77 | |||||||||||||||||
Total freestanding derivatives |
2,234 | (1,130 | ) | (5 | ) | (202 | ) | (3 | ) | 894 | (1,056 | ) | ||||||||||||||||
Reinsurance recoverable for U.S. GMWB and Japan
GMWB, GMIB, and GMAB(1),(7) |
1,058 | (433 | ) | | 7 | | 632 | (433 | ) | |||||||||||||||||||
Separate accounts [5] |
639 | | | 23 | 11 | 673 | (12 | ) | ||||||||||||||||||||
Liabilities |
||||||||||||||||||||||||||||
Other policyholder funds and benefits payable [1] |
||||||||||||||||||||||||||||
Guaranteed living benefits |
$ | (7,209 | ) | $ | 2,941 | $ | (39 | ) | $ | (60 | ) | $ | | $ | (4,367 | ) | $ | 2,941 | ||||||||||
Institutional notes |
(25 | ) | 27 | | | | 2 | 27 | ||||||||||||||||||||
Equity linked notes |
(5 | ) | (1 | ) | | | | (6 | ) | (1 | ) | |||||||||||||||||
Total other policyholder funds and benefits payable |
(7,239 | ) | 2,967 | (39 | ) | (60 | ) | | (4,371 | ) | 2,967 | |||||||||||||||||
Consumer notes |
(4 | ) | | | | | (4 | ) | | |||||||||||||||||||
[1] | The Company classifies all the gains and losses on GMWB reinsurance derivatives and GMWB embedded derivatives and reinsured GMWB, GMIB and GMAB free standing derivatives as unrealized gains/losses for purposes of disclosure in this table because it is impracticable to track on a contract-by-contract basis the realized gains/losses for these derivatives and embedded derivatives. | |
[2] | All amounts in these columns are reported in net realized capital gains (losses) except for $1, which is reported in benefits, losses and loss adjustment expenses. All amounts are before income taxes and amortization of DAC. | |
[3] | The freestanding derivatives, excluding reinsurance derivatives instruments, are reported in this table on a net basis for asset/(liability) positions and reported on the Condensed Consolidated Balance Sheet in other investments and other liabilities. | |
[4] | AOCI refers to Accumulated other comprehensive income in the Condensed Consolidated Statement of Changes in Stockholders Equity. All amounts are before income taxes and amortization of DAC. | |
[5] | The realized/unrealized gains (losses) included in net income for separate account assets are offset by an equal amount for separate account liabilities, which results in a net zero impact on net income for the Company. | |
[6] | Transfers in and/or (out) of Level 3 are attributable to a change in the availability of market observable information and re-evaluation of the observability of pricing inputs. | |
[7] | The net gain on U.S. GMWB since January 1, 2009 was primarily related to liability model assumption updates for withdrawal, lapses and credit standing which totaled $550 pre-tax. During July 2008, the Company reinsured, with a third party, U.S. GMWB risks associated with approximately $7.8 billion of account value sold between 2003 and 2006. The reinsurance agreement is an 80% quota-share agreement. The third partys financial strength is rated A+ by A.M. Best, AA- by Standard and Poors and Aa2 by Moodys. The reinsurance agreement will be accounted for as a freestanding derivative. | |
[8] | The Purchases, issuances, and settlements primarily relates to the receipt of cash on futures and option contracts classified as Level 1 and interest rate, currency and credit default swaps classified as Level 2 For GMWB reinsurance and guaranteed withdrawal benefits, purchases, issuances and settlements represent the reinsurance premium paid and the attributed fees collected, respectively. |
24
Table of Contents
Roll-forward of Financial Instruments Measured at Fair Value on a Recurring Basis Using Significant
Unobservable Inputs (Level 3) for the six months ended June 30, 2009
Changes in unrealized | ||||||||||||||||||||||||||||
gains (losses) | ||||||||||||||||||||||||||||
Fair value | Total realized/unrealized | Purchases, | included in net income | |||||||||||||||||||||||||
as of | gains (losses) included in: | issuances, | Transfers in | Fair value | related to financial | |||||||||||||||||||||||
January 1, | Net income | and | and/or (out) | as of | instruments still held at | |||||||||||||||||||||||
Asset (Liability) | 2009 | [1], [2] | OCI [3] | Settlements [7] | of Level 3 [4] | June 30, 2009 | June 30, 2009 [1] | |||||||||||||||||||||
Assets |
||||||||||||||||||||||||||||
Fixed maturities, AFS |
||||||||||||||||||||||||||||
ABS |
$ | 429 | $ | (5 | ) | $ | 26 | $ | 2 | $ | (51 | ) | $ | 401 | $ | (5 | ) | |||||||||||
CDO |
1,981 | (80 | ) | 67 | (46 | ) | | 1,922 | (79 | ) | ||||||||||||||||||
CMBS |
263 | (18 | ) | (2 | ) | (2 | ) | (79 | ) | 162 | (8 | ) | ||||||||||||||||
Corporate |
4,421 | (40 | ) | 247 | 153 | (395 | ) | 4,386 | (20 | ) | ||||||||||||||||||
Foreign govt./govt. agencies |
74 | | (2 | ) | (7 | ) | (13 | ) | 52 | | ||||||||||||||||||
Municipal |
155 | | (5 | ) | (1 | ) | 30 | 179 | | |||||||||||||||||||
RMBS |
1,419 | (123 | ) | (251 | ) | 14 | 3 | 1,062 | (78 | ) | ||||||||||||||||||
Fixed maturities, AFS |
8,742 | (266 | ) | 80 | 113 | (505 | ) | 8,164 | (190 | ) | ||||||||||||||||||
Equity securities, AFS |
59 | | | (1 | ) | (33 | ) | 25 | | |||||||||||||||||||
Derivatives [5] |
||||||||||||||||||||||||||||
Variable annuity hedging derivatives and macro
hedge program |
2,774 | (1,093 | ) | | (546 | ) | | 1,135 | (1,042 | ) | ||||||||||||||||||
Other freestanding derivatives |
(234 | ) | (4 | ) | (10 | ) | 13 | (6 | ) | (241 | ) | 10 | ||||||||||||||||
Total freestanding derivatives |
2,540 | (1,097 | ) | (10 | ) | (533 | ) | (6 | ) | 894 | (1,032 | ) | ||||||||||||||||
Reinsurance recoverable for U.S. GMWB and Japan
GMWB, GMIB, and GMAB(1) |
1,302 | (685 | ) | | 15 | | 632 | (685 | ) | |||||||||||||||||||
Separate accounts [6] |
786 | (122 | ) | | 110 | (101 | ) | 673 | (73 | ) | ||||||||||||||||||
Liabilities |
||||||||||||||||||||||||||||
Other policyholder funds and benefits payable [1] |
||||||||||||||||||||||||||||
Guaranteed living benefits |
$ | (9,206 | ) | $ | 4,761 | $ | 203 | $ | (125 | ) | $ | | $ | (4,367 | ) | $ | 4,761 | |||||||||||
Institutional notes |
(41 | ) | 43 | | | | 2 | 43 | ||||||||||||||||||||
Equity linked notes |
(8 | ) | 2 | | | | (6 | ) | 2 | |||||||||||||||||||
Total other policyholder funds and benefits payable |
(9,255 | ) | 4,806 | 203 | (125 | ) | | (4,371 | ) | 4,806 | ||||||||||||||||||
Consumer notes |
(5 | ) | 1 | | | | (4 | ) | 1 | |||||||||||||||||||
[1] | The Company classifies all the gains and losses on GMWB reinsurance derivatives and GMWB embedded derivatives and reinsured GMWB, GMIB and GMAB free standing derivatives as unrealized gains/losses for purposes of disclosure in this table because it is impracticable to track on a contract-by-contract basis the realized gains/losses for these derivatives and embedded derivatives. | |
[2] | All amounts in these columns are reported in net realized capital gains (losses) except for $2 for the six months ended June 30, 2009, which is reported in benefits, losses and loss adjustment expenses. All amounts are before income taxes and amortization of DAC. | |
[3] | OCI refers to Accumulated other comprehensive income in the Condensed Consolidated Statement of Changes in Stockholders Equity. All amounts are before income taxes and amortization of DAC. | |
[4] | Transfers in and/or (out) of Level 3 for the six months ended June 30, 2009, are attributable to a change in the availability of market observable information and re-evaluation of the observability of pricing inputs. | |
[5] | Derivatives are reported in this table on a net basis for asset/(liability) positions and reported in the Condensed Consolidated Balance Sheet in other investments and other liabilities. | |
[6] | The realized/unrealized gains (losses) included in net income for separate account assets are offset by an equal amount for separate account liabilities, which results in a net zero impact on net income for the Company. | |
[7] | The Purchases, issuances, and settlements primarily relates to the receipt of cash on futures and option contracts classified as Level 1 and interest rate, currency and credit default swaps classified as Level 2 For GMWB reinsurance and guaranteed withdrawal benefits, purchases, issuances and settlements represent the reinsurance premium paid and the attributed fees collected, respectively. |
25
Table of Contents
Fair Value Option
The Company elected the fair value option for one of its consolidated VIEs in order to employ a
consistent accounting model for the VIEs assets and liabilities. The fair value option requires
the VIEs assets and liabilities to be reported in the Companys Condensed Consolidated Balance Sheets at fair value with the changes in fair value reported in net realized capital gains and
losses in the Companys Condensed Consolidated Statements of Operations. The VIE is an investment
vehicle that holds high quality investments, derivative instruments that references third-party
corporate credit and issues notes to investors that reflect the credit characteristics of the high
quality investments and derivative instruments. The risks and rewards associated with the assets
of the VIE inure to the investors. The investors have no recourse against the Company. As a
result, there has been no adjustment to the market value of the notes for the Companys own credit
risk.
The following table presents the gains and losses recorded for those assets and liabilities
accounted using the fair value option:
Three Months Ended | Six Months Ended | |||||||
June 30, 2010 | June 30, 2010 | |||||||
Assets |
||||||||
Fixed maturities |
||||||||
ABS |
$ | 1 | $ | 2 | ||||
Corporate |
(4 | ) | (4 | ) | ||||
Other liabilities |
||||||||
Credit-linked notes |
6 | (5 | ) | |||||
Total realized capital gains (losses) |
$ | 3 | $ | (7 | ) | |||
Included in the Companys Condensed Consolidated Balance Sheet as of June 30, 2010, are high
quality investments of $328 in fixed maturities, and other liabilities comprised of derivative
instruments of $293 and notes at fair value of $16 with an outstanding principal balance of $243.
Electing the fair value option resulted in lowering other liabilities with an offsetting impact to
the cumulative effect adjustment to retained earnings of $232, representing the difference between
the fair value and outstanding principal of the notes as of January 1, 2010.
Financial Instruments Not Carried at Fair Value
The following table presents carrying amounts and fair values of the Companys financial
instruments not carried at fair value and not included in the above fair value discussion as of
June 30, 2010 and December 31, 2009.
June 30, 2010 | December 31, 2009 | |||||||||||||||
Carrying | Fair | Carrying | Fair | |||||||||||||
Amount | Value | Amount | Value | |||||||||||||
Assets |
||||||||||||||||
Policy loans |
$ | 2,129 | $ | 2,278 | $ | 2,120 | $ | 2,252 | ||||||||
Mortgage loans |
3,325 | 3,198 | 4,304 | 3,645 | ||||||||||||
Liabilities |
||||||||||||||||
Other policyholder funds and benefits payable [1] |
$ | 11,160 | 11,399 | $ | 11,919 | $ | 12,101 | |||||||||
Consumer notes [2] |
448 | 466 | 1,131 | 1,194 | ||||||||||||
[1] | Excludes group accident and health and universal life insurance contracts, including corporate owned life insurance. | |
[2] | Excludes amounts carried at fair value and included in disclosures above. |
The Company has not made any changes in its valuation methodologies for the following assets and
liabilities since December 31, 2009.
| Fair value for policy loans and consumer notes were estimated using discounted cash flow calculations using current interest rates. | |
| Fair values for mortgage loans were estimated using discounted cash flow calculations based on current lending rates for similar type loans. Current lending rates reflect changes in credit spreads and the remaining terms of the loans. | |
| Other policyholder funds and benefits payable, not carried at fair value, is determined by estimating future cash flows, discounted at the current market rate. |
26
Table of Contents
4. Investments and Derivative Instruments
Significant Investment Accounting Policies
Recognition and Presentation of Other-Than-Temporary Impairments
The Company deems debt securities and certain equity securities with debt-like characteristics
(collectively debt securities) to be other-than-temporarily impaired (impaired) if a security
meets the following conditions: a) the Company intends to sell or it is more likely than not the
Company will be required to sell the security before a recovery in value, or b) the Company does
not expect to recover the entire amortized cost basis of the security. If the Company intends to
sell or it is more likely than not the Company will be required to sell the security before a
recovery in value, a charge is recorded in net realized capital losses equal to the difference
between the fair value and amortized cost basis of the security. For those impaired debt
securities which do not meet the first condition and for which the Company does not expect to
recover the entire amortized cost basis, the difference between the securitys amortized cost basis
and the fair value is separated into the portion representing a credit other-than-temporary
impairment (impairment), which is recorded in net realized capital losses, and the remaining
impairment, which is recorded in OCI. Generally, the Company determines a securitys credit
impairment as the difference between its amortized cost basis and its best estimate of expected
future cash flows discounted at the securitys effective yield prior to impairment. The remaining
non-credit impairment, which is recorded in OCI, is the difference between the securitys fair
value and the Companys best estimate of expected future cash flows discounted at the securitys
effective yield prior to the impairment, which typically represents current market liquidity and
risk premiums. The previous amortized cost basis less the impairment recognized in net realized
capital losses becomes the securitys new cost basis. The Company accretes the new cost basis to
the estimated future cash flows over the expected remaining life of the security by prospectively
adjusting the securitys yield, if necessary.
The Company evaluates whether a credit impairment exists for debt securities by considering
primarily the following factors: (a) changes in the financial condition of the securitys
underlying collateral, (b) whether the issuer is current on contractually obligated interest and
principal payments, (c) changes in the financial condition, credit rating and near-term prospects
of the issuer, (d) the extent to which the fair value has been less than the amortized cost of the
security and (e) the payment structure of the security. The Companys best estimate of expected
future cash flows used to determine the credit loss amount is a quantitative and qualitative
process that incorporates information received from third-party sources along with certain internal
assumptions and judgments regarding the future performance of the security. The Companys best
estimate of future cash flows involves assumptions including, but not limited to, various
performance indicators, such as historical and projected default and recovery rates, credit
ratings, current delinquency rates, loan-to-value ratios and the possibility of obligor
re-financing. In addition, for structured securities, the Company considers factors including, but
not limited to, average cumulative collateral loss rates that vary by vintage year, commercial and
residential property value declines that vary by property type and location and commercial real
estate delinquency levels. These assumptions require the use of significant management judgment
and include the probability of issuer default and estimates regarding timing and amount of expected
recoveries which may include estimating the underlying collateral value. In addition, projections
of expected future debt security cash flows may change based upon new information regarding the
performance of the issuer and/or underlying collateral such as changes in the projections of the
underlying property value estimates.
For equity securities where the decline in the fair value is deemed to be other-than-temporary, a
charge is recorded in net realized capital losses equal to the difference between the fair value
and cost basis of the security. The previous cost basis less the impairment becomes the securitys
new cost basis. The Company asserts its intent and ability to retain those equity securities
deemed to be temporarily impaired until the price recovers. Once identified, these securities are
systematically restricted from trading unless approved by a committee of investment and accounting
professionals (Committee). The Committee will only authorize the sale of these securities based
on predefined criteria that relate to events that could not have been reasonably foreseen.
Examples of the criteria include, but are not limited to, the deterioration in the issuers
financial condition, security price declines, a change in regulatory requirements or a major
business combination or major disposition.
The primary factors considered in evaluating whether an impairment exists for an equity security
include, but are not limited to: (a) the length of time and extent to which the fair value has been
less than the cost of the security, (b) changes in the financial condition, credit rating and
near-term prospects of the issuer, (c) whether the issuer is current on contractually obligated
payments and (d) the intent and ability of the Company to retain the investment for a period of
time sufficient to allow for recovery.
27
Table of Contents
Net Realized Capital Gains (Losses)
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
(Before-tax) | 2010 | 2009 | 2010 | 2009 | ||||||||||||
Gross gains on sales |
$ | 234 | $ | 74 | $ | 305 | $ | 199 | ||||||||
Gross losses on sales |
(54 | ) | (133 | ) | (115 | ) | (531 | ) | ||||||||
Net OTTI losses recognized in earnings |
(89 | ) | (254 | ) | (226 | ) | (433 | ) | ||||||||
Valuation allowance on mortgage loans |
(39 | ) | (48 | ) | (111 | ) | (92 | ) | ||||||||
Japanese fixed annuity contract hedges, net [1] |
27 | (6 | ) | 11 | 35 | |||||||||||
Periodic net coupon settlements on credit derivatives/Japan |
| (8 | ) | (4 | ) | (23 | ) | |||||||||
Results of variable annuity hedge program |
||||||||||||||||
GMWB derivatives, net |
(405 | ) | 654 | (283 | ) | 1,244 | ||||||||||
Macro hedge program |
397 | (568 | ) | 233 | (364 | ) | ||||||||||
Total results of variable annuity hedge program |
(8 | ) | 86 | (50 | ) | 880 | ||||||||||
GMIB/GMAB/GMWB reinsurance |
(671 | ) | 336 | (556 | ) | 1,432 | ||||||||||
Coinsurance and modified coinsurance reinsurance contracts |
1,222 | | 843 | | ||||||||||||
Other, net |
(17 | ) | (16 | ) | (6 | ) | 27 | |||||||||
Net realized capital gains |
$ | 605 | $ | 31 | $ | 91 | $ | 1,494 | ||||||||
[1] | Relates to derivative hedging instruments, excluding periodic net coupon settlements, and is net of the Japanese fixed annuity product liability adjustment for changes in the dollar/yen exchange spot rate. |
Net realized capital gains (losses) from investment sales, after deducting the life and pension
policyholders share for certain products, are reported as a component of revenues and are
determined on a specific identification basis. Net realized capital gains (losses) previously
reported as unrealized losses in AOCI were $91 and ($36) for the three and six months ended June
30, 2010, respectively, and ($313) and ($765) for the three and six months ended June 30, 2009,
respectively. Proceeds from sales of AFS securities totaled $10.2 billion and $12.6 billion,
respectively, for the three and six months ended June 30, 2010, and $5.9 billion and $21.1 billion,
respectively, for the three and six months ended June 30, 2009.
Other-Than-Temporary Impairment Losses
The following table presents a roll-forward of the Companys cumulative credit impairments on debt
securities held. The Company adopted the impairment guidance as of April 1, 2009.
Three Months Ended | Six Months Ended | |||||||||||
June 30, | June 30, | |||||||||||
2010 | 2009 | 2010 | ||||||||||
Balance as of beginning of period |
$ | (1,763 | ) | $ | (941 | ) | $ | (1,632 | ) | |||
Additions for credit impairments recognized on [1]: |
||||||||||||
Securities not previously impaired |
(39 | ) | (171 | ) | (142 | ) | ||||||
Securities previously impaired |
(46 | ) | (35 | ) | (79 | ) | ||||||
Reductions for credit impairments previously recognized on: |
||||||||||||
Securities that matured or were sold during the period |
112 | | 113 | |||||||||
Securities that the Company intends to sell or more likely than not will be required to sell before recovery |
| 1 | | |||||||||
Securities due to an increase in expected cash flows |
11 | | 15 | |||||||||
Balance as of end of period |
$ | (1,725 | ) | $ | (1,146 | ) | $ | (1,725 | ) | |||
[1] | These additions are included in the net OTTI losses recognized in earnings in the Condensed Consolidated Statements of Operations. |
28
Table of Contents
Available-for-Sale Securities
June 30, 2010 | December 31, 2009 | |||||||||||||||||||||||||||||||||||||||
Cost or | Gross | Gross | Non- | Cost or | Gross | Gross | Non- | |||||||||||||||||||||||||||||||||
Amortized | Unrealized | Unrealized | Fair | Credit | Amortized | Unrealized | Unrealized | Fair | Credit | |||||||||||||||||||||||||||||||
Cost | Gains | Losses | Value | OTTI [1] | Cost | Gains | Losses | Value | OTTI [1] | |||||||||||||||||||||||||||||||
ABS |
$ | 2,476 | $ | 46 | $ | (386 | ) | $ | 2,136 | $ | (19 | ) | $ | 2,344 | $ | 31 | $ | (472 | ) | $ | 1,903 | $ | (26 | ) | ||||||||||||||||
CDOs |
2,807 | 35 | (764 | ) | 2,078 | (98 | ) | 3,158 | 19 | (1,012 | ) | 2,165 | (123 | ) | ||||||||||||||||||||||||||
CMBS |
6,246 | 143 | (836 | ) | 5,553 | (13 | ) | 6,844 | 76 | (1,555 | ) | 5,365 | (8 | ) | ||||||||||||||||||||||||||
Corporate |
25,174 | 1,670 | (692 | ) | 26,152 | (3 | ) | 23,621 | 985 | (939 | ) | 23,667 | (11 | ) | ||||||||||||||||||||||||||
Foreign govt./govt. agencies |
1,084 | 46 | (20 | ) | 1,110 | | 824 | 35 | (13 | ) | 846 | | ||||||||||||||||||||||||||||
Municipal |
1,026 | 12 | (110 | ) | 928 | | 971 | 3 | (194 | ) | 780 | | ||||||||||||||||||||||||||||
RMBS |
3,966 | 108 | (533 | ) | 3,541 | (129 | ) | 3,965 | 68 | (697 | ) | 3,336 | (166 | ) | ||||||||||||||||||||||||||
U.S. Treasuries |
3,609 | 13 | (109 | ) | 3,513 | | 2,557 | 5 | (221 | ) | 2,341 | | ||||||||||||||||||||||||||||
Total fixed maturities |
46,388 | 2,073 | (3,450 | ) | 45,011 | (262 | ) | 44,284 | 1,222 | (5,103 | ) | 40,403 | (334 | ) | ||||||||||||||||||||||||||
Equity securities |
400 | 31 | (59 | ) | 372 | | 447 | 38 | (66 | ) | 419 | | ||||||||||||||||||||||||||||
Total AFS securities |
$ | 46,788 | $ | 2,104 | $ | (3,509 | ) | $ | 45,383 | $ | (262 | ) | $ | 44,731 | $ | 1,260 | $ | (5,169 | ) | $ | 40,822 | $ | (334 | ) | ||||||||||||||||
[1] | Represents the amount of cumulative non-credit OTTI losses recognized in OCI on securities that also had credit impairments. These losses are included in gross unrealized losses as of June 30, 2010 and December 31, 2009. |
June 30, 2010 | ||||||||
Contractual Maturity | Amortized Cost | Fair Value | ||||||
One year or less |
$ | 969 | $ | 997 | ||||
Over one year through five years |
11,074 | 11,463 | ||||||
Over five years through ten years |
7,693 | 8,020 | ||||||
Over ten years |
11,157 | 11,223 | ||||||
Subtotal |
30,893 | 31,703 | ||||||
Mortgage-backed and asset-backed securities |
15,495 | 13,308 | ||||||
Total |
$ | 46,388 | $ | 45,011 | ||||
Estimated maturities may differ from contractual maturities due to security call or prepayment
provisions. Due to the potential for variability in payment spreads (i.e. prepayments or
extensions), mortgage-backed and asset-backed securities are not categorized by contractual
maturity.
Security Unrealized Loss Aging
The following tables present the Companys unrealized loss aging for AFS securities by type and
length of time the security was in a continuous unrealized loss position.
June 30, 2010 | ||||||||||||||||||||||||||||||||||||
Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||||||||||||||
Cost or | Cost or | Cost or | ||||||||||||||||||||||||||||||||||
Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | ||||||||||||||||||||||||||||
Cost | Value | Losses | Cost | Value | Losses | Cost | Value | Losses | ||||||||||||||||||||||||||||
ABS |
$ | 265 | $ | 239 | $ | (26 | ) | $ | 1,277 | $ | 917 | $ | (360 | ) | $ | 1,542 | $ | 1,156 | $ | (386 | ) | |||||||||||||||
CDOs |
341 | 302 | (39 | ) | 2,442 | 1,717 | (725 | ) | 2,783 | 2,019 | (764 | ) | ||||||||||||||||||||||||
CMBS |
461 | 443 | (18 | ) | 3,455 | 2,637 | (818 | ) | 3,916 | 3,080 | (836 | ) | ||||||||||||||||||||||||
Corporate |
1,781 | 1,683 | (98 | ) | 3,826 | 3,232 | (594 | ) | 5,607 | 4,915 | (692 | ) | ||||||||||||||||||||||||
Foreign govt./govt. agencies |
189 | 176 | (13 | ) | 40 | 33 | (7 | ) | 229 | 209 | (20 | ) | ||||||||||||||||||||||||
Municipal |
70 | 65 | (5 | ) | 677 | 572 | (105 | ) | 747 | 637 | (110 | ) | ||||||||||||||||||||||||
RMBS |
108 | 86 | (22 | ) | 1,640 | 1,129 | (511 | ) | 1,748 | 1,215 | (533 | ) | ||||||||||||||||||||||||
U.S. Treasuries |
1,329 | 1,328 | (1 | ) | 597 | 489 | (108 | ) | 1,926 | 1,817 | (109 | ) | ||||||||||||||||||||||||
Total fixed maturities |
4,544 | 4,322 | (222 | ) | 13,954 | 10,726 | (3,228 | ) | 18,498 | 15,048 | (3,450 | ) | ||||||||||||||||||||||||
Equity securities |
71 | 68 | (3 | ) | 197 | 141 | (56 | ) | 268 | 209 | (59 | ) | ||||||||||||||||||||||||
Total securities in an unrealized loss |
$ | 4,615 | $ | 4,390 | $ | (225 | ) | $ | 14,151 | $ | 10,867 | $ | (3,284 | ) | $ | 18,766 | $ | 15,257 | $ | (3,509 | ) | |||||||||||||||
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December 31, 2009 | ||||||||||||||||||||||||||||||||||||
Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||||||||||||||
Cost or | Cost or | Cost or | ||||||||||||||||||||||||||||||||||
Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | ||||||||||||||||||||||||||||
Cost | Value | Losses | Cost | Value | Losses | Cost | Value | Losses | ||||||||||||||||||||||||||||
ABS |
$ | 278 | $ | 230 | $ | (48 | ) | $ | 1,364 | $ | 940 | $ | (424 | ) | $ | 1,642 | $ | 1,170 | $ | (472 | ) | |||||||||||||||
CDOs |
990 | 845 | (145 | ) | 2,158 | 1,291 | (867 | ) | 3,148 | 2,136 | (1,012 | ) | ||||||||||||||||||||||||
CMBS |
1,207 | 1,016 | (191 | ) | 4,001 | 2,637 | (1,364 | ) | 5,208 | 3,653 | (1,555 | ) | ||||||||||||||||||||||||
Corporate |
3,434 | 3,207 | (227 | ) | 4,403 | 3,691 | (712 | ) | 7,837 | 6,898 | (939 | ) | ||||||||||||||||||||||||
Foreign govt./govt. agencies |
316 | 307 | (9 | ) | 30 | 26 | (4 | ) | 346 | 333 | (13 | ) | ||||||||||||||||||||||||
Municipal |
119 | 113 | (6 | ) | 791 | 603 | (188 | ) | 910 | 716 | (194 | ) | ||||||||||||||||||||||||
RMBS |
664 | 600 | (64 | ) | 1,688 | 1,055 | (633 | ) | 2,352 | 1,655 | (697 | ) | ||||||||||||||||||||||||
U.S. Treasuries |
1,573 | 1,534 | (39 | ) | 628 | 446 | (182 | ) | 2,201 | 1,980 | (221 | ) | ||||||||||||||||||||||||
Total fixed maturities |
8,581 | 7,852 | (729 | ) | 15,063 | 10,689 | (4,374 | ) | 23,644 | 18,541 | (5,103 | ) | ||||||||||||||||||||||||
Equity securities |
65 | 49 | (16 | ) | 246 | 196 | (50 | ) | 311 | 245 | (66 | ) | ||||||||||||||||||||||||
Total securities in an unrealized loss |
$ | 8,646 | $ | 7,901 | $ | (745 | ) | $ | 15,309 | $ | 10,885 | $ | (4,424 | ) | $ | 23,955 | $ | 18,786 | $ | (5,169 | ) | |||||||||||||||
As of June 30, 2010, AFS securities in an unrealized loss position, comprised of 2,150 securities,
primarily related to CMBS, CDOs and corporate securities primarily within the financial services
sector which have experienced significant price deterioration. As of June 30, 2010, 69% of these
securities were depressed less than 20% of cost or amortized cost. The decline in unrealized
losses during 2010 was primarily attributable to declining interest rates. The Company neither has
an intention to sell nor does it expect to be required to sell the securities outlined above.
Mortgage Loans
June 30, 2010 | December 31, 2009 | |||||||||||||||||||||||
Amortized | Valuation | Carrying | Amortized | Valuation | Carrying | |||||||||||||||||||
Cost (1) | Allowance | Value | Cost (1) | Allowance | Value | |||||||||||||||||||
Agricultural |
$ | 200 | $ | (5 | ) | $ | 195 | $ | 369 | $ | (3 | ) | $ | 366 | ||||||||||
Commercial |
3,213 | (83 | ) | 3,130 | 4,195 | (257 | ) | 3,938 | ||||||||||||||||
Total mortgage loans |
$ | 3,413 | $ | (88 | ) | $ | 3,325 | $ | 4,564 | $ | (260 | ) | $ | 4,304 | ||||||||||
[1] | Amortized cost represents carrying value prior to valuation allowances, if any. |
Included in the table above, are mortgage loans held for sale with a carrying value and valuation
allowance of $145 and $22, respectively as of June 30, 2010 and $161 and $79, respectively, as of
December 31, 2009. The carrying values of these loans are included in mortgage loans in the
Companys Condensed Consolidated Balance Sheet as of June 30, 2010. The following table presents
the activity within the Companys valuation allowance for mortgage loans.
2010 | 2009 | |||||||
Balance as of January 1 |
$ | (260 | ) | $ | (13 | ) | ||
Additions |
(111 | ) | (92 | ) | ||||
Deductions |
283 | 15 | ||||||
Balance as of June 30 |
$ | (88 | ) | $ | (90 | ) | ||
Mortgage Loans by Region | ||||||||||||||||
June 30, 2010 | December 31, 2009 | |||||||||||||||
Carrying | Percent of | Carrying | Percent of | |||||||||||||
Value | Total | Value | Total | |||||||||||||
East North Central |
$ | 71 | 2.1 | % | $ | 76 | 1.8 | % | ||||||||
Middle Atlantic |
317 | 9.5 | % | 592 | 13.8 | % | ||||||||||
Mountain |
51 | 1.5 | % | 51 | 1.2 | % | ||||||||||
New England |
339 | 10.2 | % | 368 | 8.6 | % | ||||||||||
Pacific |
925 | 27.9 | % | 1,102 | 25.5 | % | ||||||||||
South Atlantic |
603 | 18.1 | % | 615 | 14.3 | % | ||||||||||
West North Central |
19 | 0.6 | % | 22 | 0.5 | % | ||||||||||
West South Central |
129 | 3.9 | % | 172 | 4.0 | % | ||||||||||
Other [1] |
871 | 26.2 | % | 1,306 | 30.3 | % | ||||||||||
Total mortgage loans |
$ | 3,325 | 100.0 | % | $ | 4,304 | 100.0 | % | ||||||||
[1] | Primarily represents multi-regional properties. |
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Table of Contents
Mortgage Loans by Property Type | ||||||||||||||||
June 30, 2010 | December 31, 2009 | |||||||||||||||
Carrying | Percent of | Carrying | Percent of | |||||||||||||
Value | Total | Value | Total | |||||||||||||
Agricultural |
$ | 195 | 5.9 | % | $ | 366 | 8.5 | % | ||||||||
Industrial |
780 | 23.5 | % | 784 | 18.2 | % | ||||||||||
Lodging |
144 | 4.3 | % | 329 | 7.6 | % | ||||||||||
Multifamily |
556 | 16.7 | % | 582 | 13.5 | % | ||||||||||
Office |
875 | 26.3 | % | 1,387 | 32.3 | % | ||||||||||
Retail |
522 | 15.7 | % | 602 | 14.0 | % | ||||||||||
Other |
253 | 7.6 | % | 254 | 5.9 | % | ||||||||||
Total mortgage loans |
$ | 3,325 | 100.0 | % | $ | 4,304 | 100.0 | % | ||||||||
Variable Interest Entities
The Company is involved with various special purpose entities and other entities that are deemed to
be VIEs primarily as a collateral manager and as an investor through normal investment activities,
as well as a means of accessing capital. A VIE is an entity that either has investors that lack
certain essential characteristics of a controlling financial interest or lacks sufficient funds to
finance its own activities without financial support provided by other entities.
The Company performs ongoing qualitative assessments of its VIEs to determine whether the Company
has a controlling financial interest in the VIE and therefore is the primary beneficiary. The
Company is deemed to have a controlling financial interest when it has both the ability to direct
the activities that most significantly impact the economic performance of the VIE and the
obligation to absorb losses or right to receive benefits from the VIE that could potentially be
significant to the VIE. Based on the Companys assessment, if it determines it is the primary
beneficiary, the Company consolidates the VIE in the Companys Condensed Consolidated Financial
Statements.
Consolidated VIEs
The following table presents the carrying value of assets and liabilities, and the maximum exposure
to loss relating to the VIEs for which the Company is the primary beneficiary. Creditors have no
recourse against the Company in the event of default by these VIEs nor does the Company have any
implied or unfunded commitments to these VIEs. The Companys financial or other support provided
to these VIEs is limited to its investment management services. As a result of accounting guidance
adopted on January 1, 2010, certain CDO VIEs were consolidated in 2010 and are included in the
following table, while in prior periods they were reported in the Non-Consolidated VIEs table
further below. See Note 1 for further information on the adoption.
June 30, 2010 | December 31, 2009 | |||||||||||||||||||||||
Maximum | Maximum | |||||||||||||||||||||||
Total | Total | Exposure | Total | Total | Exposure | |||||||||||||||||||
Assets | Liabilities [1] | to Loss [2] | Assets | Liabilities | to Loss [21] | |||||||||||||||||||
CDOs [3] |
$ | 824 | $ | 453 | $ | 350 | $ | 226 | $ | 47 | $ | 181 | ||||||||||||
Limited partnerships |
22 | 9 | 13 | 31 | 13 | 18 | ||||||||||||||||||
Other investments [3] |
18 | 8 | 7 | 75 | 40 | 32 | ||||||||||||||||||
Total |
$ | 864 | $ | 470 | $ | 370 | $ | 332 | $ | 100 | $ | 231 | ||||||||||||
[1]
|
Included in other liabilities in the Companys Condensed Consolidated Balance Sheets. | |
[2]
|
The maximum exposure to loss represents the maximum loss amount that the Company could recognize as a reduction in net investment income or as a realized capital loss and is the cost basis of the Companys investment. | |
[3]
|
Total assets included in fixed maturities in the Companys Condensed Consolidated Balance Sheets. |
CDOs represent structured investment vehicles for which the Company has a controlling
financial interest as it provides collateral management services, earns a fee for those services
and also holds investments in the securities issued by these vehicles. Limited partnerships
represent a hedge fund for which the Company holds a majority interest in the funds securities as
an investment. Other investments represent an investment trust for which the Company has a
controlling financial interest as it provides investment management services, earns a fee for those
services and also holds investments in the securities issued by the trusts. Since December 31,
2009, the Company has received a paydown from this investment trust.
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Table of Contents
Non-Consolidated VIEs
The following table presents the carrying value of assets and liabilities, and the maximum exposure
to loss relating to significant VIEs for which the Company is not the primary beneficiary. The
Company has no implied or unfunded commitments to these VIEs.
June 30, 2010 | December 31, 2009 | |||||||||||||||||||||||
Maximum | Maximum | |||||||||||||||||||||||
Exposure | Exposure | |||||||||||||||||||||||
Assets | Liabilities | to Loss | Assets | Liabilities | to Loss | |||||||||||||||||||
CDOs [1] |
$ | | $ | | $ | | $ | 239 | $ | | $ | 248 | ||||||||||||
Total |
$ | | $ | | $ | | $ | 239 | $ | | $ | 248 | ||||||||||||
[1]
|
Maximum exposure to loss represents the Companys investment in securities issued by CDOs at cost. |
In addition, the Company, through normal investment activities, makes passive investments in
structured securities issued by VIEs for which the Company is not the manager which are included in
ABS, CDOs, CMBS and RMBS in the Available-for-Sale Securities table. The Company has not provided
financial or other support with respect to these investments other than its original investment.
For these investments, the Company determined it is not the primary beneficiary due to the relative
size of the Companys investment in comparison to the principal amount of the structured securities
issued by the VIEs, the level of credit subordination which reduces the Companys obligation to
absorb losses or right to receive benefits and the Companys inability to direct the activities
that most significantly impact the economic performance of the VIEs. The Companys maximum
exposure to loss on these investments is limited to the amount of the Companys investment.
Derivative Instruments
The Company utilizes a variety of over-the-counter and exchange traded derivative instruments as a
part of its overall risk management strategy, as well as to enter into replication transactions.
Derivative instruments are used to manage risk associated with interest rate, equity market, credit
spread, issuer default, price, and currency exchange rate risk or volatility. Replication
transactions are used as an economical means to synthetically replicate the characteristics and
performance of assets that would otherwise be permissible investments under the Companys
investment policies. The Company also purchases and issues financial instruments and products that
either are accounted for as free-standing derivatives, such as certain reinsurance contracts, or
may contain features that are deemed to be embedded derivative instruments, such as the GMWB rider
included with certain variable annuity products.
Cash flow hedges
Interest rate swaps
Interest rate swaps are primarily used to convert interest receipts on floating-rate fixed maturity
securities or interest payments on floating-rate guaranteed investment contracts to fixed rates.
These derivatives are predominantly used to better match cash receipts from assets with cash
disbursements required to fund liabilities.
The Company also enters into forward starting swap agreements to hedge the interest rate exposure
related to the purchase of fixed-rate securities or the anticipated future cash flows of
floating-rate fixed maturity securities due to changes in interest rates. These derivatives are
primarily structured to hedge interest rate risk inherent in the assumptions used to price certain
liabilities.
Forward rate agreements
Forward rate agreements are used to convert interest receipts on floating-rate securities to fixed
rates. These derivatives are used to lock in the forward interest rate curve and reduce income
volatility that results from changes in interest rates.
Foreign currency swaps
Foreign
currency swaps are used to convert foreign currency denominated cash flows related to certain
investment receipts and liability payments to U.S. dollars in order to minimize cash flow
fluctuations due to changes in currency rates.
Fair value hedges
Interest rate swaps
Interest rate swaps are used to hedge the changes in fair value of certain fixed rate liabilities
and fixed maturity securities due to fluctuations in interest rates.
Foreign currency swaps
Foreign
currency swaps are used to hedge the changes in fair value of certain foreign currency denominated
fixed rate liabilities due to changes in foreign currency rates by swapping the fixed foreign
payments to floating rate U.S. dollar denominated payments.
32
Table of Contents
Non-qualifying strategies
Interest rate swaps, caps, floors, and futures
The Company uses interest rate swaps, caps, floors, and futures to manage duration between assets
and liabilities in certain investment portfolios. In addition, the Company enters into interest
rate swaps to terminate existing swaps, thereby offsetting the changes in value of the original
swap. As of June 30, 2010 and December 31, 2009 the notional amount of interest rate swaps in
offsetting relationships was $4.7 billion and $4.5 billion, respectively.
Foreign currency swap and forwards
The Company enters into foreign currency swaps and forwards to convert the foreign currency
exposures to U.S. dollars in certain of its foreign denominated fixed maturity investments. The
Company also enters into foreign currency forward contracts that convert Euros to Yen in order to
economically hedge the foreign currency risk associated with certain Japanese variable
annuity products.
Japan 3Win related foreign currency swaps
During the first quarter of 2009, the Company entered into foreign currency swaps to hedge the
foreign currency exposure related to the Japan 3Win product guaranteed minimum income benefit
(GMIB) fixed liability payments.
Japanese fixed annuity hedging instruments
The Company enters into currency rate swaps and forwards to mitigate the foreign currency exchange
rate and Yen interest rate exposures associated with the Yen denominated individual fixed annuity
product.
Credit derivatives that purchase credit protection
Credit default swaps are used to purchase credit protection on an individual entity or referenced
index to economically hedge against default risk and credit-related changes in value on fixed
maturity securities. These contracts require the Company to pay a periodic fee in exchange for
compensation from the counterparty should the referenced security issuers experience a credit
event, as defined in the contract.
Credit derivatives that assume credit risk
Credit default swaps are used to assume credit risk related to an individual entity, referenced
index, or asset pool, as a part of replication transactions. These contracts entitle the Company
to receive a periodic fee in exchange for an obligation to compensate the derivative counterparty
should the referenced security issuers experience a credit event, as defined in the contract. The
Company is also exposed to credit risk due to embedded derivatives associated with credit linked
notes.
Credit derivatives in offsetting positions
The Company enters into credit default swaps to terminate existing credit default swaps, thereby
offsetting the changes in value of the original swap going forward.
Equity index swaps, options, and futures
The Company offers certain equity indexed products, which may contain an embedded derivative that
requires bifurcation. The Company enters into S&P index swaps, futures and options to economically
hedge the equity volatility risk associated with these embedded derivatives. In addition, the
Company is exposed to bifurcated options embedded in certain fixed maturity investments.
GMWB product derivatives
The Company offers certain variable annuity products with a GMWB rider in the U.S. and formerly in
the U.K. and Japan. The GMWB is a bifurcated embedded derivative that provides the policyholder
with a GRB if the account value is reduced to zero through a combination of market declines and
withdrawals. The GRB is generally equal to premiums less withdrawals. Certain contract provisions
can increase the GRB at contract holder election or after the passage of time. The notional value
of the embedded derivative is the GRB balance.
GMWB reinsurance contracts
The Company has entered into reinsurance arrangements to offset a portion of its risk exposure to
the GMWB for the remaining lives of covered variable annuity contracts. Reinsurance contracts
covering GMWB are accounted for as free-standing derivatives. The notional amount of the
reinsurance contracts is the GRB amount.
GMWB hedging instruments
The Company enters into derivative contracts to partially hedge exposure
associated with the portion of the GMWB liabilities that are not reinsured. These derivative
contracts include customized swaps, interest rate swaps and futures, and equity swaps, options, and
futures, on certain indices including the S&P 500 index, EAFE index, and NASDAQ index.
33
Table of Contents
The following table represents notional and fair value for GMWB hedging instruments.
Notional Amount | Fair Value | |||||||||||||||
June 30, | December 31, | June 30, | December 31, | |||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Customized swaps |
$ | 9,448 | $ | 10,838 | $ | 483 | $ | 234 | ||||||||
Equity swaps, options, and futures |
3,701 | 2,994 | 445 | 9 | ||||||||||||
Interest rate swaps and futures |
2,621 | 1,735 | (91 | ) | (191 | ) | ||||||||||
Total |
$ | 15,770 | $ | 15,567 | $ | 837 | $ | 52 | ||||||||
Macro hedge program
The Company utilizes equity options, currency options, and equity futures contracts to partially
hedge against a decline in the equity markets or changes in foreign currency exchange rates and the
resulting statutory surplus and capital impact primarily from guaranteed minimum death benefit
(GMDB), GMIB and GMWB obligations.
The following table represents notional and fair value for the macro hedge program.
Notional Amount | Fair Value | |||||||||||||||
June 30, | December 31, | June 30, | December 31, | |||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Equity options and futures |
$ | 11,358 | $ | 25,373 | $ | 666 | $ | 296 | ||||||||
Long currency options |
4,938 | 1,000 | 256 | 22 | ||||||||||||
Short currency options |
5,934 | 1,075 | (69 | ) | | |||||||||||
Total |
$ | 22,230 | $ | 27,448 | $ | 853 | $ | 318 | ||||||||
GMAB, GMWB and GMIB reinsurance contracts
The Company reinsured the GMAB, GMWB, and GMIB embedded derivatives for host variable annuity
contracts written by its affiliate, HLIKK, in Japan. The reinsurance contracts are accounted for as
free-standing derivative contracts. The notional amount of the reinsurance contracts is the Yen
denominated GRB balance value converted at the period-end Yen to U.S. dollar foreign spot exchange
rate. Refer to Note 10 Transactions with Affiliates for more information on this transaction.
Coinsurance and modified coinsurance reinsurance contracts
During 2009, a subsidiary entered into a coinsurance with funds withheld and modified coinsurance
reinsurance agreement with an affiliated captive reinsurer, which creates an embedded derivative.
In addition, provisions of this agreement include reinsurance to cede a portion of direct written
U.S. GMWB riders, which is accounted for as an embedded derivative. Additional provisions of this
agreement cede variable annuity contract GMAB, GMWB and GMIB riders reinsured by the Company that
have been assumed from an affiliate, HLIKK, and is accounted for as a free-standing derivative.
Refer to Note 10 Transactions with Affiliates for more information on this transaction.
34
Table of Contents
Derivative Balance Sheet Classification
The table below summarizes the balance sheet classification of the Companys derivative related
fair value amounts, as well as the gross asset and liability fair value amounts. The fair value
amounts presented do not include income accruals or cash collateral held amounts, which are netted
with derivative fair value amounts to determine balance sheet presentation. Derivatives in the
Companys separate accounts are not included because the associated gains and losses accrue
directly to policyholders. The Companys derivative instruments are held for risk management
purposes, unless otherwise noted in the table below. The notional amount of derivative contracts
represents the basis upon which pay or receive amounts are calculated and is presented in the table
to quantify the volume of the Companys derivative activity. Notional amounts are not necessarily
reflective of credit risk.
Net Derivatives | Asset Derivatives | Liability Derivatives | ||||||||||||||||||||||||||||||
Notional Amount | Fair Value | Fair Value | Fair Value | |||||||||||||||||||||||||||||
Hedge Designation/ Derivative Type | Jun. 30, 2010 |
Dec. 31, 2009 |
Jun. 30, 2010 |
Dec. 31, 2009 |
Jun. 30, 2010 |
Dec. 31, 2009 |
Jun. 30, 2010 |
Dec. 31, 2009 |
||||||||||||||||||||||||
Cash flow hedges |
||||||||||||||||||||||||||||||||
Interest rate swaps |
$ | 7,869 | $ | 8,729 | $ | 273 | $ | 53 | $ | 278 | $ | 201 | $ | (5 | ) | $ | (148 | ) | ||||||||||||||
Forward rate agreements |
| 3,000 | | | | | | | ||||||||||||||||||||||||
Foreign currency swaps |
266 | 301 | (1 | ) | (4 | ) | 24 | 21 | (25 | ) | (25 | ) | ||||||||||||||||||||
Total cash flow hedges |
8,135 | 12,030 | 272 | 49 | 302 | 222 | (30 | ) | (173 | ) | ||||||||||||||||||||||
Fair value hedges |
||||||||||||||||||||||||||||||||
Interest rate swaps |
1,043 | 1,744 | (66 | ) | (21 | ) | 2 | 16 | (68 | ) | (37 | ) | ||||||||||||||||||||
Foreign currency swaps |
696 | 696 | (49 | ) | (9 | ) | 44 | 53 | (93 | ) | (62 | ) | ||||||||||||||||||||
Total fair value hedges |
1,739 | 2,440 | (115 | ) | (30 | ) | 46 | 69 | (161 | ) | (99 | ) | ||||||||||||||||||||
Non-qualifying strategies |
||||||||||||||||||||||||||||||||
Interest rate contracts |
||||||||||||||||||||||||||||||||
Interest rate swaps, caps, floors, and futures |
5,640 | 5,511 | (262 | ) | (79 | ) | 229 | 157 | (491 | ) | (236 | ) | ||||||||||||||||||||
Foreign exchange contracts |
||||||||||||||||||||||||||||||||
Foreign currency swaps and forwards |
471 | 484 | 39 | (19 | ) | 43 | | (4 | ) | (19 | ) | |||||||||||||||||||||
Japan 3Win related foreign currency swaps |
2,514 | 2,514 | (10 | ) | (19 | ) | 21 | 35 | (31 | ) | (54 | ) | ||||||||||||||||||||
Japanese fixed annuity hedging instruments |
2,201 | 2,271 | 418 | 316 | 418 | 319 | | (3 | ) | |||||||||||||||||||||||
Credit contracts |
||||||||||||||||||||||||||||||||
Credit derivatives that purchase credit protection |
1,976 | 1,887 | 33 | (34 | ) | 54 | 36 | (21 | ) | (70 | ) | |||||||||||||||||||||
Credit derivatives that assume credit risk [1] |
1,428 | 902 | (487 | ) | (176 | ) | 2 | 2 | (489 | ) | (178 | ) | ||||||||||||||||||||
Credit derivatives in offsetting positions |
3,970 | 3,591 | (63 | ) | (52 | ) | 100 | 114 | (163 | ) | (166 | ) | ||||||||||||||||||||
Equity contracts |
||||||||||||||||||||||||||||||||
Equity index swaps, options, and futures |
195 | 221 | (11 | ) | (16 | ) | 4 | 3 | (15 | ) | (19 | ) | ||||||||||||||||||||
Variable annuity hedge program |
||||||||||||||||||||||||||||||||
GMWB product derivatives [2] |
44,794 | 46,906 | (3,192 | ) | (1,991 | ) | | | (3,192 | ) | (1,991 | ) | ||||||||||||||||||||
GMWB reinsurance contracts |
9,517 | 10,301 | 550 | 347 | 550 | 347 | | | ||||||||||||||||||||||||
GMWB hedging instruments |
15,770 | 15,567 | 837 | 52 | 969 | 264 | (132 | ) | (212 | ) | ||||||||||||||||||||||
Macro hedge program |
22,230 | 27,448 | 853 | 318 | 923 | 558 | (70 | ) | (240 | ) | ||||||||||||||||||||||
Other |
||||||||||||||||||||||||||||||||
GMAB, GMWB, and GMIB reinsurance contracts |
20,172 | 19,618 | (2,153 | ) | (1,448 | ) | | | (2,153 | ) | (1,448 | ) | ||||||||||||||||||||
Coinsurance and modified coinsurance reinsurance
contracts |
49,553 | 49,545 | 1,896 | 761 | 1,932 | 1,226 | (36 | ) | (465 | ) | ||||||||||||||||||||||
Total non-qualifying strategies |
180,431 | 186,766 | (1,552 | ) | (2,040 | ) | 5,245 | 3,061 | (6,797 | ) | (5,101 | ) | ||||||||||||||||||||
Total cash flow hedges, fair value hedges, and
non-qualifying strategies |
$ | 190,305 | $ | 201,236 | $ | (1,395 | ) | $ | (2,021 | ) | $ | 5,593 | $ | 3,352 | $ | (6,988 | ) | $ | (5,373 | ) | ||||||||||||
Balance Sheet Location |
||||||||||||||||||||||||||||||||
Fixed maturities, available-for-sale |
$ | 144 | $ | 170 | $ | (1 | ) | $ | (8 | ) | $ | | $ | | $ | (1 | ) | $ | (8 | ) | ||||||||||||
Other investments |
50,960 | 18,049 | 2,108 | 220 | 2,767 | 270 | (659 | ) | (50 | ) | ||||||||||||||||||||||
Other liabilities |
15,067 | 56,524 | (592 | ) | 113 | 344 | 1,509 | (936 | ) | (1,396 | ) | |||||||||||||||||||||
Consumer notes |
39 | 64 | (4 | ) | (5 | ) | | | (4 | ) | (5 | ) | ||||||||||||||||||||
Reinsurance recoverables |
57,298 | 58,380 | 2,446 | 1,108 | 2,482 | 1,573 | (36 | ) | (465 | ) | ||||||||||||||||||||||
Other policyholder funds and benefits payable |
66,797 | 68,049 | (5,352 | ) | (3,449 | ) | | | (5,352 | ) | (3,449 | ) | ||||||||||||||||||||
Total derivatives |
$ | 190,305 | $ | 201,236 | $ | (1,395 | ) | $ | (2,021 | ) | $ | 5,593 | $ | 3,352 | $ | (6,988 | ) | $ | (5,373 | ) | ||||||||||||
[1]
|
The derivative instruments related to these strategies are held for other investment purposes. | |
[2]
|
These derivatives are embedded within liabilities and are not held for risk management purposes. |
35
Table of Contents
Change in Notional Amount
The decrease in notional amount of derivatives since December 31, 2009, was primarily due to the
following:
| The notional amount related to the macro hedge program declined $5.2 billion primarily due to the expiration of certain equity index options during January of 2010. |
| The Company terminated $3.0 billion notional of forward rate agreements. The $3.0 billion notional was comprised of a series of one month forward contracts that were hedging the variability of cash flows related to coupon payments on $250 of variable rate securities for consecutive monthly periods during 2010 offset by the extension of the macro hedge program to 2011. |
| The GMWB product derivative notional declined $2.1 billion primarily as a result of policyholder lapses and withdrawals. |
Change in Fair Value
The change in the total fair value of derivative instruments since December 31, 2009, was primarily
due to the following:
| The increase in fair value of the macro hedge program is primarily due to lower equity market valuation, appreciation of the Japanese yen, and purchases made in the first half of the year. |
| Under an internal reinsurance agreement with an affiliate, the increase in fair value liability associated with the GMAB, GMWB, and GMIB reinsurance along with a portion of the GMWB related derivatives are ceded to the affiliated reinsurer and result in an offsetting increase in fair value of the coinsurance and modified coinsurance reinsurance contracts. |
| The fair value related to credit derivatives that assume credit risk decreased as a result of the Company adopting new accounting guidance related to the consolidation of VIEs, see Adoption of New Accounting Standards in Note 1. As a result of this new guidance, the Company has consolidated a Company sponsored CDO that included credit default swaps with a notional amount of $353 and a fair value of $(293) as of June 30, 2010. These swaps reference a standard market basket of corporate issuers. |
| The decrease in the net fair value of GMWB product, reinsurance, and hedging derivatives was primarily due to higher implied market volatility and the general decrease in long-term interest rates. |
Cash Flow Hedges
For derivative instruments that are designated and qualify as cash flow hedges, the effective
portion of the gain or loss on the derivative is reported as a component of OCI and reclassified
into earnings in the same period or periods during which the hedged transaction affects earnings.
Gains and losses on the derivative representing hedge ineffectiveness are recognized in current
earnings. All components of each derivatives gain or loss were included in the assessment of
hedge effectiveness.
The following table presents the components of the gain or loss on derivatives that qualify as cash
flow hedges:
Derivatives in Cash Flow Hedging Relationships | ||||||||||||||||||||||||||||||||||
Gain (Loss) Recognized in | Gain (Loss) Recognized in | |||||||||||||||||||||||||||||||||
OCI on Derivative | Income on Derivative | |||||||||||||||||||||||||||||||||
(Effective Portion) | (Ineffective Portion) | |||||||||||||||||||||||||||||||||
Three Months | Six Months | Three Months | Six Months | |||||||||||||||||||||||||||||||
Ended | Ended | Ended | Ended | |||||||||||||||||||||||||||||||
June 30, | June 30, | June 30, | June 30, | |||||||||||||||||||||||||||||||
2010 | 2009 | 2010 | 2009 | 2010 | 2009 | 2010 | 2009 | |||||||||||||||||||||||||||
Interest rate swaps |
Net realized capital gains (losses) | $ | 208 | $ | (300 | ) | $ | 285 | $ | (357 | ) | $ | 1 | $ | 1 | $ | 1 | $ | | |||||||||||||||
Foreign currency swaps |
Net realized capital gains (losses) | | (122 | ) | 4 | (123 | ) | | 24 | | 39 | |||||||||||||||||||||||
Total |
$ | 208 | $ | (422 | ) | $ | 289 | $ | (480 | ) | $ | 1 | $ | 25 | $ | 1 | $ | 39 | ||||||||||||||||
Derivatives in Cash Flow Hedging Relationships | ||||||||||||||||||
Gain (Loss) Reclassified from AOCI into Income (Effective Portion) | ||||||||||||||||||
Three Months Ended | Six Months Ended | |||||||||||||||||
June 30, | June 30, | |||||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||||
Interest rate swaps |
Net realized capital gains (losses) | $ | 1 | $ | | $ | 1 | $ | | |||||||||
Interest rate swaps |
Net investment income (loss) | 12 | 6 | 19 | 12 | |||||||||||||
Foreign currency swaps |
Net realized capital gains (losses) | (11 | ) | (41 | ) | (16 | ) | (73 | ) | |||||||||
Foreign currency swaps |
Net investment income (loss) | | 1 | | 2 | |||||||||||||
Total |
$ | 2 | $ | (34 | ) | $ | 4 | $ | (59 | ) | ||||||||
36
Table of Contents
For the three months ended June 30, 2010, the before-tax deferred net gains on derivative
instruments recorded in AOCI that are expected to be reclassified to earnings during the next
twelve months are $49. This expectation is based on the anticipated interest payments on hedged
investments in fixed maturity securities that will occur over the next twelve months, at which time
the Company will recognize the deferred net gains (losses) as an adjustment to interest income over
the term of the investment cash flows. The maximum term over which the Company is hedging its
exposure to the variability of future cash flows (for forecasted transactions, excluding interest
payments on existing variable-rate financial instruments) is three years.
During the three months ended June 30, 2010, the Company has less than $1 of net reclassifications
from AOCI to earnings resulting from the discontinuance of cash-flow hedges due to forecasted
transactions that were no longer probable of occurring. For the three months ended June 30, 2009,
the Company had no net reclassifications from AOCI to earnings resulting from the discontinuance of
cash-flow hedges due to forecasted transactions that were no longer probable of occurring.
Fair Value Hedges
For derivative instruments that are designated and qualify as a fair value hedge, the gain or loss
on the derivative, as well as the offsetting loss or gain on the hedged item attributable to the
hedged risk are recognized in current earnings. The Company includes the gain or loss on the
derivative in the same line item as the offsetting loss or gain on the hedged item. All components
of each derivatives gain or loss were included in the assessment of hedge effectiveness.
The Company recognized in income gains (losses) representing the ineffective portion of fair value
hedges as follows:
Derivatives in Fair Value Hedging Relationships | ||||||||||||||||||||||||||||||||
Gain (Loss) Recognized in Income [1] | ||||||||||||||||||||||||||||||||
Three Months Ended | Six Months Ended | |||||||||||||||||||||||||||||||
June 30, | June 30, | |||||||||||||||||||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||||||||||||||||||
Hedge | Hedge | Hedge | Hedge | |||||||||||||||||||||||||||||
Derivative | Item | Derivative | Item | Derivative | Item | Derivative | Item | |||||||||||||||||||||||||
Interest rate swaps |
||||||||||||||||||||||||||||||||
Net realized capital gains (losses) |
$ | (40 | ) | $ | 37 | $ | 49 | $ | (45 | ) | $ | (52 | ) | $ | 47 | $ | 66 | $ | (62 | ) | ||||||||||||
Benefits, losses and loss adjustment expenses |
(7 | ) | 8 | (26 | ) | 27 | (2 | ) | 3 | (42 | ) | 44 | ||||||||||||||||||||
Foreign currency swaps |
||||||||||||||||||||||||||||||||
Net realized capital gains (losses) |
(11 | ) | 11 | 63 | (63 | ) | (40 | ) | 40 | 47 | (47 | ) | ||||||||||||||||||||
Benefits, losses and loss adjustment expenses |
| | (5 | ) | 5 | (1 | ) | 1 | | | ||||||||||||||||||||||
Total |
$ | (58 | ) | $ | 56 | $ | 81 | $ | (76 | ) | $ | (95 | ) | $ | 91 | $ | 71 | $ | (65 | ) | ||||||||||||
[1]
|
The amounts presented do not include the periodic net coupon settlements of the derivative or the coupon income (expense) related to the hedged item. The net of the amounts presented represents the ineffective portion of the hedge. |
37
Table of Contents
Non-qualifying Strategies
For non-qualifying strategies, including embedded derivatives that are required to be bifurcated
from their host contracts and accounted for as derivatives, the gain or loss on the derivative is
recognized currently in earnings within net realized capital gains or losses. The following table
presents the gain or loss recognized in income on non-qualifying strategies:
Non-qualifying Strategies | ||||||||||||||||
Gain (Loss) Recognized within Net Realized Capital Gains (Losses) | ||||||||||||||||
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Interest rate contracts |
||||||||||||||||
Interest rate swaps, caps, floors, and forwards |
$ | (4 | ) | $ | 6 | $ | (4 | ) | $ | 21 | ||||||
Foreign exchange contracts |
||||||||||||||||
Foreign currency swaps and forwards |
45 | (26 | ) | 61 | (40 | ) | ||||||||||
Japan 3Win related foreign currency swaps [1] |
65 | 119 | 9 | (110 | ) | |||||||||||
Japanese fixed annuity hedging instruments [2] |
160 | 50 | 141 | (118 | ) | |||||||||||
Credit contracts |
||||||||||||||||
Credit derivatives that purchase credit protection |
26 | (199 | ) | 25 | (280 | ) | ||||||||||
Credit derivatives that assume credit risk |
(45 | ) | 130 | (13 | ) | 58 | ||||||||||
Equity contracts |
||||||||||||||||
Equity index swaps, options, and futures |
4 | (2 | ) | 5 | (4 | ) | ||||||||||
Variable annuity hedge program |
||||||||||||||||
GMWB product derivatives |
(1,476 | ) | 2,605 | (1,130 | ) | 3,329 | ||||||||||
GMWB reinsurance contracts |
246 | (433 | ) | 185 | (685 | ) | ||||||||||
GMWB hedging instruments |
825 | (1,518 | ) | 662 | (1,400 | ) | ||||||||||
Macro hedge program |
397 | (568 | ) | 233 | (364 | ) | ||||||||||
Other |
||||||||||||||||
GMAB, GMWB, and GMIB reinsurance contracts |
(671 | ) | 336 | (556 | ) | 1,432 | ||||||||||
Coinsurance and modified coinsurance reinsurance contracts |
1,222 | | 843 | | ||||||||||||
Total |
$ | 794 | $ | 500 | $ | 461 | $ | 1,839 | ||||||||
[1]
|
The associated liability is adjusted for changes in spot rates through realized capital gains and losses and was $(103) and $(44) for the three months ended June 30, 2010 and 2009, respectively, and $(96) and $140 for the six months ended June 30, 2010 and 2009, respectively. | |
[2]
|
The associated liability is adjusted for changes in spot rates through realized capital gains and losses and was $(126) and $(54) for the three months ended June 30, 2010 and 2009, respectively and $(119) and $151 for the six months ended June 30, 2010 and 2009. |
For the three and six months ended June 30, 2010, the net realized capital gain (loss) related
to derivatives used in non-qualifying strategies was primarily due to the following:
| The net gain associated with the macro hedge program is primarily due to lower equity market valuation and appreciation of the Japanese yen. |
| The net gain on the Japanese fixed annuity hedging instruments is primarily due to the U.S. dollar weakening in comparison to the Japanese yen. |
| The net gain for the three months ended June 30, 2010, related to the Japan 3 Win hedging derivatives is primarily due to the U.S. dollar weakening in comparison to the Japanese yen, partially offset by the decrease in long-term interest rates. |
| The net loss on derivatives associated with GMAB, GMWB, and GMIB product reinsurance contracts, which are reinsured to an affiliated captive reinsurer, was primarily due to a decline in the Japan equity markets, a decrease in Japan interest rates, and an increase in Japan equity market volatility, partially offset by the impact of credit standing. |
| The loss on net GMWB product, reinsurance, and hedging derivatives is primarily driven by higher implied market volatility and the general decrease in long-term interest rates. |
| The net gain on the coinsurance and modified coinsurance reinsurance agreement, which is accounted for as a derivative instrument, primarily offsets the net loss on the GMAB, GMWB, and GMIB reinsurance contracts as well as a portion of the GMWB product derivatives. For a discussion related to the reinsurance agreement refer to Note 10 Transactions with Affiliates for more information on this transaction. |
38
Table of Contents
For the three and six months ended June 30, 2009, the net realized capital gain (loss) related to
derivatives used in non-qualifying strategies was primarily due to the following:
| The gain on the net GMWB product, reinsurance, and hedging derivatives was primarily due to market-based valuation changes, including a decrease in equity volatility levels and an increase in interest rates, as well as policyholder behavior and liability model assumption updates. For further discussion on liability model assumption updates, refer to Note 3. |
| The net gain on derivatives associated with GMAB, GMWB and GMIB product reinsurance contracts, which are reinsured to an affiliated captive reinsurer, was primarily due to an increase in the equity markets and a decrease in Japan equity market volatility for the three months ended June 30, 2009 and liability model assumption updates for credit standing for the six months ended June 30, 2009. For further discussion on liability model assumption updates, refer to Note 3. |
| The net gain on the Japanese fixed annuity and Japan 3 Win hedging instruments for the three months ended June 30, 2009 was primarily due to weakening of the U.S. dollar against the Japanese yen and an increase in U.S. interest rates. The net loss for the six months ended June 30, 2009 was primarily due to the U.S. dollar strengthening against the Japanese yen. |
| The net loss on the macro hedge program was primarily the result of a higher equity market valuation and the impact of trading activity. |
| The loss on credit derivatives that purchase credit protection and the net gain on credit derivatives that assume credit risk as a part of replication transactions resulted from credit spreads tightening. |
Refer to Note 8 for additional disclosures regarding contingent credit related features in
derivative agreements.
Credit Risk Assumed through Credit Derivatives
The Company enters into credit default swaps that assume credit risk from a single entity,
referenced index, or asset pool in order to synthetically replicate investment transactions. The
Company will receive periodic payments based on an agreed upon rate and notional amount and will
only make a payment if there is a credit event. A credit event payment will typically be equal to
the notional value of the swap contract less the value of the referenced security issuers debt
obligation. A credit event is generally defined as a default on contractually obligated interest
or principal payments or bankruptcy of the referenced entity. The credit default swaps in which
the Company assumes credit risk primarily reference investment grade single corporate issuers and
baskets, which include trades ranging from baskets of up to five corporate issuers to standard and
customized diversified portfolios of corporate issuers. The diversified portfolios of corporate
issuers are established within sector concentration limits and are typically divided into tranches
that possess different credit ratings.
The following tables present the notional amount, fair value, and weighted average years to
maturity, underlying referenced credit obligation type and average credit ratings, and offsetting
notional amounts and fair value for credit derivatives in which the Company is assuming credit risk
as of June 30, 2010 and December 31, 2009.
As of June 30, 2010 | ||||||||||||||||||||||||||||
Underlying Referenced | ||||||||||||||||||||||||||||
Weighted | Credit Obligation(s) [1] | |||||||||||||||||||||||||||
Average | Average | Offsetting | ||||||||||||||||||||||||||
Credit Derivative type by derivative | Notional | Fair | Years to | Credit | Notional | Offsetting | ||||||||||||||||||||||
risk exposure | Amount [2] | Value | Maturity | Type | Rating | Amount [3] | Fair Value [3] | |||||||||||||||||||||
Single name credit default swaps |
||||||||||||||||||||||||||||
Investment grade risk exposure |
$ | 987 | $ | (16 | ) | 4 years | Corporate Credit/Foreign Gov. |
A+ | $ | 954 | $ | (34 | ) | |||||||||||||||
Below investment grade risk exposure |
114 | (8 | ) | 3 years | Corporate Credit | BB- | 95 | (9 | ) | |||||||||||||||||||
Basket credit default swaps [4] |
||||||||||||||||||||||||||||
Investment grade risk exposure |
834 | (2 | ) | 4 years | Corporate Credit | BBB+ | 584 | | ||||||||||||||||||||
Investment grade risk exposure |
352 | (76 | ) | 7 years | CMBS Credit | A- | 352 | 76 | ||||||||||||||||||||
Below
investment grade risk exposure |
1,077 | (480 | ) | 4 years | Corporate Credit | BBB | | | ||||||||||||||||||||
Credit linked notes |
||||||||||||||||||||||||||||
Investment grade risk exposure |
49 | 48 | 2 years | Corporate Credit | BBB- | | | |||||||||||||||||||||
Total |
$ | 3,413 | $ | (534 | ) | $ | 1,985 | $ | 33 | |||||||||||||||||||
39
Table of Contents
As of December 31, 2009 | ||||||||||||||||||||||||||||
Underlying Referenced | ||||||||||||||||||||||||||||
Weighted | Credit Obligation(s) [1] | |||||||||||||||||||||||||||
Average | Average | Offsetting | ||||||||||||||||||||||||||
Credit Derivative type by derivative | Notional | Fair | Years to | Credit | Notional | Offsetting | ||||||||||||||||||||||
risk exposure | Amount [2] | Value | Maturity | Type | Rating | Amount [3] | Fair Value [3] | |||||||||||||||||||||
Single name credit default swaps |
||||||||||||||||||||||||||||
Investment grade risk exposure |
$ | 755 | $ | 4 | 4 years | Corporate Credit/Foreign Gov. |
AA- | $ | 742 | $ | (43 | ) | ||||||||||||||||
Below investment grade risk
exposure |
114 | (4 | ) | 4 years | Corporate Credit | B+ | 75 | (11 | ) | |||||||||||||||||||
Basket credit default swaps [4] |
||||||||||||||||||||||||||||
Investment grade risk exposure |
1,276 | (57 | ) | 4 years | Corporate Credit | BBB+ | 626 | (11 | ) | |||||||||||||||||||
Investment grade risk exposure |
352 | (91 | ) | 7 years | CMBS Credit | A | 352 | 91 | ||||||||||||||||||||
Below investment grade risk
exposure |
125 | (98 | ) | 5 years | Corporate Credit | BBB+ | | | ||||||||||||||||||||
Credit linked notes |
||||||||||||||||||||||||||||
Investment grade risk exposure |
76 | 73 | 2 years | Corporate Credit | BBB+ | | | |||||||||||||||||||||
Total |
$ | 2,698 | $ | (173 | ) | $ | 1,795 | $ | 26 | |||||||||||||||||||
[1]
|
The average credit ratings are based on availability and the midpoint of the applicable ratings among Moodys, S&P, and Fitch. If no rating is available from a rating agency, then an internally developed rating is used. | |
[2]
|
Notional amount is equal to the maximum potential future loss amount. There is no specific collateral related to these contracts or recourse provisions included in the contracts to offset losses. | |
[3]
|
The Company has entered into offsetting credit default swaps to terminate certain existing credit default swaps, thereby offsetting the future changes in value of, or losses paid related to, the original swap. | |
[4]
|
Includes $1.7 billion and $1.6 billion as of June 30, 2010 and December 31, 2009, respectively, of standard market indices of diversified portfolios of corporate issuers referenced through credit default swaps. These swaps are subsequently valued based upon the observable standard market index. Also includes $528 and $175 as of June 30, 2010 and December 31, 2009 of customized diversified portfolios of corporate issuers referenced through credit default swaps. |
5. Deferred Policy Acquisition Costs and Present Value of Future Profits
Changes in DAC balance are as follows:
2010 | 2009 | |||||||
Balance, January 1 |
5,779 | 9,944 | ||||||
Deferred costs |
254 | 366 | ||||||
Amortization
DAC |
(186 | ) | (673 | ) | ||||
Amortization
Unlock, pre-tax [1], [2] |
(17 | ) | (1026 | ) | ||||
Adjustments to unrealized gains and losses on securities, available-for-sale and other [3] |
(781 | ) | 141 | |||||
Effect of currency translation adjustment |
(4 | ) | 24 | |||||
Effects of new accounting guidance for investments other-than-temporarily impaired [4] |
| (54 | ) | |||||
Balance, June 30 |
5,045 | 8,722 | ||||||
[1]
|
The most significant contributor to the Unlock charge recorded during the six months ended June 30, 2010 was actual separate account returns from January 1, 2010 to June 30, 2010 being below our aggregated estimated return. | |
[2]
|
The most significant contributor to the Unlock amount recorded during the six months ended June 30, 2009 was a result of actual separate account returns from the period ending October 1, 2008 to June 30, 2009 being significantly below our aggregated estimated return. | |
[3]
|
The adjustment reflects the effect of credit spreads tightening, resulting in unrealized gains on securities in 2010. | |
[4]
|
The effect of adopting new accounting guidance for investments, other-than-temporarily impaired resulted in an increase to retained earnings and as a result a DAC charge of $54 in 2009. In addition, an offsetting amount was recorded in unrealized losses as unrealized losses increased upon adoption of new accounting guidance for investments, other-than-temporarily impaired. |
40
Table of Contents
6. Separate Accounts, Death Benefits and Other Insurance Benefit Features
Changes in the gross GMDB and UL secondary guarantee benefits are as follows:
UL Secondary | ||||||||
GMDB [1] | Guarantees [1] | |||||||
Liability balance as of January 1, 2010 |
$ | 1,304 | $ | 76 | ||||
Incurred |
145 | 20 | ||||||
Unlock |
111 | | ||||||
Paid |
(182 | ) | | |||||
Liability balance as of June 30, 2010 |
$ | 1,378 | 96 | |||||
[1]
|
The reinsurance recoverable asset related to the U.S. GMDB was $832 as of June 30, 2010. The reinsurance recoverable asset related to the UL secondary guarantees was $26 as of June 30, 2010. |
UL Secondary | ||||||||
GMDB [1] | Guarantees [1] | |||||||
Liability balance as of January 1, 2009 |
$ | 882 | $ | 40 | ||||
Incurred |
194 | 14 | ||||||
Unlock |
776 | | ||||||
Paid |
(293 | ) | | |||||
Liability balance as of June 30, 2009 |
$ | 1,559 | $ | 54 | ||||
[1]
|
The reinsurance recoverable asset related to the U.S. GMDB was $927 as of June 30, 2009. The reinsurance recoverable asset related to the UL secondary guarantees was $19 as of June 30, 2009. |
The following table provides details concerning GMDB and GMIB exposure as of June 30, 2010:
Breakdown of Variable Annuity Account Value by GMDB/GMIB Type | ||||||||||||||||
Account | Net amount | Retained Net Amount |
Weighted Average | |||||||||||||
Value | at Risk | at Risk | Attained Age of | |||||||||||||
Maximum anniversary value (MAV) [1] | (AV)[8] | (NAR)[10] | (RNAR)[10] | Annuitant | ||||||||||||
MAV only |
23,810 | 9,254 | 890 | 66 | ||||||||||||
With 5% rollup [2] |
1,633 | 733 | 57 | 67 | ||||||||||||
With Earnings Protection Benefit Rider (EPB) [3] |
5,940 | 1,637 | 29 | 63 | ||||||||||||
With 5% rollup & EPB |
678 | 253 | 10 | 66 | ||||||||||||
Total MAV |
32,061 | 11,877 | 986 | |||||||||||||
Asset Protection Benefit (APB) [4] |
25,638 | 6,257 | 1,226 | 65 | ||||||||||||
Lifetime Income Benefit (LIB) [5] |
1,197 | 266 | 82 | 63 | ||||||||||||
Reset [6] (5-7 years) |
3,364 | 614 | 337 | 68 | ||||||||||||
Return of Premium [7] /Other |
20,597 | 1,869 | 562 | 64 | ||||||||||||
Subtotal U.S. GMDB [8] |
82,857 | 20,883 | 3,193 | 65 | ||||||||||||
Less: General Account Value with U.S. GMBD |
6,788 | |||||||||||||||
Subtotal Separate Account Liabilities with GMDB |
76,069 | |||||||||||||||
Separate Account Liabilities without U.S. GMDB |
78,801 | |||||||||||||||
Total Separate Account Liabilities |
154,870 | |||||||||||||||
Japan GMDB and GMIB [9] |
16,172 | 4,188 | | 69 | ||||||||||||
[1]
|
MAV: the GMDB is the greatest of current AV, net premiums paid and the highest AV on any anniversary before age 80 (adjusted for withdrawals). | |
[2]
|
Rollup: the GMDB is the greatest of the MAV, current AV, 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 GMDB is the greatest of the MAV, current AV, or contract value plus a percentage of the contracts growth. The contracts growth is AV less premiums net of withdrawals, subject to a cap of 200% of premiums net of withdrawals. | |
[4]
|
APB GMDB is the greater of current AV or MAV, not to exceed current AV plus 25% times the greater of net premiums and MAV (each adjusted for premiums in the past 12 months). | |
[5]
|
LIB GMDB is the greatest of current AV, net premiums paid, or for certain contracts a benefit amount that ratchets over time, generally based on market performance. | |
[6]
|
Reset GMDB is the greatest of current AV, net premiums paid and the most recent five to seven year anniversary AV before age 80 (adjusted for withdrawals). | |
[7]
|
ROP: the GMDB is the greater of current AV and net premiums paid. |
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[8]
|
AV includes the contract holders investment in the separate account and the general account. | |
[9]
|
Assumed GMDB includes a ROP and MAV (before age 80) paid in a single lump sum. GMIB is a guarantee to return initial investment, adjusted for earnings liquidity, paid through a fixed annuity, after a minimum deferral period of 10, 15 or 20 years. The guaranteed remaining balance (GRB) related to the Japan GMIB was $19.6 billion and $19.1 billion as of June 30, 2010 and December 31, 2009, respectively. The GRB related to the Japan GMAB and GMWB was $536 and $522 as of June 30, 2010 and December 31, 2009. NAR increased due to lower equity markets during the second quarter, as well as the strengthening of the Yen | |
[10]
|
NAR is defined as the guaranteed benefit in excess of the current AV. RNAR represents NAR reduced for reinsurance. NAR and RNAR are highly sensitive to equity markets movements and increase when equity markets decline. |
See Note 3
for a description of the Companys guaranteed living benefits
and variable annuity hedging derivatives that are accounted for at
fair value.
Account balances of contracts with guarantees were invested in variable separate accounts as
follows:
Asset type | June 30, 2010 | December 31, 2009 | ||||||
Equity securities |
$ | 67,530 | $ | 75,720 | ||||
Cash and cash equivalents |
8,539 | 9,298 | ||||||
Total |
$ | 76,069 | $ | 85,018 | ||||
As of June 30, 2010 and December 31, 2009, approximately 18% and 16%, respectively, of the equity
securities above were invested in fixed income securities through these funds and approximately 82%
and 84%, respectively, were invested in equity securities.
7. Sales Inducements
Changes in deferred sales inducement activity were as follows for the six months ended June 30:
2010 | 2009 | |||||||
Balance, January 1 |
$ | 194 | $ | 533 | ||||
Sales inducements deferred |
5 | 28 | ||||||
Unlock |
(1 | ) | (57 | ) | ||||
Amortization charged to income |
(3 | ) | (81 | ) | ||||
Balance, June 30 |
$ | 195 | $ | 423 | ||||
8. Commitments and Contingencies
Litigation
The Company is involved in claims litigation arising in the ordinary course of business, both as a
liability insurer defending or providing indemnity for third-party claims brought against insureds
and as an insurer defending coverage claims brought against it. The Company accounts for such
activity through the establishment of unpaid loss and loss adjustment expense reserves. Management
expects that the ultimate liability, if any, with respect to such ordinary-course claims
litigation, after consideration of provisions made for potential losses and costs of defense, will
not be material to the consolidated financial condition, results of operations or cash flows of the
Company.
The Company is also involved in other kinds of legal actions, some of which assert claims for
substantial amounts. These actions include, among others, putative state and federal class actions
seeking certification of a state or national class. Such putative class actions have alleged, for
example, improper sales practices in connection with the sale of life insurance and other
investment products; and improper fee arrangements in connection with investment products and
structured settlements. The Company also is involved in individual actions in which punitive
damages are sought, such as claims alleging bad faith in the handling of insurance claims.
Management expects that the ultimate liability, if any, with respect to such lawsuits, after
consideration of provisions made for estimated losses, will not be material to the consolidated
financial condition of the Company. Nonetheless, given the large or indeterminate amounts sought in
certain of these actions, and the inherent unpredictability of litigation, an adverse outcome in
certain matters could, from time to time, have a material adverse effect on the Companys
consolidated results of operations or cash flows in particular quarterly or annual periods.
Broker Compensation Litigation - Following the New York Attorney Generals filing of a
civil complaint against Marsh & McLennan Companies, Inc., and Marsh, Inc. (collectively, Marsh)
in October 2004 alleging that certain insurance companies, including The Hartford, participated
with Marsh in arrangements to submit inflated bids for business insurance and paid contingent
commissions to
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ensure that Marsh would direct business to them, private plaintiffs brought several
lawsuits against The Hartford predicated on the allegations in the Marsh complaint, to which The
Hartford was not party. Among these is a multidistrict litigation in the United States District
Court for the District of New Jersey. There are two consolidated amended complaints filed in the
multidistrict litigation, one related to conduct in connection with the sale of property-casualty
insurance and the other related to alleged conduct in connection with
the sale of group benefits products. The Company is named in the group benefits products
complaint. The complaints assert, on behalf of a putative class of persons who purchased insurance
through broker defendants, claims under the Sherman Act, the Racketeer Influenced and Corrupt
Organizations Act (RICO), state law, and in the case of the group benefits products complaint,
claims under the Employee Retirement Income Security Act of 1974 (ERISA). The claims are
predicated upon allegedly undisclosed or otherwise improper payments of contingent commissions to
the broker defendants to steer business to the insurance company defendants. The district court
has dismissed the Sherman Act and RICO claims in both complaints for failure to state a claim and
has granted the defendants motions for summary judgment on the ERISA claims in the group-benefits
products complaint. The district court further has declined to exercise supplemental jurisdiction
over the state law claims, has dismissed those state law claims without prejudice, and has closed
both cases. The plaintiffs have appealed the dismissal of claims in both consolidated amended
complaints, except the ERISA claims.
Spencer v. The Hartford Financial Services Group, Inc., United States District Court, District of
Connecticut. In October 2005, a putative nationwide class action was filed in the United States
District Court for the District of Connecticut against the Company and several of its subsidiaries
on behalf of persons who had asserted claims against an insured of a Hartford property & casualty
insurance company that resulted in a settlement in which some or all of the settlement amount was
structured to afford a schedule of future payments of specified amounts funded by an annuity from a
Hartford life insurance company (Structured Settlements). The operative complaint alleges that
since 1997 the Company deprived the settling claimants of the value of their damages recoveries by
secretly deducting 15% of the annuity premium of every Structured Settlement to cover brokers
commissions, other fees and costs, taxes, and a profit for the annuity provider, and asserts claims
under the Racketeer Influenced and Corrupt Organizations Act (RICO) and state law. The district
court certified a class for the RICO and fraud claims in March 2009, and the Companys petition to
the United States Court of Appeals for the Second Circuit for permission to file an interlocutory
appeal of the class-certification ruling was denied in October 2009. In April 2010, the parties
reached an agreement in principle to settle on a nationwide class basis, under which the Company
would pay $54 in exchange for a full release and dismissal of the litigation. The $54 was accrued
in the first quarter of 2010. The settlement received preliminary court approval in June 2010 and
remains contingent upon final approval of the court.
Derivative Commitments
Certain of the Companys derivative agreements contain provisions that are tied to the financial
strength ratings of the individual legal entity that entered into the derivative agreement as set
by nationally recognized statistical rating agencies. If the legal entitys financial strength
were to fall below certain ratings, the counterparties to the derivative agreements could demand
immediate and ongoing full collateralization and in certain instances demand immediate settlement
of all outstanding derivative positions traded under each impacted bilateral agreement. The
settlement amount is determined by netting the derivative positions transacted under each
agreement. If the termination rights were to be exercised by the counterparties, it could impact
the legal entitys ability to conduct hedging activities by increasing the associated costs and
decreasing the willingness of counterparties to transact with the legal entity. The aggregate fair
value of all derivative instruments with credit-risk-related contingent features that are in a net
liability position as of June 30, 2010, is $320. Of this $320, the legal entities have posted
collateral of $349 in the normal course of business. Based on derivative market values as of June
30, 2010, a downgrade of one level below the current financial strength ratings by either Moodys
or S&P could require approximately an additional $4 to be posted as collateral. These collateral
amounts could change as derivative market values change, as a result of changes in our hedging
activities or to the extent changes in contractual terms are negotiated. The nature of the
collateral that we may be required to post is primarily in the form of U.S. Treasury bills and U.S.
Treasury notes.
9. Stock Compensation Plans
Hartford Lifes employees are included in The Hartford 2005 Incentive Stock Plan, The Hartford
Employee Stock Purchase Plan and The Hartford Deferred Stock Unit Plan.
On May 19, 2010 at the Companys Annual Meeting of Shareholders, the shareholders of The Hartford
approved The Hartford 2010 Incentive Stock Plan (the 2010 Stock Plan), which supersedes and
replaces The Hartford 2005 Incentive Stock Plan. The terms of the 2010 Stock Plan are
substantially similar to the terms of the superseded plan. However, the 2010 Stock Plan provides
for an increased maximum number of shares that may be awarded to employees of the Company, and also
permits awards to be made to third party service providers, and permits additional forms of
stock-based awards.
The 2010 Stock Plan provides for awards to be granted in the form of non-qualified or incentive
stock options qualifying under Section 422 of the Internal Revenue Code, stock appreciation rights,
performance shares, restricted stock or restricted stock units, or any other form of stock based
award. The aggregate number of shares of stock, which may be awarded, is subject to a maximum
limit of 18,000,000 shares applicable to all awards for the ten-year duration of the 2010 Stock
Plan. If any award under the prior The Hartford
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Incentive Stock Plan (as approved by the Companys
shareholders in 2000) or under the prior The Hartford 2005 Incentive Stock Plan (as approved by the
Companys shareholders in 2005) that was outstanding as of March 31, 2010, is forfeited,
terminated, surrendered, exchanged, expires unexercised, or is settled in cash in lieu of stock
(including to effect tax withholding) or for the net issuance of a lesser number of shares than the
number subject to the award, the shares of stock subject to such award (or the relevant portion
thereof) shall be available for awards under the 2010 Stock Plan and such shares shall be added to
the maximum limit to the extent of such forfeiture, termination, expiration, or cash or net
settlement of such awards.
Under the 2010 Stock Plan, all options granted have an exercise price at least equal to the market
price of the Companys common stock on the date of grant, and an options maximum term is not to
exceed ten years. For any year, no individual employee may receive an award of options for more
than 2,000,000 shares.
Performance awards of common stock granted under the 2010 Stock Plan become payable upon the
attainment of specific performance goals achieved over a period of not less than one nor more than
five years, and the restricted stock granted is subject to a restriction period. For any year, the
maximum award of performance shares, restricted stock awards, or restricted stock unit awards for
any individual employee in any year is 500,000 shares or units.
Shares issued in satisfaction of stock-based compensation may be made available from authorized but
unissued shares, shares held by The Hartford in treasury or from shares purchased in the open
market. The Hartford typically issues shares from treasury in satisfaction of stock-based
compensation. Hartford Life was allocated compensation expense of $6 and $2 for the three months
ended June 30, 2010 and 2009 and $14 and $6 for the six months ended June 30, 2010 and 2009,
respectively. Hartford Lifes income tax benefit recognized for stock-based compensation plans was
$2 and $1 for the three months ended June 30, 2010 and 2009 and $5 and $2 for the six months ended
June 30, 2010 and 2009, respectively. Hartford Life did not capitalize any cost of stock-based
compensation.
10. Transactions with Affiliates
Transactions of the Company with Hartford Fire Insurance Company, Hartford Holdings and its
affiliates relate principally to tax settlements, reinsurance, insurance coverage, rental and
service fees, payment of dividends and capital contributions. In addition, an affiliated entity
purchased group annuity contracts from the Company to fund structured settlement periodic payment
obligations assumed by the affiliated entity as part of claims settlements with property casualty
insurance companies and self-insured entities. As of June 30, 2010 and December 31, 2009 the
Company had $52.8 and $50 of reserves for claim annuities purchased by affiliated entities. For
the three months ended June 30, 2010 and June 30, 2009, the Company recorded earned premiums of $6
and $62 for these intercompany claim annuities. For the six months ended June 30, 2010 and June 30,
2009, the Company recorded earned premiums of $20 and $221 for these intercompany claim annuities.
In the fourth quarter of 2008, The Company issued a payout annuity to an affiliate for $2.2 billion
of consideration. The Company will pay the benefits associated with this payout annuity over 12
years.
Substantially all general insurance expenses related to the Company, including rent and employee
benefit plan expenses are initially paid by The Hartford. Direct expenses are allocated to the
Company using specific identification, and indirect expenses are allocated using other applicable
methods. Indirect expenses include those for corporate areas which, depending on type, are
allocated based on either a percentage of direct expenses or on utilization.
The Company has issued a guarantee to retirees and vested terminated employees (Retirees) of The
Hartford Retirement Plan for U.S. Employees (the Plan) who retired or terminated prior to January
1, 2004. The Plan is sponsored by The Hartford. The guarantee is an irrevocable commitment to pay
all accrued benefits which the Retiree or the Retirees designated beneficiary is entitled to
receive under the Plan in the event the Plan assets are insufficient to fund those benefits and The
Hartford is unable to provide sufficient assets to fund those benefits. The Company believes that
the likelihood that payments will be required under this guarantee is remote.
Reinsurance Assumed from Affiliates
Prior to June 1, 2009, Hartford Life sold fixed market value adjusted (MVA) annuity products to
customers in Japan. The yen based MVA product was written by the Hartford Life Insurance KK
(HLIKK), a wholly owned Japanese subsidiary of Hartford Life and subsequently reinsured to the
Company. As of June 30, 2010 and December 31, 2009, $2.6 billion and $2.6 billion,
respectively, of the account value had been assumed by the Company.
A subsidiary of the Company, Hartford Life and Annuity Insurance Company (HLAI), entered into a
reinsurance agreement with HLIKK. Through this agreement, HLIKK agreed to cede and HLAI agreed to
reinsure 100% of the risks associated with the in-force and prospective GMIB riders and the GMDB
riders on covered contracts that have an associated GMIB rider issued by HLIKK on its variable
annuity business. The reinsurance agreement applies to all contracts, GMIB riders and GMDB riders
in-force and issued as of July 31, 2006 and prospectively, except for policies and GMIB riders
issued prior to April 1, 2005. This agreement contains a tiered reinsurance premium structure.
While the form of the agreement between HLAI and HLIKK for GMIB business is reinsurance, in
substance and for accounting purposes the agreement is a free standing derivative. As such, the
reinsurance agreement for GMIB business is recorded at fair value on the Companys balance sheet,
with prospective changes in fair value recorded in net realized capital gains (losses) in net
income. The fair value of GMIB liability at June 30, 2010 and December 31, 2009 is $2.1 billion and
$1.4 billion, respectively.
In addition to this agreement, HLAI has two additional reinsurance agreements with HLIKK, one to
assume 100% of the GMAB, GMIB and GMDB riders issued by HLIKK on certain of its variable annuity
business. The second agreement is for HLAI to assume 100% of
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the in-force and prospective GMWB
riders issued by HLIKK on certain variable annuity business. The GMAB, GMIB and GMWB reinsurance is
accounted for as freestanding derivatives at fair value. The fair value of the GMWB and GMAB was a
liability of $21 and $1 at June 30, 2010 and $13 and $1 at December 2009, respectively. The
Reinsurance Agreement for GMDB business is accounted for as a Death Benefit and Other Insurance
Benefit Reserves which is not reported at fair value. The liability and net amount at risk for the
assumed GMDB reinsurance was $58 and $4.3 billion at June 30, 2010 and $52 and $2.7
billion at December 31, 2009, respectively.
Reinsurance Ceded to Affiliates
Effective October 1, 2009, HLAI entered into a modified coinsurance and coinsurance with funds
withheld reinsurance agreement with an affiliated captive reinsurer, White River Life Reinsurance
(WRR). The agreement provides that HLAI will cede, and WRR will reinsure 100% of the in-force and
prospective variable annuities and riders written or reinsured by HLAI summarized below:
| Direct written variable annuities and the associated GMDB and GMWB riders. |
| Variable annuity contract rider benefits written by HLIKK, which are reinsured to HLAI. |
| Annuity contracts and riders written by Union Security Insurance Company, an affiliate that is reinsured to HLAI. |
| Annuitizations of and certain other settlement options offered under deferred annuity contracts |
Under modified coinsurance, the assets and the liabilities associated with the reinsured business
will remain on the consolidated balance sheet of HLIC in segregated portfolios, and WRR will
receive the economic risks and rewards related to the reinsured business through modco adjustments.
These modco adjustments are recorded as an adjustment to operating expenses. For the 6 months ending
June 30, 2010 the impact of this transaction was an increase to earnings of $57 after-tax. Included
in this amount are net realized capital gains of $930, which represents the change in valuation of
the derivative, associated with this transaction. In addition, the balance sheet of the Company reflects a modco reinsurance recoverable, a deposit
liability as well as a net reinsurance recoverable that is comprised of an embedded derivative. The
balance of the modco reinsurance recoverable, deposit liability and net reinsurance recoverable
were ($835), $640, $1,896 and $182, $600 and $761 at June 30, 2010 and December 31, 2009,
respectively.
Effective November 1, 2007, a subsidiary insurance company (Ceding Company) entered into a
coinsurance with funds withheld and modified coinsurance reinsurance agreement (Agreement) with
an affiliate reinsurance company (Reinsurer) to provide statutory surplus relief for certain life
insurance policies. The Agreement is accounted for as a financing transaction for GAAP. A standby
unaffiliated third party Letter of Credit (LOC) supports a portion of the statutory reserves that
have been ceded to the Reinsurer.
11. Equity
Noncontrolling Interests
Noncontrolling interest includes VIEs in which the Company has concluded that it is the primary
beneficiary; see Note 4 for further discussion of the Companys involvement in VIEs, and general
account mutual funds where the Company holds the majority interest in seed money investments.
During the quarter ended June 30, 2010, the Company recognized the noncontrolling interest in these
entities in other liabilities since these entities represent investment vehicles whereby the
noncontrolling interests may redeem these investments at any time.
12. Sale of Joint Venture Interest in ICATU Hartford Seguros, S.A.
On November 23, 2009, in keeping with the Companys June 2009 announcement to return to its
historical strengths as a U.S.-centric insurance company, the Company entered into a Share Purchase
Agreement to sell its joint venture interest in ICATU Hartford Seguros, S.A. (IHS), its Brazilian
insurance operation, to its partner, ICATU Holding S.A., for $135. The transaction closed in the
second quarter of 2010, and the Company received cash proceeds of $130, which was net of capital
gains tax withheld of $5. The investment in IHS was reported as an equity method investment in
Other assets.
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Item 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
(Dollar amounts in millions, unless otherwise stated)
Managements Discussion and Analysis of Financial Condition and Results of Operations (MD&A)
addresses the financial condition of Hartford Life Insurance Company and its subsidiaries
(Hartford Life Insurance Company, Life or the Company) as of June 30, 2010, and its results
of operations for the three and six months ended June 30, 2010 compared to the equivalent 2009
periods. This discussion should be read in conjunction with the MD&A in Hartford Life Insurance
Companys 2009 Form 10-K Annual Report.
The Company meets the conditions specified in General Instruction H(1)(a) and (b) of Form 10-Q and
is filing this Form with the reduced disclosure format permitted for wholly-owned subsidiaries of
reporting entities. The Company has omitted, from this Form 10-Q, certain information in Part I
Item 2 Management Discussion and Analysis of Financial Condition and Results of Operations. The
Company has included, under Item 2, Consolidated Results of Operations to explain any material
changes in revenue and expense items for the periods presented.
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INDEX
47 | ||||
50 | ||||
53 | ||||
58 | ||||
74 | ||||
78 |
OVERVIEW
Hartford Life Insurance Company is among the largest providers of insurance and investment products
in the United States. The Company also assumes fixed annuity products and living and death benefit
riders on variable annuities from The Hartfords Japan operations and also cedes insurance risks to
affiliates and third party reinsurance companies.
Effective January 1, 2010, the Company changed its reporting structure to realign mutual funds
business into Retirement from Global Annuity-U.S. The Company is organized into these four
reporting segments: Global Annuity U.S. (formerly Retail), Individual Life, Retirement and
Institutional. Lifes Other category includes: corporate items not directly allocated to any of its
reportable operating segments; intersegment eliminations; assumed and ceded reinsurance of death
and living benefits from The Hartfords Japan operations; certain direct group life and group
disability insurance that is ceded to an affiliate; as well as other International operations. In
addition, certain fee revenue and commission expenses associated with sales of non-proprietary
products by a subsidiary broker-dealer have been moved from Global Annuity-U.S. to Other. The
realignment of this business was retrospectively applied to the financial statements of the Company
for all periods presented.
Principal Products
Global Annuity- U.S. provides individual variable, fixed, and single premium immediate annuities
living and death benefit guarantees in the United States. In October 2009, the Company launched a
new variable annuity product designed to meet customer needs for growth and income within the risk
tolerances of The Hartford which is replacing its guaranteed minimum withdrawal benefit product. A
significant portion of the living and death benefit guarantees associated with the variable
annuities issued by this segment have been reinsured to an affiliated captive reinsurer. See
Reinsurance Ceded to Affiliates in the MD&A for further information.
Individual Life provides variable universal life, universal life, and term life insurance products
to affluent, emerging affluent and business life insurance clients.
Retirement provides retirement products and services as well as asset management and plan
administration, to small and medium-size corporations pursuant to Section 401(k) of the Internal
Revenue Code of 1986, as amended (401(k)). Retirement also provides retirement products and
services, including asset management and plan administration, to municipalities and not-for-profit
organizations pursuant to Section 457 and 403(b) of the Internal Revenue Code of 1986, as amended
(457 and 403(b)). In addition, Retirement also provides retail and institutional mutual funds,
529 plans, longevity assurance, and income annuities. In 2008, Retirement completed three
acquisitions. These three acquisitions were not accretive to 2008 net income. Furthermore, return
on assets was lower for Retirement overall in 2009 reflecting, in part, a full year of the new
business mix represented by the acquisitions, which includes larger, more institutionally priced
plans, predominantly executed on a mutual fund platform, and the cost of maintaining multiple
technology platforms during the integration period.
Institutional, provides variable private placement life insurance (PPLI), and stable value
investment products. The private placement life insurance industry (including the corporate-owned
and bank-owned life insurance markets) has experienced a slowdown in sales due to, among other
things, limited availability of stable value wrap providers. We believe that the Companys current
PPLI assets will experience high persistency, but our ability to grow this business in the future
will be affected by near term market and industry challenges. The remaining businesses, Structured
Settlements, leveraged private placement life insurance and most Institutional Annuities will be
managed in conjunction with other businesses that the Company has previously decided will not be
actively marketed.
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Distribution
Global Annuity U.S.s distribution network includes national and regional broker-dealer
organizations, banks and other financial institutions and independent financial advisors. Life
periodically negotiates provisions and terms of its relationships with unaffiliated parties, and
there can be no assurance that such terms will remain acceptable to Life or such third parties.
Lifes primary wholesaler of its individual annuities is Hartford Life Distributors, LLC, and its
affiliate, PLANCO, LLC (collectively HLD) which are indirect wholly-owned subsidiaries of
Hartford Life. HLD provides sales support to registered representatives, financial planners and
broker-dealers at brokerage firms and banks across the United States. As part of the Companys
assessment of its opportunities in the variable annuity marketplace it significantly scaled back
its HLD operations in 2009.
Individual Lifes distribution network includes national and regional broker-dealer organizations,
banks, independent agents, independent life and property-casualty agents, and Woodbury Financial
Services, an indirect, wholly-owned subsidiary retail broker-dealer. To wholesale Lifes products,
Life has a group of highly qualified life insurance professionals with specialized training in
sophisticated life insurance sales.
Retirements distribution network includes Company employees with extensive experience selling its
retirement plan products and services through national and regional broker-dealer firms, banks and
other financial institutions. Retirement also utilizes HLD to wholesale certain mutual fund and
other investment products.
Institutionals PPLI distribution network includes: specialized brokers, with expertise in the
large case market; financial advisors that work with individual investors; investment banking and
wealth management specialists; benefits consulting firms; investment consulting firms employed by
retirement plan sponsors; and Hartford employees.
Competition
Global Annuity U.S. and Retirement compete with numerous other insurance companies as well as
certain banks, securities brokerage firms, independent financial advisors and other financial
intermediaries marketing annuities, mutual funds and other retirement-oriented products. Product
sales are affected by competitive factors such as investment performance ratings, product design,
visibility in the marketplace, financial strength ratings, distribution capabilities, levels of
charges and credited rates, reputation and customer service. Global Annuity U.S. annuity deposits
continue to decline resulting from the recent equity market volatility. Many competitors have
responded to the recent equity market volatility by increasing the price of their living benefit
products and changing the level of the guarantee offered. Management believes that the most
significant industry de-risking changes have occurred. In the first six months of 2009, the Company
increased fees on in-force variable annuity guarantees in order to address the risks and costs
associated with variable annuity benefit features. The Company continues to explore other risk
limiting techniques including product design, hedging and reinsurance. As part of the Companys
de-risking initiative, the Company is transitioning to a new variable annuity product designed to
meet customers future income needs within the risk tolerances of the Company.
For the 457 and 403(b) as well as the 401(k) markets within Retirement, which offer mutual funds
wrapped in a variable annuity, variable funding agreement, or mutual fund retirement program, the
variety of available funds and their performance is most important to plan sponsors. The
competitors tend to be the major mutual fund companies. The past few years have seen consolidation
among industry providers seeking to increase scale, improve cost efficiencies, and enter new market
segments. The consolidation of providers is expected to continue as smaller providers exit the
market.
Retail mutual funds within Retirement compete with other mutual fund companies and differentiate
themselves through product solutions, performance, expenses, wholesaling and service. In this
non-proprietary broker sold market, the Company and its competitors compete aggressively for net
sales. Success will be driven by diversifying net sales across the mutual fund platform, delivering
superior investment performance and creating new investment solutions for current and future mutual
fund shareholders. Insurance product mutual funds are sold through Company sponsored annuity,
individual life, retirement and other insurance and investment products. The variety of available
funds, fee levels, and fund performance are most important to contract holders and plan sponsors
and investment consultants. Competitors tend to be the major mutual fund companies. For investment
only mutual funds, the variety of available funds, fee levels, and fund performance are most
important to plan sponsors and investment consultants. Competitors tend to be the major mutual fund
companies, insurance companies, and asset managers.
Individual Life competes with approximately 1,000 life insurance companies in the United States, as
well as other financial intermediaries marketing insurance products. Product sales are affected
primarily by the breadth and quality of life insurance products, pricing, relationships with
third-party distributors, effectiveness of wholesaling support, pricing and availability of
reinsurance, and the quality of underwriting and customer service. The individual life industry
continues to see a distribution shift away from the traditional life insurance sales agents, to the
consultative financial advisor as the place people go to buy their life insurance. Individual
Lifes regional sales office system is a differentiator in the market and allows it to compete
effectively across multiple distribution outlets.
Institutional competes with other life insurance companies and asset managers who provide
investment and risk management solutions. Product sales are often affected by competitive factors
such as investment performance, company credit ratings, perceived financial strength, product
design, marketplace visibility, distribution capabilities, fees, credited rates, and customer
service. In 2009, ratings
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agency downgrades, as well as changes in the Companys strategic business
model, limited Institutional sales and resulted in the Company exiting certain markets.
Reinsurance
The Company cedes a share of the risks it has underwritten to other insurance companies through
reinsurance treaties. The Company also assumes reinsurance of certain insurance risks that other
insurance companies have underwritten.
The Company cedes insurance to other insurers in order to limit its maximum losses and to diversify
its exposures and provide surplus relief. The Company also assumes reinsurance from other insurers
and is a member of and participates in reinsurance pools and associations. The Company reinsures
certain of its risks to other reinsurers under yearly renewable term, coinsurance, and modified
coinsurance arrangements.
Reinsurance Assumed from Affiliates
Hartford Life, Inc. sells fixed market value adjusted (MVA) annuity products to customers in
Japan. The yen based MVA product is written by the Hartford Life Insurance KK (HLIKK), a wholly
owned Japanese subsidiary of Hartford Life and subsequently reinsured to the Company, effective
August 31, 2005. Through this agreement, HLIKK agreed to cede and HLAI agreed to reinsure 100% of
the risks associated with the in-force and prospective GMIB riders issued by HLIKK on its variable
annuity business. Effective July 31, 2006, the agreement was modified to include the GMDB on
covered contracts that have an associated GMIB rider. The modified reinsurance agreement applies to
all contracts, GMIB riders and GMDB riders in-force and issued as of July 31, 2006 and
prospectively, except for policies and GMIB riders issued prior to April 1, 2005, which were
recaptured. Additionally, a tiered reinsurance premium structure was implemented. GMIB riders
issued by HLIKK subsequent to April 1, 2005 continue to be reinsured by HLAI.
Effective September 30, 2007, HLAI entered into another reinsurance agreement where HLIKK agreed to
cede and HLAI agreed to reinsure 100% of the risks associated with the in-force and prospective
GMAB, GMIB and GMDB riders issued by HLIKK on certain of its variable annuity business
Effective February 29, 2008, HLAI entered into another reinsurance agreement where HLIKK agreed to
cede and HLAI agreed to reinsure 100% of the risks associated with the in-force and prospective
GMWB riders issued by HLIKK on certain variable annuity business.
Reinsurance Ceded to Affiliates
Effective October 1, 2009, HLAI entered into a modified coinsurance and coinsurance with funds
withheld reinsurance agreement with an affiliated captive reinsurer, White River Life Reinsurance
(WRR). The agreement provides that HLAI will cede, and the affiliated captive reinsurer will
reinsure 100% of the in-force and prospective variable annuities and riders written or reinsured by
HLAI: direct written variable annuities and the associated GMDB and GMWB riders, variable annuity
contract rider benefits written by HLIKK, which are reinsured to HLAI, annuity contracts and riders
written by Union Security Insurance Company, an affiliate, that are reinsured to HLAI,
annuitizations of and certain other settlement options offered under deferred annuity contracts.
Under modified coinsurance, the assets and the liabilities associated with the reinsured business
will remain on the consolidated balance sheet of HLIC in segregated portfolios, and the affiliated
reinsurer will receive the economic risks and rewards related to the reinsured business through
modco adjustments. This transaction creates differences in certain inputs used in the valuation of
the reinsurance derivative as compared to the direct business. This results in valuation
differences that can be volatile period over period which can have a significant positive or
negative effect on the results of the Company. See the Equity Product Risk section for further
discussion of Managements overall risk management strategy.
Effective November 1, 2007, a subsidiary insurance company (Ceding Company) entered into a
coinsurance with funds withheld and modified coinsurance reinsurance agreement (Agreement) with
an affiliate reinsurance company (Reinsurer) to provide statutory surplus relief for certain life
insurance policies. The Agreement is accounted for as a financing transaction for GAAP. A standby
unaffiliated third party Letter of Credit (LOC) supports a portion of the statutory reserves that
have been ceded to the Reinsurer.
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CONSOLIDATED RESULTS OF OPERATIONS
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
Operating Summary | 2010 | 2009 | 2010 | 2009 | ||||||||||||
Fee income and other |
$ | 960 | $ | 823 | $ | 1,920 | $ | 1,787 | ||||||||
Earned premiums |
62 | 96 | 117 | 336 | ||||||||||||
Net investment income |
||||||||||||||||
Securities available-for-sale and other |
690 | 644 | 1,327 | 1,237 | ||||||||||||
Equity securities held for trading [1] |
(105 | ) | 120 | 13 | 9 | |||||||||||
Total net investment income |
585 | 764 | 1,340 | 1,246 | ||||||||||||
Net realized capital gains (losses ): |
||||||||||||||||
Total other-than-temporary impairment (OTTI) losses |
(247 | ) | (411 | ) | (563 | ) | (590 | ) | ||||||||
OTTI losses recognized in other comprehensive income |
158 | 157 | 337 | 157 | ||||||||||||
Net OTTI losses recognized in earnings |
(89 | ) | (254 | ) | (226 | ) | (433 | ) | ||||||||
Net realized capital gains (losses), excluding net OTTI
losses recognized in earnings |
694 | 285 | 317 | 1,927 | ||||||||||||
Total net realized capital gains (losses) |
605 | 31 | 91 | 1,494 | ||||||||||||
Total revenues |
2,212 | 1,714 | 3,468 | 4,863 | ||||||||||||
Benefits, losses and loss adjustment expenses |
851 | 662 | 1,578 | 2,325 | ||||||||||||
Benefits, loss and loss adjustment expenses returns
credited on International unit-linked bonds and pension
products [1] |
(105 | ) | 120 | 13 | 9 | |||||||||||
Insurance operating costs and other expenses |
1,518 | 449 | 1,851 | 888 | ||||||||||||
Amortization of deferred policy acquisition costs and
present value of future profits |
134 | 167 | 202 | 1,699 | ||||||||||||
Dividends to policyholders |
5 | 5 | 7 | 1 | ||||||||||||
Total benefits, losses and expenses |
2,403 | 1,403 | 3,651 | 4,932 | ||||||||||||
Income (loss) before income taxes |
(191 | ) | 311 | (183 | ) | (69 | ) | |||||||||
Income tax expense (benefit) |
(106 | ) | 94 | (90 | ) | (78 | ) | |||||||||
Net income (loss) |
$ | (85 | ) | $ | 217 | $ | (93 | ) | $ | 9 | ||||||
Net (income) loss attributable to the noncontrolling interest |
(3 | ) | (1 | ) | (5 | ) | (6 | ) | ||||||||
Net income (loss) attributable to shareholder |
$ | (88 | ) | $ | 216 | $ | (98 | ) | $ | 3 | ||||||
[1] | Net investment income includes investment income and mark-to-market effects of equity securities, trading, supporting the international variable annuity business, which are classified in net investment income with corresponding amounts credited to policyholders. |
Three months ended June 30, 2010 compared to the three months ended June 30, 2009
The Companys results on a year over year basis were materially impacted by an internal reinsurance
agreement effective October 1st, 2009, that cede all of the living benefit risks of HLAI
to an affiliate captive reinsurer. Due to the structure of the agreement the Company net settles
all activity, As a result, this reinsurance agreement significantly affected both realized capital
gains and insurance and other operating costs.. For further discussions on transaction with
affiliates, refer to Note 10. Other items either contributing to or offsetting this loss are:
| Fee income and other increased, as a result of an increase in average variable annuity account values and average mutual fund assets attributed to equity market appreciation on a year over year basis. | ||
| Earned premiums decreased due to the suspension of new sales within the Institutional segment. In 2009, Institutional contributed 77% of the total earned premiums of the Company. In 2010, Institutionals contribution declined to 3%. Also contributing to the overall decline in earned premium is the cession of premium on the living benefit riders associated with the assumed International variable annuity contracts to an affiliated captive reinsurer. | ||
| Net investment income on available-for-sale securities increased primarily due to higher investment income from limited partnership and other alternative investments, as well as the re-deployment of capital by strategically shifting in asset allocation from shorter term, lower yielding positions to longer term, higher yielding fixed maturity securities. Net losses on trading securities are offset in benefits losses and loss adjustment expenses. | ||
| Realized gains recognized during the second quarter 2010 are primarily attributed favorable trading gains and lower impairments and valuation allowance activity in the current year period. This was offset by unfavorable variable annuity hedge results as compared to last year. In addition the change in fair value of the Companys assumed and ceded living benefits reinsurance programs contributed to the Companys net gain position. For further discussion on realized gains and losses, refer to the table in Note 4 Investment and Derivative Instruments. |
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| Insurance operating costs and other expenses increased slightly on a comparative basis. In addition in the current period, expenses have increased significantly due to net settlement amounts attributed to the modco internal reinsurance program. For further discussions on transaction with affiliates, refer to Note 10. | ||
| The Company recorded a DAC Unlock charge of $30 in the second quarter of 2010 verses a benefit of $96, after tax during the second quarter of 2009. See Critical Accounting Estimates with Managements Discussion and Analysis for a further discussion on the DAC Unlock. In addition, ongoing DAC amortization was lower primarily as a result of the entry into a modified coinsurance agreement by HLAI with an affiliated captive reinsurer which resulted in an acceleration of DAC amortization on October 1, 2009 as well as higher gross profits, due primarily to improved equity markets and net investment income. | ||
| The increasing benefits, losses and loss adjustment expenses resulted from a decreased benefits ratio used in the calculation of GMDB reserves within Global Annuity U.S. in the second quarter 2010 Unlock compared to an Unlock benefit recorded in 2009. See Critical Accounting Estimates with Managements Discussion and Analysis for a further discussion on the DAC Unlock. Declines, partially offsetting this increase, can be attributed to the decision to suspend sales in the Institutional segment. |
Six months ended June 30, 2010 compared to the six months ended June 30, 2009
The Company recognized a net loss as compared to a net gain from the prior year comparable period.
This can be primarily attributed to higher realized capital gains on GMIB/GMAB/GMWB reinsurance and
the variable annuity hedge program recognized in the first half of 2009. In addition, the net
settlement of the internal modco reinsurance agreement significantly increased insurance and other
operating expenses.. Other items either contributing to or offsetting this loss are:
| Fee income and other increased, as a result of an increase in average variable annuity account values and average mutual fund assets attributed to equity market appreciation on a year over year basis. Additionally, average mutual fund assets values in Retirement have increased due to equity market appreciation and deposits as investors re-enter the capital markets. | ||
| Earned premiums decreased due to the suspension of new sales within the Institutional segment. In 2009, Institutional contributed 85% of the total earned premiums of the Company. In 2010, Institutionals contribution declined to 12%. Also contributing to the overall decline in earned premium is the cession of premium on the living benefit riders associated with the assumed International variable annuity contracts to an affiliated captive reinsurer. | ||
| Net investment income on available-for-sale securities increased primarily due to higher investment income from limited partnership and other alternative investments, which had significant losses in 2009, as well as the re-deployment of capital by strategically shifting in asset allocation from shorter term, lower yielding positions to longer term, higher yielding fixed maturity securities. Net income on trading securities is offset in Benefits losses and loss adjustment expenses. | ||
| Lower net realized gains in the six months ended 2010 can be attributed to losses associated with the fair value of the living benefit riders, both direct and assumed, partially offset by gains in the fair value of the corresponding variable annuity hedging program and gains on the associated reinsurance program. 2009 net realized gains were primarily due to gains on the GMIB/GMAB/GMWB reinsurance and the variable annuity hedge program. For further discussion on realized gains and losses, refer to the table in Note 4 Investment and Derivative Instruments. | ||
| Insurance operating costs and other expenses increased as a result of the impact of litigation reserves recognized in the first quarter of 2010. In addition in the current period, expenses have increased significantly due to net settlement amounts attributed to the modco internal reinsurance program. For further discussions on transaction with affiliates, refer to Note 10. | ||
| The Company recorded a DAC Unlock after tax charge of $12 during the first half of 2010 verses a charge of $694 in the first half of 2009.. See Critical Accounting Estimates with Managements Discussion and Analysis for a further discussion on the DAC Unlock. In addition, ongoing DAC amortization was lower primarily as a result of the entry into a modified coinsurance agreement by HLAI with an affiliated captive reinsurer which resulted in a write-off of HLAI DAC on October 1, 2009 as well as higher gross profits, due primarily to improved equity markets and net investment income. | ||
| The decrease in benefits losses and loss adjustment expenses resulted from a lower DAC Unlock charge of $48 in the first half of 2010 compared to a charge of $390 on a comparative period basis. See Critical Accounting Estimates with Managements Discussion and Analysis for a further discussion on the DAC Unlock. Declines can also be attributed to the decision to suspend sales in the Institutional segment, as well decreased in Global Annuity U.S. resulting from both the cession of the assumed International living benefits riders, and the base and rider contracts of the domestic variable annuity products directly written by a subsidiary of the Company. |
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Income Taxes
A reconciliation of the tax provision at the U.S. Federal statutory rate to the provision (benefit)
for income taxes is as follows:
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Tax expense (benefit) at the U.S. federal statutory rate |
$ | (67 | ) | $ | 109 | $ | (64 | ) | $ | (24 | ) | |||||
Dividends received deduction |
(39 | ) | (37 | ) | (78 | ) | (75 | ) | ||||||||
Foreign related investments |
| 20 | (3 | ) | 26 | |||||||||||
Investment valuation allowance |
| | 56 | | ||||||||||||
Other |
| 2 | (1 | ) | (5 | ) | ||||||||||
Income tax expense (benefit) |
(106 | ) | 94 | (90 | ) | (78 | ) | |||||||||
The separate account DRD is estimated for the current year using information from the prior
year-end, adjusted for current year equity market performance and other appropriate factors,
including estimated levels of corporate dividend payments. The actual current year DRD can vary
from estimates based on, but not limited to, changes in eligible dividends received by the mutual
funds, amounts of distribution from these mutual funds, amounts of short-term capital gains at the
mutual fund level and the Companys taxable income before the DRD. Given recent financial markets
volatility, the Company is reviewing its DRD computations on a quarterly basis.
The Companys federal income tax returns are routinely audited by the Internal Revenue Service
(IRS) as part of the Hartfords consolidated tax return. Audits have been concluded for all
years through 2006. The audit of 2007 and 2008 commenced in the second quarter of 2010. In
addition, the Company is working with the IRS on a possible settlement of a DRD issue related to
prior periods which, if settled, may result in the booking of tax benefits. Such benefits are not
expected to be material to the statement of operations.
The Company has recorded a deferred tax asset valuation allowance that is adequate to reduce the
total deferred tax asset to an amount that will more likely than not be realized. The deferred tax
asset valuation allowance as of June 30, 2010 was approximately $137, which has not materially
changed from the first quarter of 2010. In assessing the need for a valuation allowance,
management considered future reversals of existing taxable temporary differences, future taxable
income exclusive of reversing temporary differences and carryforwards, and taxable income in prior
carry back years, as well as tax planning strategies that include holding debt securities with
market value losses until recovery, selling appreciated securities to offset capital losses, and
sales of certain corporate assets, including subsidiaries. Such tax planning strategies are viewed
by management as prudent and feasible and will be implemented if necessary to realize the deferred
tax asset. An increase in interest rates can adversely impact the Companys tax planning
strategies and in particular the Companys ability to utilize tax benefits to offset certain
previously recognized realized capital losses. Even under a separate entity approach, the
Company would not record an additional valuation allowance relating to realized capital losses.
Under a separate entity approach, the current tax benefit related to any of the Companys tax
attributes realized by virtue of its inclusion in The Hartfords consolidated tax return would have
been recorded directly to surplus rather than income. These benefits would have been $0 and $79
for the six months ended June 30, 2010 and 2009, respectively.
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CRITICAL ACCOUNTING ESTIMATES
The preparation of financial statements, in conformity with accounting principles generally
accepted in the United States of America (U.S. GAAP), requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from those estimates.
The Company has identified the following estimates as critical in that they involve a higher degree
of judgment and are subject to a significant degree of variability: estimated gross profits used in
the valuation and amortization of assets and liabilities associated with variable annuity and other
universal life-type contracts; living benefits required to be fair valued; valuation of investments
and derivative instruments; evaluation of other-than-temporary impairments on available-for-sale
securities and contingencies relating to corporate litigation, goodwill and regulatory matters
certain of these estimates are particularly sensitive to market conditions, and deterioration
and/or volatility in the worldwide debt or equity markets could have material impact on the
condensed consolidated financial statements. In developing these estimates management makes
subjective and complex judgments that are inherently uncertain and subject to material change as
facts and circumstances develop. Although variability is inherent in these estimates, management
believes the amounts provided are appropriate based upon the facts available upon compilation of
the financial statements. For discussion of the critical accounting estimates not discussed below,
see MD&A in the Companys 2009 Form 10-K Annual Report filed on February 23, 2010
Life Estimated Gross Profits Used in the Valuation and Amortization of Assets and Liabilities
Associated with Variable Annuity and Other Universal Life-Type Contracts
Estimated gross profits (EGPs) are used in the amortization of: Lifes deferred policy
acquisition cost (DAC) asset, which includes the present value of future profits; sales
inducement assets (SIA); and unearned revenue reserves (URR). See Note 5 of the Notes to
Consolidated Financial Statements for additional information on DAC. See Note 7 of the Notes to
Consolidated Financial Statements for additional information on SIA. EGPs are also used in the
valuation of reserves for death and other insurance benefit features on variable annuity and
universal life-type contracts. See Note 6 of the Notes to Consolidated Financial Statements for
additional information on death and other insurance benefit feature reserves.
The after-tax impact on the Companys assets and liabilities as a result of the Unlock are as
follows:
Three months ended June 30, 2010:
Death and | ||||||||||||||||||||
Other | ||||||||||||||||||||
Insurance | ||||||||||||||||||||
Segment | Benefit | |||||||||||||||||||
After-tax (charge) benefit | DAC | URR | Reserves [1] | SIA | Total [2] | |||||||||||||||
Global Annuity U.S. |
$ | (14 | ) | $ | | $ | (47 | ) | $ | (1 | ) | $ | (62 | ) | ||||||
Retirement |
(5 | ) | | | | (5 | ) | |||||||||||||
Individual Life |
(8 | ) | 5 | | | (3 | ) | |||||||||||||
Other |
(3 | ) | | (4 | ) | | (7 | ) | ||||||||||||
Total |
$ | (30 | ) | $ | 5 | $ | (51 | ) | $ | (1 | ) | $ | (77 | ) | ||||||
[1] | As a result of the Unlock, Global Annuity U.S. reserves increased $165, pre-tax, offset by an increase in reinsurance recoverables of, $92 pre-tax. | |
[2] | The most significant contributor to the Unlock charge recorded during the second quarter of 2010 was actual separate account returns from April 1, 2010 to June 30, 2010 being below our aggregated estimated return. |
Six months ended June 30, 2010:
Death and | ||||||||||||||||||||
Other | ||||||||||||||||||||
Insurance | ||||||||||||||||||||
Segment | Benefit | |||||||||||||||||||
After-tax (charge) benefit | DAC | URR | Reserves [1] | SIA | Total [2] | |||||||||||||||
Global Annuity U.S. |
$ | 1 | $ | | $ | (29 | ) | $ | | $ | (28 | ) | ||||||||
Retirement |
(4 | ) | | | | (4 | ) | |||||||||||||
Individual Life |
(6 | ) | 6 | | | | ||||||||||||||
Other |
(4 | ) | | (2 | ) | | (6 | ) | ||||||||||||
Total |
$ | (13 | ) | $ | 6 | $ | (31 | ) | $ | | $ | (38 | ) | |||||||
[1] | As a result of the Unlock, Global Annuity U.S. reserves increased $107, pre-tax, offset by an increase in reinsurance recoverables of $63, pre-tax. | |
[2] | The most significant contributors to the Unlock charge recorded during the first quarter of 2010 was actual separate account returns from January 1, 2010 to June 30, 2010 being below our aggregated estimated return and the impact of increased hedging costs. |
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Three months ended June 30, 2009:
Death and | ||||||||||||||||||||
Other | ||||||||||||||||||||
Insurance | ||||||||||||||||||||
Segment | Benefit | |||||||||||||||||||
After-tax (charge) benefit | DAC | URR | Reserves [1] | SIA | Total | |||||||||||||||
Global Annuity U.S. |
$ | 163 | $ | (21 | ) | $ | 98 | $ | 13 | $ | 253 | |||||||||
Retirement |
1 | | | | 1 | |||||||||||||||
Individual Life |
3 | (1 | ) | | | 2 | ||||||||||||||
Other [2] |
(75 | ) | 6 | 15 | (8 | ) | (62 | ) | ||||||||||||
Total |
$ | 92 | $ | (16 | ) | $ | 113 | $ | 5 | $ | 194 | |||||||||
[1] | As a result of the Unlock, Global Annuity U.S. reserves decreased $307, pre-tax, offset by a decrease in reinsurance recoverables of $157, pre-tax. | |
[2] | Includes $(49) related to DAC recoverability associated with the decision to suspend sales in the U.K. variable annuity business. |
Six months ended June 30, 2009:
Death and | ||||||||||||||||||||
Other | ||||||||||||||||||||
Insurance | ||||||||||||||||||||
Segment | Benefit | |||||||||||||||||||
After-tax (charge) benefit | DAC | URR | Reserves [1] | SIA | Total | |||||||||||||||
Global Annuity U.S. |
$ | (503 | ) | $ | 31 | $ | (230 | ) | $ | (30 | ) | $ | (732 | ) | ||||||
Retirement |
(53 | ) | | (2 | ) | (1 | ) | (56 | ) | |||||||||||
Individual Life |
(64 | ) | 40 | | | (24 | ) | |||||||||||||
Other |
(74 | ) | 6 | (23 | ) | (8 | ) | (99 | ) | |||||||||||
Total |
$ | (694 | ) | $ | 77 | $ | (255 | ) | $ | (39 | ) | $ | (911 | ) | ||||||
[1] | As a result of the Unlock, Global Annuity U.S. reserves increased $741, pre-tax, offset by an increase in reinsurance recoverables of $386, pre-tax. |
An Unlock revises EGPs, on a quarterly basis, to reflect market updates of policyholder
account value and the Companys current best estimate assumptions. After each quarterly Unlock,
the Company also tests the aggregate recoverability of DAC by comparing the DAC balance to the
present value of future EGPs. As of June 30, 2010, the margin between the DAC balance and the
present value of future EGPs was 3% for U.S. individual variable annuities. If the margin between
the DAC asset and the present value of future EGPs is exhausted, further reductions in EGPs would
cause portions of DAC to be unrecoverable.
Goodwill Impairment
The Company completed its annual goodwill
assessment for the individual reporting units within Life as of January 1, 2010, which resulted in no
write-downs of goodwill in 2010. The reporting units passed the first step of their annual impairment
tests with a significant margin with the exception of the Individual Life reporting unit. Individual Life
completed the second step of the annual goodwill impairment test resulting in an implied goodwill
value that was in excess of its carrying value. Even though the fair value of the reporting unit was
lower than its carrying value, the implied level of goodwill in Individual Life exceeded the carrying
amount of goodwill. In the implied purchase accounting required by the Step 2 goodwill impairment test, the
implied present value of future profits was substantially lower than that of the DAC asset removed in
purchase accounting. A higher discount rate was used for calculating the present value of future
profits as compared to that used for calculating the present value of estimated gross profits for DAC.
As a result, in the implied purchase accounting, implied goodwill exceeded the carrying amount of goodwill.
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Investment Results
Composition of Invested Assets
The Companys primary investment objective is to maximize economic value, consistent with
acceptable risk parameters, including the management of credit risk and interest rate sensitivity
of invested assets, while generating sufficient after-tax income to meet policyholder and corporate
obligations. Investment strategies are developed based on a variety of factors including business
needs, regulatory requirements and tax considerations.
June 30, 2010 | December 31, 2009 | |||||||||||||||
Amount | Percent | Amount | Percent | |||||||||||||
Fixed maturities, AFS, at fair value |
$ | 45,011 | 77.3 | % | $ | 40,403 | 75.6 | % | ||||||||
Equity securities, AFS, at fair value |
372 | 0.6 | % | 419 | 0.8 | % | ||||||||||
Mortgage loans |
3,325 | 5.7 | % | 4,304 | 8.0 | % | ||||||||||
Policy loans, at outstanding balance |
2,129 | 3.7 | % | 2,120 | 4.0 | % | ||||||||||
Limited partnerships and other alternative investments |
782 | 1.3 | % | 759 | 1.4 | % | ||||||||||
Other investments [1] |
2,098 | 3.6 | % | 338 | 0.6 | % | ||||||||||
Short-term investments |
4,545 | 7.8 | % | 5,128 | 9.6 | % | ||||||||||
Total investments excluding equity securities, trading |
$ | 58,262 | 100.0 | % | $ | 53,471 | 100.0 | % | ||||||||
Equity securities, trading, at fair value [2] |
2,101 | 2,443 | ||||||||||||||
Total investments |
$ | 60,363 | $ | 55,914 | ||||||||||||
[1] | Primarily relates to derivative instruments. Also includes investments in real estate. | |
[2] | These assets primarily support the European variable annuity business. Changes in these balances are also reflected in the respective liabilities. |
Total investments increased since December 31, 2009 primarily due to increases in fixed
maturities and other investments, partially offset by declines in mortgage loans and short-term
investments. The increase in fixed maturities was largely the result of improved security
valuations due to declining interest rates, as well as the reinvestment of short-term proceeds,
which contributed to the decline in short-term investments. The increase in other investments
primarily related to increases in value related to derivatives. The decline in mortgage loans
resulted primarily from sales.
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Net Investment Income (Loss)
Three Months Ended | Six Months Ended | |||||||||||||||||||||||||||||||
June 30, | June 30, | |||||||||||||||||||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||||||||||||||||||
(Before-tax) | Amount | Yield [1] | Amount | Yield [1] | Amount | Yield [1] | Amount | Yield [1] | ||||||||||||||||||||||||
Fixed maturities [2] |
$ | 501 | 4.5 | % | $ | 544 | 4.5 | % | $ | 992 | 4.5 | % | $ | 1,107 | 4.5 | % | ||||||||||||||||
Equity securities, AFS |
3 | 3.4 | % | 13 | 10.2 | % | 7 | 3.6 | % | 23 | 8.2 | % | ||||||||||||||||||||
Mortgage loans |
49 | 5.4 | % | 60 | 5.0 | % | 100 | 5.2 | % | 119 | 4.9 | % | ||||||||||||||||||||
Policy loans |
34 | 6.4 | % | 35 | 6.5 | % | 67 | 6.3 | % | 71 | 6.6 | % | ||||||||||||||||||||
Limited partnerships and
other alternative
investments |
50 | 27.1 | % | (45 | ) | (19.5 | %) | 57 | 15.4 | % | (149 | ) | (30.9 | %) | ||||||||||||||||||
Other [3] |
68 | | 52 | | 134 | | 98 | | ||||||||||||||||||||||||
Investment expense |
(15 | ) | | (15 | ) | | (30 | ) | | (32 | ) | | ||||||||||||||||||||
Total net investment
income excl. equity
securities, trading |
690 | 4.9 | % | 644 | 4.2 | % | 1,327 | 4.7 | % | 1,237 | 4.0 | % | ||||||||||||||||||||
Equity securities, trading |
(105 | ) | 120 | | 13 | 9 | | |||||||||||||||||||||||||
Total net investment income |
$ | 585 | $ | 764 | | $ | 1,340 | $ | 1,246 | | ||||||||||||||||||||||
[1] | Yields calculated using annualized investment income before investment expenses divided by the monthly average invested assets at cost, amortized cost, or adjusted carrying value, as applicable, excluding securities lending collateral and consolidated variable interest entity noncontrolling interests. Included in the fixed maturity yield is other, which primarily relates to fixed maturities (see footnote [3] below). Included in the total net investment income yield is investment expense. | |
[2] | Includes net investment income on short-term investments. | |
[3] | Includes income from derivatives that qualify for hedge accounting and hedge fixed maturities. |
Three and six months ended June 30, 2010 compared to the three and six months ended June 30,
2009
Total net investment income, excluding equity securities, trading, increased primarily due to
improved performance of limited partnerships and other alternative investments primarily within
real estate and private equity funds, partially offset by lower income on fixed maturities
resulting from a decline in average short-term interest rates.
The decline in equity securities, trading, for the three months ended June 30, 2010 compared to the
prior period resulted from deteriorations in market performance of the underlying investment funds
supporting the European variable annuity product.
Net Realized Capital Gains (Losses)
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
(Before-tax) | 2010 | 2009 | 2010 | 2009 | ||||||||||||
Gross gains on sales |
$ | 234 | $ | 74 | $ | 305 | $ | 199 | ||||||||
Gross losses on sales |
(54 | ) | (133 | ) | (115 | ) | (531 | ) | ||||||||
Net OTTI losses recognized in earnings |
(89 | ) | (254 | ) | (226 | ) | (433 | ) | ||||||||
Valuation allowance on mortgage loans |
(39 | ) | (48 | ) | (111 | ) | (92 | ) | ||||||||
Japanese fixed annuity contract hedges, net [1] |
27 | (6 | ) | 11 | 35 | |||||||||||
Periodic net coupon settlements on credit derivatives/Japan |
| (8 | ) | (4 | ) | (23 | ) | |||||||||
Results of variable annuity hedge program |
||||||||||||||||
GMWB derivatives, net |
(405 | ) | 654 | (283 | ) | 1,244 | ||||||||||
Macro hedge program |
397 | (568 | ) | 233 | (364 | ) | ||||||||||
Total results of variable annuity hedge program |
(8 | ) | 86 | (50 | ) | 880 | ||||||||||
GMAB/GMWB/GMIB reinsurance |
(671 | ) | 336 | (556 | ) | 1,432 | ||||||||||
Coinsurance and modified coinsurance reinsurance contracts |
1,222 | | 843 | | ||||||||||||
Other, net |
(17 | ) | (16 | ) | (6 | ) | 27 | |||||||||
Net realized capital gains |
$ | 605 | $ | 31 | $ | 91 | $ | 1,494 | ||||||||
[1] | Relates to derivative hedging instruments, excluding periodic net coupon settlements, and is net of the Japanese fixed annuity product liability adjustment for changes in the dollar/yen exchange spot rate. |
56
Table of Contents
The circumstances giving rise to the Companys net realized capital gains and losses are as
follows:
Gross gains and losses on sales
|
Gross gains and losses on
sales for the three and six months
ended June 30, 2010 were
predominantly from U.S. Treasuries
and investment grade corporate
securities in order to take
advantage of attractive market
opportunities. |
|
Gross gains and losses on
sales for the three and six months
June 30, 2009 were predominantly
within financial services,
structured and government securities
due to efforts to reduce portfolio
risk while simultaneously
reallocating the portfolio to
securities with more favorable
risk/return profiles. |
||
Net OTTI losses
|
For further information, see
Other-Than-Temporary Impairments
within the Investment Credit Risk
section of the MD&A. |
|
Valuation allowances on mortgage
loans
|
For further information, see
Valuation Allowances on Mortgage
Loans within the Investment Credit
Risk section of the MD&A. |
|
Variable annuity hedge program
|
The loss on GMWB
derivatives, net, for the three and
six months ended June 30, 2010 was
primarily due to losses on higher
implied market volatility of $196
and $82, respectively, and losses
due to a general decrease in
long-term interest rates of $192 and
$214, respectively. The net gain on
the macro hedge program was
primarily the result of lower equity
market valuation and appreciation of
the Japanese yen. |
|
The gain on GMWB
derivatives, net, for the three
months ended June 30, 2009 was
primarily due to the relative
outperformance of the underlying
actively managed funds as compared
to their respective indices of $239,
lower implied market volatility of
$232, an increase on long-term
interest rates of $185, and
liability model changes and
assumption updates of $118. The
gain on GMWB derivatives, net, for
the six months ended June 30, 2009
was primarily due to liability model
changes and assumption updates of
$631, outperformance of the
underlying actively managed funds as
compared to their respective indices
of $391, lower implied market
volatility of $216, and an increase
in long-term interest rates of $164.
For more information, see Note 3 of
the Notes to Condensed Consolidated
Financial Statements. The net
losses on the macro hedge program
for the three and six months ended
June 30, 2009 were primarily the
result of a higher equity market
valuation, lower implied market
volatility and time decay. |
||
GMAB/GMWB/GMIB reinsurance
|
For the three and six months
ended June 30, 2010, the net loss on
derivatives associated with
GMAB/GMWB/GMIB product assumed
reinsurance contracts, which are
reinsured to an affiliated captive
reinsurer, was primarily due to a
decline in the Japan equity markets,
a decrease in Japan interest rates,
and an increase in Japan equity
market volatility, partially offset
by the impact of credit standing. |
|
The net gain on derivatives
associated with GMAB/GMWB/GMIB
reinsurance for the three months
ended June 30, 2009 was primarily
due to an increase in the Japan
equity markets and a decrease in
equity volatility, while the gain
for the six months ended was
primarily due to liability model
assumption updates for credit
standing. |
||
Coinsurance and modified coinsurance
reinsurance contracts
|
Under the reinsurance
agreement with an affiliate, the
losses experienced from the GMAB,
GMWB, and GMIB reinsurance along
with a portion of the net losses
from GMWB derivatives are ceded to
the affiliated reinsurer and
resulted in a realized gain. |
|
Other, net
|
Other, net losses for the
three and six months ended June 30,
2010 were primarily due to net
losses of $38 and $87, respectively,
related to Japan 3Win derivatives
due to a decline in U.S. interest
rates, partially offset by gains of
$32 and $45, respectively, related
to Japan variable annuity hedges due
to the Japanese yen strengthening.
The six months ended June 30, 2010,
also included a net gain of $28
related to credit derivatives as a
result of credit spread widening. |
|
Other, net losses for the
three months ended June 30, 2009
primarily resulted from net losses
of $52 on credit derivatives due to
credit spread widening, losses of
$42 related to transactional foreign
currency adjustments, and losses of
$18 related to non-qualifying
foreign currency asset hedges,
partially offset by net gains
related to the Japan 3Win contract
hedges of $75 and gains of $24
related to ineffectiveness on
foreign currency cash flow hedges. |
||
Other, net gains for the six
months ended June 30, 2009,
primarily resulted from $184 related
to transactional foreign currency
adjustments, $39 related to
ineffectiveness on foreign currency
cash flow hedges, and $30 related to
the Japan 3Win contract hedges,
partially offset by losses of $200
on credit derivatives and $21 on
non-qualifying foreign currency
asset hedges. |
57
Table of Contents
INVESTMENT CREDIT RISK
The Company has established investment credit policies that focus on the credit quality of
obligors and counterparties, limit credit concentrations, encourage diversification and require
frequent creditworthiness reviews. Investment activity, including setting of policy and defining
acceptable risk levels, is subject to regular review and approval by senior management.
The Company primarily invests in securities which are rated investment grade and has established
exposure limits, diversification standards and review procedures for all credit risks including
borrower, issuer and counterparty. Creditworthiness of specific obligors is determined by
consideration of external determinants of creditworthiness, typically ratings assigned by
nationally recognized ratings agencies and are supplemented by an internal credit evaluation.
Obligor, asset sector and industry concentrations are subject to established Company limits and are
monitored on a regular basis.
The Company is not exposed to any credit concentration risk of a single issuer greater than 10% of
the Companys stockholders equity other than U.S. government and government agencies backed by the
full faith and credit of the U.S. government. For further discussion of concentration of credit
risk, see the Concentration of Credit Risk section in Note 4 of the Notes to Consolidated Financial
Statements in the Companys 2009 Form 10-K Annual Report.
Derivative Instruments
In the normal course of business, the Company uses various derivative counterparties in executing
its derivative transactions. The use of counterparties creates credit risk that the counterparty
may not perform in accordance with the terms of the derivative transaction. The Company has
developed exposure policies which limit the Companys exposure to credit risk.
The derivative counterparty exposure policy establishes market-based credit limits, favors
long-term financial stability and creditworthiness of the counterparty and typically requires
credit enhancement/credit risk reducing agreements.
The Company minimizes the credit risk of derivative instruments by entering into transactions with
high quality counterparties rated A2/A or better, which are monitored and evaluated by the
Companys risk management team and reviewed by senior management. In addition, the Company
monitors counterparty credit exposure on a monthly basis to ensure compliance with Company policies
and statutory limitations. The Company also generally requires that derivative contracts, other
than exchange traded contracts, certain forward contracts, and certain embedded and reinsurance
derivatives, be governed by an International Swaps and Derivatives Association Master Agreement
which is structured by legal entity and by counterparty and permits right of offset.
The Company has developed credit exposure thresholds which are based upon counterparty ratings.
Credit exposures are measured using the market value of the derivatives, resulting in amounts owed
to the Company by its counterparties or potential payment obligations from the Company to its
counterparties. Credit exposures are generally quantified daily based on the prior business days
market value and collateral is pledged to and held by, or on behalf of, the Company to the extent
the current value of derivatives exceeds the contractual thresholds. In accordance with industry
standards and the contractual agreements, collateral is typically settled on the next business day.
The Company has exposure to credit risk for amounts below the exposure thresholds which are
uncollateralized, as well as for market fluctuations that may occur between contractual settlement
periods of collateral movements.
The maximum uncollateralized threshold for a derivative counterparty for a single legal entity is
$10. The Company currently transacts over-the-counter derivatives in two legal entities and
therefore the maximum combined threshold for a single counterparty over all legal entities that use
derivatives is $20. In addition, the Company may have exposure to multiple counterparties in a
single corporate family due to a common credit support provider. As of June 30, 2010, the maximum
combined threshold for all counterparties under a single credit support provider over all legal
entities that use derivatives is $40. Based on the contractual terms of the collateral agreements,
these thresholds may be immediately reduced due to a downgrade in a counterpartys credit rating.
For further discussion, see the Derivative Commitments section of Note 9 of the Notes to Condensed
Consolidated Financial Statements.
For the three and six months ended June 30, 2010, the Company has incurred no losses on derivative
instruments due to counterparty default.
In addition to counterparty credit risk, the Company enters into credit default swaps to manage
credit exposure. Credit default swaps involve a transfer of credit risk of one or many referenced
entities from one party to another in exchange for periodic payments. The party that purchases
credit protection will make periodic payments based on an agreed upon rate and notional amount, and
for certain transactions there will also be an upfront premium payment. The second party, who
assumes credit risk, will typically only make a payment if there is a credit event and such payment
will be equal to the notional value of the swap contract less the value of the referenced security
issuers debt obligation following the credit event. A credit event is generally defined as
default on contractually obligated interest or principal payments or bankruptcy of the referenced
entity after the occurrence of the credit event.
58
Table of Contents
The Company uses credit derivatives to purchase credit protection and, to a lesser extent, assume
credit risk with respect to a single entity, referenced index, or asset pool. The Company
purchases credit protection through credit default swaps to economically hedge and manage credit
risk of certain fixed maturity investments across multiple sectors of the investment portfolio.
The Company has also entered into credit default swaps that assume credit risk as part of
replication transactions. Replication transactions are used as an economical means to
synthetically replicate the characteristics and performance of assets that would otherwise be
permissible investments under the Companys investment policies. These swaps reference investment
grade single corporate issuers and baskets, which include trades ranging from baskets of up to five
corporate issuers to standard and customized diversified portfolios of corporate issuers, which are
established within sector concentration limits and are typically divided into tranches which
possess different credit ratings ranging from AAA through the CCC rated first loss position.
Investments
The following table presents the Companys fixed maturities by credit quality. The ratings
referenced below are based on the ratings of a nationally recognized rating organization or, if not
rated, assigned based on the Companys internal analysis of such securities.
Fixed Maturities by Credit Quality | ||||||||||||||||||||||||
June 30, 2010 | December 31, 2009 | |||||||||||||||||||||||
Percent of | Percent of | |||||||||||||||||||||||
Amortized | Total Fair | Amortized | Total Fair | |||||||||||||||||||||
Cost | Fair Value | Value | Cost | Fair Value | Value | |||||||||||||||||||
United States Government/Government agencies |
$ | 5,996 | $ | 6,003 | 13.3 | % | $ | 4,707 | $ | 4,552 | 11.3 | % | ||||||||||||
AAA |
6,290 | 6,154 | 13.7 | % | 6,564 | 5,966 | 14.8 | % | ||||||||||||||||
AA |
6,631 | 6,277 | 13.9 | % | 6,701 | 5,867 | 14.5 | % | ||||||||||||||||
A |
11,824 | 11,858 | 26.3 | % | 11,957 | 11,093 | 27.4 | % | ||||||||||||||||
BBB |
12,172 | 11,980 | 26.7 | % | 11,269 | 10,704 | 26.5 | % | ||||||||||||||||
BB & below |
3,475 | 2,739 | 6.1 | % | 3,086 | 2,221 | 5.5 | % | ||||||||||||||||
Total fixed maturities |
$ | 46,388 | $ | 45,011 | 100.0 | % | $ | 44,284 | $ | 40,403 | 100.0 | % | ||||||||||||
The movement within the Companys investment ratings was primarily attributable to purchases
predominantly of investment grade corporate securities and U.S. Treasuries, partially offset by
rating agency downgrades across multiple sectors. Downgrades associated with commercial
mortgage-backed securities (CMBS), commercial real estate (CRE) collateralized debt obligations
(CDOs) and residential mortgage-backed securities (RMBS) may continue to impact the portfolio
pending further collateral deterioration.
59
Table of Contents
The following table presents the Companys AFS securities by type.
Available-for-Sale Securities by Type | ||||||||||||||||||||||||||||||||||||||||
June 30, 2010 | December 31, 2009 | |||||||||||||||||||||||||||||||||||||||
Percent | Percent | |||||||||||||||||||||||||||||||||||||||
Cost or | Gross | Gross | of Total | Cost or | Gross | Gross | of Total | |||||||||||||||||||||||||||||||||
Amortized | Unrealized | Unrealized | Fair | Fair | Amortized | Unrealized | Unrealized | Fair | Fair | |||||||||||||||||||||||||||||||
Cost | Gains | Losses | Value | Value | Cost | Gains | Losses | Value | Value | |||||||||||||||||||||||||||||||
Asset-backed
securities (ABS) |
||||||||||||||||||||||||||||||||||||||||
Consumer loans |
$ | 1,799 | $ | 19 | $ | (204 | ) | $ | 1,614 | 3.6 | % | $ | 1,596 | $ | 13 | $ | (248 | ) | $ | 1,361 | 3.4 | % | ||||||||||||||||||
Small business |
391 | | (155 | ) | 236 | 0.5 | % | 418 | | (185 | ) | 233 | 0.6 | % | ||||||||||||||||||||||||||
Other |
286 | 27 | (27 | ) | 286 | 0.6 | % | 330 | 18 | (39 | ) | 309 | 0.8 | % | ||||||||||||||||||||||||||
CDOs |
||||||||||||||||||||||||||||||||||||||||
CLOs |
1,740 | | (172 | ) | 1,568 | 3.5 | % | 1,997 | | (208 | ) | 1,789 | 4.4 | % | ||||||||||||||||||||||||||
CREs |
1,052 | 32 | (592 | ) | 492 | 1.1 | % | 1,157 | 14 | (804 | ) | 367 | 0.9 | % | ||||||||||||||||||||||||||
Other |
15 | 3 | | 18 | | 4 | 5 | | 9 | | ||||||||||||||||||||||||||||||
CMBS |
||||||||||||||||||||||||||||||||||||||||
Agency backed [1] |
168 | 10 | | 178 | 0.4 | % | 62 | 3 | | 65 | 0.2 | % | ||||||||||||||||||||||||||||
Bonds |
5,530 | 79 | (816 | ) | 4,793 | 10.6 | % | 6,138 | 33 | (1,519 | ) | 4,652 | 11.5 | % | ||||||||||||||||||||||||||
Interest only (IOs) |
548 | 54 | (20 | ) | 582 | 1.3 | % | 644 | 40 | (36 | ) | 648 | 1.6 | % | ||||||||||||||||||||||||||
Corporate |
||||||||||||||||||||||||||||||||||||||||
Basic industry |
1,995 | 126 | (15 | ) | 2,106 | 4.7 | % | 1,794 | 78 | (45 | ) | 1,827 | 4.5 | % | ||||||||||||||||||||||||||
Capital goods |
2,092 | 186 | (23 | ) | 2,255 | 5.0 | % | 2,078 | 100 | (33 | ) | 2,145 | 5.3 | % | ||||||||||||||||||||||||||
Consumer cyclical |
1,313 | 90 | (17 | ) | 1,386 | 3.1 | % | 1,324 | 53 | (33 | ) | 1,344 | 3.3 | % | ||||||||||||||||||||||||||
Consumer non-cyclical |
3,927 | 351 | (9 | ) | 4,269 | 9.5 | % | 3,260 | 205 | (15 | ) | 3,450 | 8.6 | % | ||||||||||||||||||||||||||
Energy |
2,269 | 182 | (39 | ) | 2,412 | 5.4 | % | 2,239 | 130 | (13 | ) | 2,356 | 5.8 | % | ||||||||||||||||||||||||||
Financial services |
5,218 | 176 | (448 | ) | 4,946 | 11.0 | % | 5,054 | 84 | (590 | ) | 4,548 | 11.3 | % | ||||||||||||||||||||||||||
Tech./comm. |
2,744 | 199 | (41 | ) | 2,902 | 6.4 | % | 2,671 | 145 | (40 | ) | 2,776 | 6.9 | % | ||||||||||||||||||||||||||
Transportation |
646 | 44 | (4 | ) | 686 | 1.5 | % | 544 | 16 | (19 | ) | 541 | 1.3 | % | ||||||||||||||||||||||||||
Utilities |
4,336 | 307 | (25 | ) | 4,618 | 10.3 | % | 3,790 | 161 | (52 | ) | 3,899 | 9.7 | % | ||||||||||||||||||||||||||
Other |
634 | 9 | (71 | ) | 572 | 1.3 | % | 867 | 13 | (99 | ) | 781 | 1.9 | % | ||||||||||||||||||||||||||
Foreign govt./govt.
agencies |
1,084 | 46 | (20 | ) | 1,110 | 2.5 | % | 824 | 35 | (13 | ) | 846 | 2.1 | % | ||||||||||||||||||||||||||
Municipal |
1,026 | 12 | (110 | ) | 928 | 2.1 | % | 971 | 3 | (194 | ) | 780 | 1.9 | % | ||||||||||||||||||||||||||
RMBS |
||||||||||||||||||||||||||||||||||||||||
Agency |
2,219 | 93 | | 2,312 | 5.1 | % | 2,088 | 63 | (5 | ) | 2,146 | 5.3 | % | |||||||||||||||||||||||||||
Non-agency |
114 | | (9 | ) | 105 | 0.2 | % | 125 | | (14 | ) | 111 | 0.3 | % | ||||||||||||||||||||||||||
Alt-A |
161 | 2 | (30 | ) | 133 | 0.3 | % | 187 | | (52 | ) | 135 | 0.3 | % | ||||||||||||||||||||||||||
Sub-prime |
1,472 | 13 | (494 | ) | 991 | 2.2 | % | 1,565 | 5 | (626 | ) | 944 | 2.3 | % | ||||||||||||||||||||||||||
U.S. Treasuries |
3,609 | 13 | (109 | ) | 3,513 | 7.8 | % | 2,557 | 5 | (221 | ) | 2,341 | 5.8 | % | ||||||||||||||||||||||||||
Total fixed maturities |
46,388 | 2,073 | (3,450 | ) | 45,011 | 100.0 | % | 44,284 | 1,222 | (5,103 | ) | 40,403 | 100.0 | % | ||||||||||||||||||||||||||
Equity securities |
||||||||||||||||||||||||||||||||||||||||
Financial services |
199 | | (54 | ) | 145 | 273 | 4 | (51 | ) | 226 | ||||||||||||||||||||||||||||||
Other |
201 | 31 | (5 | ) | 227 | 174 | 34 | (15 | ) | 193 | ||||||||||||||||||||||||||||||
Total equity securities |
400 | 31 | (59 | ) | 372 | 447 | 38 | (66 | ) | 419 | ||||||||||||||||||||||||||||||
Total AFS securities |
$ | 46,788 | $ | 2,104 | $ | (3,509 | ) | $ | 45,383 | $ | 44,731 | $ | 1,260 | $ | (5,169 | ) | $ | 40,822 | ||||||||||||||||||||||
[1] | Represents securities with pools of loans by the Small Business Administration whose issued loans are backed by the full faith and credit of the U.S. government. |
The Company continues to reallocate its AFS investment portfolio to securities with more
favorable risk/return profiles, in particular investment grade
corporate securities and U.S. Treasuries, while reducing its exposure to real estate related securities. The Companys AFS
net unrealized loss position decreased primarily as a result of improved security valuations due to
declining interest rates. The following sections highlight the Companys significant investment
sectors.
60
Table of Contents
Financial Services
While financial services companies generally continued to exhibit modest signs of stabilization,
with improved earnings performance and positive asset quality trends, financial results remain
significantly weaker than historical norms. Market conditions have become increasingly volatile as
uncertainty surrounding the pace of a recovery, as well as concerns around the potential impact of
European sovereign and bank issues have weighed on the market. Additionally, the industry is
facing heightened regulatory oversight and costs as a result of the regulatory reform bill. Costs
related to financial reform may potentially be a significant headwind to financial services
companies future earnings but should eventually lead to a safer, less volatile industry over time.
The Company has exposure to the financial services sector predominantly through banking and
insurance firms. The following table presents the Companys exposure to the financial services
sector included in the AFS Securities by Type table above.
June 30, 2010 | December 31, 2009 | |||||||||||||||||||||||
Percent of | Percent of | |||||||||||||||||||||||
Amortized | Total Fair | Amortized | Total Fair | |||||||||||||||||||||
Cost | Fair Value | Value | Cost | Fair Value | Value | |||||||||||||||||||
AAA |
$ | 167 | $ | 170 | 3.3 | % | $ | 151 | $ | 152 | 3.2 | % | ||||||||||||
AA |
1,612 | 1,604 | 31.5 | % | 1,311 | 1,273 | 26.7 | % | ||||||||||||||||
A |
2,492 | 2,309 | 45.4 | % | 2,702 | 2,373 | 49.7 | % | ||||||||||||||||
BBB |
870 | 790 | 15.5 | % | 805 | 681 | 14.2 | % | ||||||||||||||||
BB & below |
276 | 218 | 4.3 | % | 358 | 295 | 6.2 | % | ||||||||||||||||
Total |
$ | 5,417 | $ | 5,091 | 100.0 | % | $ | 5,327 | $ | 4,774 | 100.0 | % | ||||||||||||
Commercial Mortgage Loans
The following tables present the Companys exposure to CMBS bonds, CRE CDOs and CMBS IOs by current
credit quality and vintage year, included in the AFS Securities by Type table above. This sector
continues to face pressure from commercial real estate market fundamentals including lower rent
rates in certain markets and increased delinquencies. Credit protection represents the current
weighted average percentage of the outstanding capital structure subordinated to the Companys
investment holding that is available to absorb losses before the security incurs the first dollar
loss of principal and excludes any equity interest or property value in excess of outstanding debt.
CMBS Bonds [1]
June 30, 2010 | ||||||||||||||||||||||||||||||||||||||||||||||||
AAA | AA | A | BBB | BB and Below | Total | |||||||||||||||||||||||||||||||||||||||||||
Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | |||||||||||||||||||||||||||||||||||||
Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | |||||||||||||||||||||||||||||||||||||
2003 & Prior |
$ | 745 | $ | 756 | $ | 139 | $ | 135 | $ | 56 | $ | 47 | $ | 9 | $ | 7 | $ | 19 | $ | 17 | $ | 968 | $ | 962 | ||||||||||||||||||||||||
2004 |
325 | 339 | 34 | 28 | 36 | 29 | 26 | 18 | 6 | 4 | 427 | 418 | ||||||||||||||||||||||||||||||||||||
2005 |
419 | 426 | 135 | 111 | 118 | 78 | 108 | 74 | 85 | 66 | 865 | 755 | ||||||||||||||||||||||||||||||||||||
2006 |
1,222 | 1,142 | 362 | 293 | 304 | 222 | 272 | 175 | 322 | 230 | 2,482 | 2,062 | ||||||||||||||||||||||||||||||||||||
2007 |
243 | 209 | 12 | 11 | 62 | 52 | 188 | 117 | 253 | 177 | 758 | 566 | ||||||||||||||||||||||||||||||||||||
2008 |
30 | 30 | | | | | | | | | 30 | 30 | ||||||||||||||||||||||||||||||||||||
Total |
$ | 2,984 | $ | 2,902 | $ | 682 | $ | 578 | $ | 576 | $ | 428 | $ | 603 | $ | 391 | $ | 685 | $ | 494 | $ | 5,530 | $ | 4,793 | ||||||||||||||||||||||||
Credit protection |
27.1% | 24.2% | 11.7% | 12.9% | 11.9% | 22.1% | ||||||||||||||||||||||||||||||||||||||||||
December 31, 2009 | ||||||||||||||||||||||||||||||||||||||||||||||||
AAA | AA | A | BBB | BB and Below | Total | |||||||||||||||||||||||||||||||||||||||||||
Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | |||||||||||||||||||||||||||||||||||||
Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | |||||||||||||||||||||||||||||||||||||
2003 & Prior |
$ | 1,198 | $ | 1,192 | $ | 159 | $ | 120 | $ | 50 | $ | 34 | $ | 14 | $ | 13 | $ | 6 | $ | 4 | $ | 1,427 | $ | 1,363 | ||||||||||||||||||||||||
2004 |
342 | 338 | 61 | 39 | 27 | 17 | 15 | 7 | | | 445 | 401 | ||||||||||||||||||||||||||||||||||||
2005 |
490 | 449 | 199 | 133 | 126 | 72 | 87 | 54 | 61 | 45 | 963 | 753 | ||||||||||||||||||||||||||||||||||||
2006 |
1,293 | 1,091 | 374 | 238 | 377 | 167 | 244 | 95 | 199 | 71 | 2,487 | 1,662 | ||||||||||||||||||||||||||||||||||||
2007 |
283 | 223 | 36 | 24 | 116 | 42 | 180 | 88 | 201 | 96 | 816 | 473 | ||||||||||||||||||||||||||||||||||||
Total |
$ | 3,606 | $ | 3,293 | $ | 829 | $ | 554 | $ | 696 | $ | 332 | $ | 540 | $ | 257 | $ | 467 | $ | 216 | $ | 6,138 | $ | 4,652 | ||||||||||||||||||||||||
Credit protection |
27.4% | 21.5% | 13.3% | 11.7% | 9.1% | 22.2% | ||||||||||||||||||||||||||||||||||||||||||
[1] | The vintage year represents the year the pool of loans was originated. |
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CRE CDOs [1] [2]
June 30, 2010 | ||||||||||||||||||||||||||||||||||||||||||||||||
AAA | AA | A | BBB | BB and Below | Total | |||||||||||||||||||||||||||||||||||||||||||
Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | |||||||||||||||||||||||||||||||||||||
Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | |||||||||||||||||||||||||||||||||||||
2003 & Prior |
$ | 21 | $ | 18 | $ | 13 | $ | 9 | $ | 80 | $ | 39 | $ | 147 | $ | 61 | $ | 52 | $ | 12 | $ | 313 | $ | 139 | ||||||||||||||||||||||||
2004 |
| | 7 | 5 | 33 | 14 | 99 | 34 | 19 | 7 | 158 | 60 | ||||||||||||||||||||||||||||||||||||
2005 |
| | 36 | 12 | 12 | 7 | 69 | 28 | 28 | 11 | 145 | 58 | ||||||||||||||||||||||||||||||||||||
2006 |
| | 94 | 49 | 32 | 16 | 85 | 33 | 50 | 28 | 261 | 126 | ||||||||||||||||||||||||||||||||||||
2007 |
| | 12 | 6 | 41 | 22 | 19 | 14 | 37 | 30 | 109 | 72 | ||||||||||||||||||||||||||||||||||||
2008 |
| | | | 10 | 5 | 6 | 5 | 23 | 13 | 39 | 23 | ||||||||||||||||||||||||||||||||||||
2009 |
| | | | 7 | 4 | 4 | 3 | 13 | 5 | 24 | 12 | ||||||||||||||||||||||||||||||||||||
2010 |
| | | | | | 1 | 1 | 2 | 1 | 3 | 2 | ||||||||||||||||||||||||||||||||||||
Total |
$ | 21 | $ | 18 | $ | 162 | $ | 81 | $ | 215 | $ | 107 | $ | 430 | $ | 179 | $ | 224 | $ | 107 | $ | 1,052 | $ | 492 | ||||||||||||||||||||||||
Credit protection |
65.5% | 9.3% | 40.8% | 24.7% | 27.9% | 27.3% | ||||||||||||||||||||||||||||||||||||||||||
December 31, 2009 | ||||||||||||||||||||||||||||||||||||||||||||||||
AAA | AA | A | BBB | BB and Below | Total | |||||||||||||||||||||||||||||||||||||||||||
Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | |||||||||||||||||||||||||||||||||||||
Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | |||||||||||||||||||||||||||||||||||||
2003 & Prior |
$ | 37 | $ | 24 | $ | 30 | $ | 15 | $ | 65 | $ | 24 | $ | 143 | $ | 38 | $ | 53 | $ | 7 | $ | 328 | $ | 108 | ||||||||||||||||||||||||
2004 |
18 | 11 | 70 | 22 | 33 | 8 | 24 | 3 | 20 | 3 | 165 | 47 | ||||||||||||||||||||||||||||||||||||
2005 |
16 | 8 | 73 | 12 | 23 | 6 | 39 | 5 | 22 | 5 | 173 | 36 | ||||||||||||||||||||||||||||||||||||
2006 |
23 | 12 | 108 | 33 | 76 | 23 | 62 | 20 | 21 | 10 | 290 | 98 | ||||||||||||||||||||||||||||||||||||
2007 |
51 | 26 | 12 | 3 | 20 | 5 | 26 | 8 | 15 | 10 | 124 | 52 | ||||||||||||||||||||||||||||||||||||
2008 |
17 | 9 | | | 5 | 1 | 15 | 4 | 13 | 3 | 50 | 17 | ||||||||||||||||||||||||||||||||||||
2009 |
12 | 6 | | | 2 | | 4 | 1 | 9 | 2 | 27 | 9 | ||||||||||||||||||||||||||||||||||||
Total |
$ | 174 | $ | 96 | $ | 293 | $ | 85 | $ | 224 | $ | 67 | $ | 313 | $ | 79 | $ | 153 | $ | 40 | $ | 1,157 | $ | 367 | ||||||||||||||||||||||||
Credit protection |
39.9% | 10.9% | 22.4% | 35.0% | 31.3% | 26.8% | ||||||||||||||||||||||||||||||||||||||||||
[1] | The vintage year represents the year that the underlying collateral in the pool was originated. Individual CRE CDO fair value is allocated by the proportion of collateral within each vintage year. | |
[2] | For certain CRE CDOs, the collateral manager has the ability to reinvest proceeds that become available, primarily from collateral maturities. The increase in recent vintage years represents reinvestment under these CRE CDOs. |
CMBS IOs [1]
June 30, 2010 | ||||||||||||||||||||||||||||||||||||||||
AAA | A | BBB | BB and Below | Total | ||||||||||||||||||||||||||||||||||||
Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | |||||||||||||||||||||||||||||||
Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | |||||||||||||||||||||||||||||||
2003 & Prior |
$ | 174 | $ | 194 | $ | | $ | | $ | | $ | | $ | | $ | | $ | 174 | $ | 194 | ||||||||||||||||||||
2004 |
106 | 119 | | | | | | | 106 | 119 | ||||||||||||||||||||||||||||||
2005 |
143 | 149 | | | 1 | 1 | | | 144 | 150 | ||||||||||||||||||||||||||||||
2006 |
75 | 69 | | | | | | | 75 | 69 | ||||||||||||||||||||||||||||||
2007 |
49 | 50 | | | | | | | 49 | 50 | ||||||||||||||||||||||||||||||
Total |
$ | 547 | $ | 581 | $ | | $ | | $ | 1 | $ | 1 | $ | | $ | | $ | 548 | $ | 582 | ||||||||||||||||||||
December 31, 2009 | ||||||||||||||||||||||||||||||||||||||||
AAA | A | BBB | BB and Below | Total | ||||||||||||||||||||||||||||||||||||
Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | Amortized | Fair | |||||||||||||||||||||||||||||||
Cost | Value | Cost | Value | Cost | Value | Cost | Value | Cost | Value | |||||||||||||||||||||||||||||||
2003 & Prior |
$ | 224 | $ | 241 | $ | | $ | | $ | | $ | | $ | | $ | | $ | 224 | $ | 241 | ||||||||||||||||||||
2004 |
123 | 130 | | | | | | | 123 | 130 | ||||||||||||||||||||||||||||||
2005 |
160 | 156 | | | 1 | 1 | | | 161 | 157 | ||||||||||||||||||||||||||||||
2006 |
79 | 68 | 2 | 1 | | | 1 | 1 | 82 | 70 | ||||||||||||||||||||||||||||||
2007 |
54 | 50 | | | | | | | 54 | 50 | ||||||||||||||||||||||||||||||
Total |
$ | 640 | $ | 645 | $ | 2 | $ | 1 | $ | 1 | $ | 1 | $ | 1 | $ | 1 | $ | 644 | $ | 648 | ||||||||||||||||||||
[1] | The vintage year represents the year the pool of loans was originated. |
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Table of Contents
In addition to CMBS, the Company has exposure to commercial mortgage loans as presented in the
following table. These loans are collateralized by a variety of commercial properties and are
diversified both geographically throughout the United States and by property type. These loans may
be either in the form of a whole loan, where the Company is the sole lender, or a loan
participation. Loan participations are loans where the Company has purchased or retained a portion
of an outstanding loan or package of loans and participates on a pro-rata basis in collecting
interest and principal pursuant to the terms of the participation agreement. In general, A-Note
participations have senior payment priority, followed by B-Note participations and then mezzanine
loan participations. As of June 30, 2010, loans within the Companys mortgage loan portfolio have
had minimal extension or restructurings. The ongoing deterioration in the global real estate
market, as evidenced by declining market rents and increases in property vacancy rates and
delinquencies, has negatively impacted property values. Should these trends continue, additional
valuation allowances may result.
Commercial Mortgage Loans
June 30, 2010 | December 31, 2009 | |||||||||||||||||||||||
Amortized | Valuation | Carrying | Amortized | Valuation | Carrying | |||||||||||||||||||
Cost [1] | Allowance | Value | Cost [1] | Allowance | Value | |||||||||||||||||||
Whole loans |
$ | 2,460 | $ | (20 | ) | $ | 2,440 | $ | 2,505 | $ | (26 | ) | $ | 2,479 | ||||||||||
A-Note participations |
309 | | 309 | 326 | | 326 | ||||||||||||||||||
B-Note participations |
221 | (10 | ) | 211 | 508 | (131 | ) | 377 | ||||||||||||||||
Mezzanine loans |
223 | (53 | ) | 170 | 856 | (100 | ) | 756 | ||||||||||||||||
Total [2] |
$ | 3,213 | $ | (83 | ) | $ | 3,130 | $ | 4,195 | $ | (257 | ) | $ | 3,938 | ||||||||||
[1] | Amortized cost represents carrying value prior to valuation allowances, if any. | |
[2] | Excludes agricultural loans. For further information on the total mortgage loan portfolio, see Note 4 of the Notes to Condensed Consolidated Financial Statements. |
Since December 31, 2009, the Company significantly reduced its exposure to B-Note
participations and mezzanine loans primarily through sales and as of June 30, 2010, the Company has
identified an additional $63 of carrying value as held-for-sale, with valuation allowances of $17.
These loans are included in the table above.
At origination, the weighted average loan-to-value (LTV) ratio of the Companys commercial
mortgage loan portfolio was approximately 64%. As of June 30, 2010, the current weighted average
LTV ratio was approximately 80%. LTV ratios compare the loan amount to the value of the underlying
property collateralizing the loan. The loan values are updated periodically through property level
reviews of the portfolio. Factors considered in the property valuation include, but are not
limited to, actual and expected property cash flows, geographic market data and capitalization
rates.
Limited Partnerships and Other Alternative Investments
The following table presents the Companys investments in limited partnerships and other
alternative investments which include hedge funds, mortgage and real estate funds, mezzanine debt
funds, and private equity and other funds. Hedge funds include investments in funds of funds and
direct funds. Mortgage and real estate funds consist of investments in funds whose assets consist
of mortgage loans, mortgage loan participations, mezzanine loans or other notes which may be below
investment grade, as well as equity real estate and real estate joint ventures. Mezzanine debt
funds include investments in funds whose assets consist of subordinated debt that often
incorporates equity-based options such as warrants and a limited amount of direct equity
investments. Private equity and other funds primarily consist of investments in funds whose assets
typically consist of a diversified pool of investments in small non-public businesses with high
growth potential.
June 30, 2010 | December 31, 2009 | |||||||||||||||
Carrying | Carrying | |||||||||||||||
Value | Percent | Value | Percent | |||||||||||||
Hedge funds |
$ | 66 | 8.4 | % | $ | 105 | 13.8 | % | ||||||||
Mortgage and real estate funds |
125 | 16.0 | % | 124 | 16.4 | % | ||||||||||
Mezzanine debt funds |
71 | 9.1 | % | 66 | 8.7 | % | ||||||||||
Private equity and other funds |
520 | 66.5 | % | 464 | 61.1 | % | ||||||||||
Total |
$ | 782 | 100.0 | % | $ | 759 | 100.0 | % | ||||||||
The decline in hedge funds since December 31, 2009 was primarily attributable to redemptions, while
private equity and other funds increased primarily due to the funding of prior commitments, as well
as market value appreciation.
Security Unrealized Loss Aging
As part of the Companys ongoing security monitoring process, the Company has reviewed its AFS
securities in an unrealized loss position and concluded that there were no additional impairments
as of June 30, 2010 and that these securities have sufficient expected future cash flows to recover
the entire amortized cost basis, are temporarily depressed and are expected to recover in value as
the securities approach maturity or as real estate related market spreads return to more normalized
levels.
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Table of Contents
Most of the securities depressed over 20% for greater than nine months or more are real estate
backed and financial services sector securities and have a weighted average current rating of BBB+.
Current market spreads continue to be significantly wider for real estate
backed securities, as compared to spreads at the securitys respective purchase date, largely due
to the continued effects of the recession and the economic and market uncertainties regarding
future performance of commercial and residential real estate. The Company reviewed these
securities as part of its impairment analysis. The Companys best estimate of future cash flows
utilized in its impairment analysis involves both macroeconomic and security specific assumptions
that may differ based on asset class, vintage year and property location including, but not limited
to, historical and projected default and recovery rates, current and expected future delinquency
rates, property value declines and the impact of obligor re-financing. For these securities in an
unrealized loss position where a credit impairment has not been recorded, the Companys best
estimate of expected future cash flows are sufficient to recover the amortized cost basis of the
security.
The same market conditions noted above also apply to AFS securities depressed over 50% for greater
than twelve months, which consist primarily of CRE CDOs, sub-prime RMBS and CMBS bonds. Based upon
the Companys cash flow modeling and current market and collateral performance assumptions, these
securities have sufficient credit protection levels to receive contractually obligated principal
and interest payments, and accordingly the Company has concluded that no credit impairment exists
on these securities. Furthermore, the Company neither has an intention to sell nor does it expect
to be required to sell these securities.
For the CRE CDOs and CMBS bonds which primarily comprise the AFS securities depressed over 50% for
greater than twelve months, current market pricing reflects market illiquidity and risk premiums,
and for a majority of the securities, a floating coupon rate. The illiquidity and risk premiums
are the result of the underlying collateral performance to-date and the potential uncertainty in
the securities future cash flows. Because of the uncertainty surrounding the future performance
of commercial real estate, market participants are requiring substantially greater returns, in
comparison to the securities stated coupon rate, to assume the associated securities credit risk.
If the securities collateral underperforms the macroeconomic and collateral assumptions in the
future, the loss severity may be significant mainly due to the securities structure. In addition,
coupon amounts associated with floating rate coupon securities are typically based upon a market
based rate such as LIBOR. When the floating rate on which the coupon is based declines, the
valuation of the respective security may also decline. LIBOR rates have declined subsequent to the
date the CMBS bonds and CRE CDOs were purchased. For further information regarding the Companys
security valuation process, see Note 3 of the Notes to Condensed Consolidated Financial Statements.
For further information regarding the future collateral cash flows assumptions included in the
Companys impairment analysis, see Other-Than-Temporary Impairments in the Investment Credit Risk
section of this MD&A. For further discussion on the Companys ongoing security monitoring process
and the factors considered in determining whether a credit impairment exists, see the Recognition
and Presentation of Other-Than-Temporary Impairments section in Note 4 of the Notes to Condensed
Consolidated Financial Statements.
The following table presents the Companys unrealized loss aging for AFS securities by length of
time the security was in a continuous unrealized loss position.
June 30, 2010 | December 31, 2009 | |||||||||||||||||||||||||||||||
Cost or | Cost or | |||||||||||||||||||||||||||||||
Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | |||||||||||||||||||||||||||
Items | Cost | Value | Loss | Items | Cost | Value | Loss | |||||||||||||||||||||||||
Three months or less |
720 | $ | 3,047 | $ | 2,975 | $ | (72 | ) | 766 | $ | 5,878 | $ | 5,622 | $ | (256 | ) | ||||||||||||||||
Greater than three to six months |
108 | 583 | 550 | (33 | ) | 39 | 161 | 143 | (18 | ) | ||||||||||||||||||||||
Greater than six to nine months |
110 | 941 | 829 | (112 | ) | 172 | 1,106 | 931 | (175 | ) | ||||||||||||||||||||||
Greater than nine to twelve months |
10 | 44 | 36 | (8 | ) | 62 | 1,501 | 1,205 | (296 | ) | ||||||||||||||||||||||
Greater than twelve months |
1,202 | 14,151 | 10,867 | (3,284 | ) | 1,434 | 15,309 | 10,885 | (4,424 | ) | ||||||||||||||||||||||
Total |
2,150 | $ | 18,766 | $ | 15,257 | $ | (3,509 | ) | 2,473 | $ | 23,955 | $ | 18,786 | $ | (5,169 | ) | ||||||||||||||||
The following tables present the Companys unrealized loss aging for AFS securities continuously
depressed over 20% by length of time (included in the table above).
June 30, 2010 | December 31, 2009 | |||||||||||||||||||||||||||||||
Cost or | Cost or | |||||||||||||||||||||||||||||||
Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | |||||||||||||||||||||||||||
Consecutive Months | Items | Cost | Value | Loss | Items | Cost | Value | Loss | ||||||||||||||||||||||||
Three months or less |
125 | $ | 937 | $ | 710 | $ | (227 | ) | 79 | $ | 591 | $ | 395 | $ | (196 | ) | ||||||||||||||||
Greater than three to six months |
19 | 87 | 65 | (22 | ) | 16 | 52 | 36 | (16 | ) | ||||||||||||||||||||||
Greater than six to nine months |
32 | 185 | 119 | (66 | ) | 99 | 1,237 | 844 | (393 | ) | ||||||||||||||||||||||
Greater than nine to twelve months |
7 | 25 | 17 | (8 | ) | 67 | 1,201 | 801 | (400 | ) | ||||||||||||||||||||||
Greater than twelve months |
482 | 5,094 | 2,931 | (2,163 | ) | 585 | 6,235 | 3,115 | (3,120 | ) | ||||||||||||||||||||||
Total |
665 | $ | 6,328 | $ | 3,842 | $ | (2,486 | ) | 846 | $ | 9,316 | $ | 5,191 | $ | (4,125 | ) | ||||||||||||||||
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The following tables present the Companys unrealized loss aging for AFS securities continuously
depressed over 50% by length of time (included in the tables above).
June 30, 2010 | December 31, 2009 | |||||||||||||||||||||||||||||||
Cost or | Cost or | |||||||||||||||||||||||||||||||
Amortized | Fair | Unrealized | Amortized | Fair | Unrealized | |||||||||||||||||||||||||||
Consecutive Months | Items | Cost | Value | Loss | Items | Cost | Value | Loss | ||||||||||||||||||||||||
Three months or less |
30 | $ | 170 | $ | 80 | $ | (90 | ) | 42 | $ | 132 | $ | 46 | $ | (86 | ) | ||||||||||||||||
Greater than three to six months |
| | | | 11 | 5 | 2 | (3 | ) | |||||||||||||||||||||||
Greater than six to nine months |
14 | 30 | 10 | (20 | ) | 51 | 175 | 69 | (106 | ) | ||||||||||||||||||||||
Greater than nine to twelve months |
3 | 2 | 1 | (1 | ) | 52 | 499 | 173 | (326 | ) | ||||||||||||||||||||||
Greater than twelve months |
165 | 1,332 | 423 | (909 | ) | 205 | 2,105 | 601 | (1,504 | ) | ||||||||||||||||||||||
Total |
212 | $ | 1,534 | $ | 514 | $ | (1,020 | ) | 361 | $ | 2,916 | $ | 891 | $ | (2,025 | ) | ||||||||||||||||
Other-Than-Temporary Impairments
The following table presents the Companys impairments recognized in earnings by security type.
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
ABS |
$ | 5 | $ | 3 | $ | 5 | $ | 6 | ||||||||
CDOs |
||||||||||||||||
CREs |
27 | 81 | 89 | 89 | ||||||||||||
Other |
| 1 | | 2 | ||||||||||||
CMBS |
||||||||||||||||
Bonds |
30 | 49 | 90 | 49 | ||||||||||||
IOs |
| 14 | | 17 | ||||||||||||
Corporate |
2 | 12 | 2 | 105 | ||||||||||||
Equity |
4 | 41 | 5 | 76 | ||||||||||||
RMBS |
||||||||||||||||
Non-agency |
1 | 1 | 1 | 1 | ||||||||||||
Alt-A |
6 | 1 | 8 | 1 | ||||||||||||
Sub-prime |
14 | 49 | 26 | 85 | ||||||||||||
U.S. Treasuries |
| 2 | | 2 | ||||||||||||
Total |
$ | 89 | $ | 254 | $ | 226 | $ | 433 | ||||||||
Three and six months ended June 30, 2010
For the three and six months ended June 30, 2010, impairments recognized in earnings were comprised
of credit impairments of $85 and $221, respectively, and impairments on equity securities of $4 and
$5, respectively.
Credit
impairments were primarily concentrated in structured securities associated with commercial
and residential real estate which were impaired primarily due to continued property-specific
deterioration of the underlying collateral and increased
delinquencies. The Company calculated these impairments utilizing both a top down modeling approach and, for certain commercial real
estate backed securities, a loan by loan collateral review. The top down modeling approach used
discounted cash flow models that considered losses under current and expected future economic
conditions. Assumptions used over the current recessionary period included macroeconomic factors,
such as a high unemployment rate, as well as sector specific factors such as property value
declines, commercial real estate delinquency levels and changes in net operating income. Those
assumptions included CMBS peak-to-trough property value declines, on
average, of 40%, and RMBS peak-to-trough property value declines, on average, of 35%. The macroeconomic assumptions considered by the Company did not materially change from
the previous several quarters and, as such, the credit impairments recognized for the three and six
months ended June 30, 2010 were largely driven by actual or expected collateral deterioration,
largely as a result of the Companys loan-by-loan collateral review.
The loan-by-loan collateral review is performed to estimate potential future losses. This review
incorporates assumptions about expected future collateral cash flows, including projected rental
rates and occupancy levels that varied based on property type and sub-market. The results of the
loan by loan collateral review allowed the Company to estimate the expected timing of a securitys
first loss, if any, and the probability and severity of potential ultimate losses. The Company
then discounted these anticipated future cash flows at the securitys book yield prior to
impairment.
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Table of Contents
The results of cash flow modeling utilized by the Company result in cumulative
collateral loss rates that vary by vintage year. For the 2007 vintage
year, the Companys cash flow modeling resulted in cumulative
collateral loss rates for CMBS and sub-prime RMBS of approximately
13% and 42% respectively.
In addition to the credit impairments recognized in earnings, the Company recognized non-credit
impairments in other comprehensive income of $158 and $337, respectively, for the three and six
months ended June 30, 2010, predominantly concentrated in RMBS and CRE CDOs. These non-credit
impairments represent the difference between fair value and the Companys best estimate of expected
future cash flows discounted at the securitys effective yield prior to impairment, rather than at
current market implied credit spreads. These non-credit impairments primarily represent increases
in market liquidity premiums and credit spread widening that occurred after the securities were
purchased. In general, larger liquidity premiums and wider credit spreads are the result of
deterioration of the underlying collateral performance of the securities, as well as the risk
premium required to reflect future uncertainty in the real estate market.
Future impairments may develop as the result of changes in intent to sell of specific securities or
if actual results underperform current modeling assumptions, which may be the result of, but are
not limited to, macroeconomic factors, changes in assumptions used and property performance below
current expectations.
Three and six months ended June 30, 2009
For the three and six months ended June 30, 2009, the Company recognized $254 and $433,
respectively, of impairments recognized in earnings. Of these losses, $206 and $279, respectively,
represented credit impairments primarily concentrated in CRE CDOs, sub-prime RMBS and CMBS bonds.
Also included were impairments on equity securities of $41 and $76, respectively, largely related
to affiliated mutual funds, as well as debt securities for which the Company intended to sell of $7
and $78, respectively, mainly comprised of corporate financial services securities.
Valuation Allowances on Mortgage Loans
The following table presents additions to valuation allowances on mortgage loans.
Three Months Ended | Six Months Ended | |||||||||||||||
June 30, | June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Credit-related concerns |
$ | 35 | $ | 48 | $ | 43 | $ | 92 | ||||||||
Held for sale |
||||||||||||||||
B-note participations |
| | 10 | | ||||||||||||
Mezzanine |
1 | | 51 | | ||||||||||||
Agricultural |
3 | | 7 | | ||||||||||||
Total |
$ | 39 | $ | 48 | $ | 111 | $ | 92 | ||||||||
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Table of Contents
CAPITAL MARKETS RISK MANAGEMENT
The Company has a disciplined approach to managing risks associated with its capital markets
and asset/liability management activities. Investment portfolio management is organized to focus
investment management expertise on the specific classes of investments, while asset/liability
management is the responsibility of a dedicated risk management unit supporting the Company.
Derivative instruments are utilized in compliance with established Company policy and regulatory
requirements and are monitored internally and reviewed by senior management.
The Company utilizes a variety of over-the-counter and exchange traded derivative instruments as a
part of its overall risk management strategy, as well as to enter into replication transactions.
Derivative instruments are used to manage risk associated with interest rate, equity market, credit
spread, issuer default, price, and currency exchange rate risk or volatility. Replication
transactions are used as an economical means to synthetically replicate the characteristics and
performance of assets that would otherwise be permissible investments under the Companys
investment policies. For further information, see Note 4 of the Notes to Condensed Consolidated
Financial Statements.
Derivative activities are monitored and evaluated by the Companys risk management team and
reviewed by senior management. In addition, the Company monitors counterparty credit exposure on a
monthly basis to ensure compliance with Company policies and statutory limitations. The notional
amounts of derivative contracts represent the basis upon which pay or receive amounts are
calculated and are not reflective of credit risk. For further information on the Companys use of
derivatives, see Note 4 of the Notes to Condensed Consolidated Financial Statements.
Market Risk
The Company is exposed to market risk, primarily relating to the market price and/or cash flow
variability associated with changes in interest rates, credit spreads including issuer defaults,
equity prices or market indices, and foreign currency exchange rates. The Company is also exposed
to credit and counterparty repayment risk. For further discussion of market risk, see the Capital
Markets Risk Management section of the MD&A in the Companys 2009 Form 10-K Annual Report.
Interest Rate Risk
The Companys exposure to interest rate risk relates to the market price and/or cash flow
variability associated with changes in market interest rates. The Company manages its exposure to
interest rate risk by constructing investment portfolios that maintain asset allocation limits and
asset/liability duration matching targets which include the use of derivatives. For further
discussion of interest rate risk, see the Interest Rate Risk discussion within the Capital Markets
Risk Management section of the MD&A in the Companys 2009 Form 10-K Annual Report.
The Company is also exposed to interest rate risk based upon the discount rate assumption
associated with the Companys pension and other postretirement benefit obligations. The discount
rate assumption is based upon an interest rate yield curve comprised of bonds rated Aa with
maturities primarily between zero and thirty years. For further discussion of interest rate risk
associated with the benefit obligations, see the Critical Accounting Estimates section of the MD&A
under Pension and Other Postretirement Benefit Obligations and Note 14 of the Notes to Consolidated
Financial Statements in the Companys 2009 Form 10-K Annual Report.
In addition, management evaluates performance of certain products based on net investment spread
which is, in part, influenced by changes in interest rates. These products include those that have
insignificant mortality risk, such as fixed annuities, certain general account universal life
contracts and certain institutional contracts. Net investment spread is determined by taking the
difference between the earned rate, (excluding the effects of realized capital gains and losses,
including those related to the Companys GMWB product and related reinsurance and hedging
programs), and the related crediting rates on average general account assets under management. The
net investment spreads are for the total portfolio of relevant contracts in each segment and
reflect business written at different times. When pricing products, the Company considers current
investment yields and not the portfolio average. The determination of credited rates is based upon
consideration of current market rates for similar products, portfolio yields and contractually
guaranteed minimum credited rates. Net investment spread can be volatile period over period, which
can have a significant positive or negative effect on the operating results of each segment. The
volatile nature of net investment spread is driven primarily by earnings on limited partnership and
other alternative investments and prepayment premiums on securities. Investment earnings can also
be influenced by factors such as changes in interest rates, credit spreads and decisions to hold
higher levels of short-term investments. For further discussion, see the Consolidated Results
section of the MD&A.
As interest rates decline, certain mortgage-backed securities are more susceptible to paydowns and
prepayments. During such periods, the Company generally will not be able to reinvest the proceeds
at comparable yields. Lower interest rates will also likely result in lower net investment income,
increased hedging cost associated with variable annuities and, if declines are sustained for a long
period of time, it may subject the Company to reinvestment risks, higher pension costs expense and
possibly reduced profit margins associated with guaranteed crediting rates on certain products.
Conversely, the fair value of the investment portfolio will increase when interest rates decline
and the Companys interest expense will be lower on its variable rate debt obligations.
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Credit Risk
The Company is exposed to credit risk within our investment portfolio and through counterparties.
Credit risk relates to the uncertainty of an obligors continued ability to make timely payments in
accordance with the contractual terms of the instrument or contract. The Company manages credit
risk through established investment credit policies which address quality of obligors and
counterparties, credit concentration limits, diversification requirements and acceptable risk
levels under expected and stressed scenarios. For further discussion of credit risk, see the
Credit Risk section of the MD&A in the Companys 2009 Form 10-K Annual Report.
For further information on credit risk associated with derivatives, see the Investment Credit Risk
section of the MD&A.
The Company is also exposed to credit spread risk related to security market price and cash flows
associated with changes in credit spreads. Credit spread tightening will reduce net investment
income associated with new purchases of fixed maturities and increase the fair value of the
investment portfolio resulting in lower impairment losses. Credit spread widening will reduce the
fair value of the investment portfolio and increase net investment income for new purchases. For a
discussion of the movement of credit spread impacts on the Companys statutory financial results as
it relates to the accounting and reporting for market value fixed annuities, see the Capital
Resources & Liquidity section of the MD&A.
Foreign Currency Exchange Risk
The Companys foreign currency exchange risk is related to nonU.S. dollar denominated investments,
which primarily consist of fixed maturity investments, the investment in and net income of the U.K.
Life operations, and non-U.S. dollar denominated liability contracts, including its GMDB, GMAB,
GMWB and GMIB benefits associated with its reinsurance of Japanese variable annuities, and a yen
denominated individual fixed annuity product. A portion of the Companys foreign currency exposure
is mitigated through the use of derivatives.
For further information on foreign currency exchange risk, see Foreign Currency Exchange Risk
within the Capital Markets Risk Management section of the MD&A included in the Companys 2009
Annual Report on Form 10-K.
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Equity Product Risk
The Companys equity product risk is managed at the Life Operations level of the Hartford Financial
Services Group (HFSG). The disclosures in the following equity product risk section are
reflective of Life Operations risk management program, including reinsurance with third parties and
the dynamic and macro derivative hedging programs which are structured at a parent company level.
The following disclosures are also reflective of the Companys reinsurance of the majority of
variable annuities with living and death benefit riders to an affiliated captive reinsurer,
effective October 1, 2009. See Note 10 Transactions with Affiliates for further information on the
reinsurance transaction.
The Companys operations are significantly influenced by the U.S., Japanese and other global equity
markets. Increases or decreases in equity markets impact certain assets and liabilities related to
the Companys variable products and the Companys earnings derived from those products. These
variable products include variable annuities, mutual funds, and variable life insurance.
Generally, declines in equity markets will:
| reduce the value of assets under management and the amount of fee income generated from those assets; | |
| increase the liability for direct GMWB benefits, and reinsured GMWB and GMIB benefits, resulting in realized capital losses; | |
| increase the value of derivative assets used to dynamically hedge product guarantees resulting in realized capital gains; | |
| increase the costs of the hedging instruments we use in our hedging program; | |
| increase the Companys net amount at risk for GMDB benefits; | |
| decrease the Companys actual gross profits, resulting in increased DAC amortization; | |
| increase the amount of required assets to be held for backing variable annuity guarantees to maintain required regulatory reserve levels and targeted risk based capital ratios; | |
| adversely affect customer sentiment toward equity-linked products negative, causing a decline in sales; and | |
| decrease the Companys estimated future gross profits. See Life Estimated Gross Profits Used in the Valuation and Amortization of Assets and Liabilities Associated with Variable Annuity and Other Universal Life-Type Contracts within Critical Accounting Estimates for further information. |
Generally, increases in equity markets will reduce the value of derivative assets used to provide a
macro hedge on statutory surplus, resulting in realized capital losses during periods of market
appreciation.
GMWB and Intercompany Reinsurance of GMWB and GMIB
The majority of the Companys U.S. and U.K. variable annuities include a GMWB rider. In the second
quarter of 2009, the Company suspended all product sales in the U.K and Japan. The Companys new
U.S. variable annuity product, launched in October 2009, does not offer a GMWB. Declines in the
equity markets will increase the Companys liability for these benefits. The Company reinsures a
majority of the GMWB benefits with an affiliated captive reinsurer. A GMWB contract is in the
money if the contract holders guaranteed remaining benefit (GRB) becomes greater than the
account value. As of June 30, 2010 and December 31, 2009, 66% and 55%, respectively, of all
unreinsured U.S. GMWB in-force contracts were in the money. For U.S. and U.K. GMWB contracts
that were in the money the Companys exposure to the GRB, after internal and external
reinsurance, as of June 30, 2010 and December 31, 2009, was $1.0 billion and $775, respectively.
However, the Company expects to incur these payments in the future only if the policyholder has an
in the money GMWB at their death or their account value is reduced to a specified minimum level,
through contractually permitted withdrawals and/or market declines. If the account value is reduced
to the specified level, the contract holder will receive an annuity equal to the remaining GRB. For
the Companys life-time GMWB products, this annuity can continue beyond the GRB. As the account
value fluctuates with equity market returns on a daily basis, and the life-time GMWB payments can
exceed the GRB, the ultimate amount to be paid by the Company, if any, is uncertain and could be
significantly more or less than $1.0 billion. For additional information on the Companys GMWB
liability, see Note 3 of Notes to Consolidated Financial Statements.
The Company enters into various reinsurance agreements to reinsure GMWB and GMIB benefits issued by
HLIKK, a Japan affiliate of the Company. In the second quarter of 2009, the Company suspended new
product sales in the Companys Japan affiliate and in the fourth quarter the Company reinsured 100%
of the assumed benefits to an affiliated captive reinsurer. See Note 10 Transactions with
Affiliates for further discussion.
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GMDB and Intercompany Reinsurance of GMDB
The majority of the Companys variable annuity contracts include a GMDB rider. A majority of the
Companys GMDB benefits, both direct and assumed, are reinsured with an affiliated captive
reinsurer. Declines in the equity market will increase the Companys liability GMDB
riders. The Companys total gross exposure (i.e. before reinsurance) to U.S. GMDBs as of June 30,
2010 and December 31, 2009 is $20.9 and $18.4 billion. The Company will incur these
payments in the future only if the policyholder has an in-the-money GMDB at their time of death.
As of June 30, 2010 and December 31, 2009, 78% and 73%, respectively, of all unreinsured U.S. GMBD
in-force contracts were in the money. The Company reinsures a majority of these GMDB benefit
guarantees externally and internally with an affiliated captive reinsurer. As of June 30, 2010, of
the remaining net amount at risk for the GMDB benefit after the Companys 52% of external
reinsurance, 68% is internally reinsured with an affiliated captive reinsurer. As of December 31,
2009, of the remaining net amount at risk for GMDB benefit after the Companys 53% of external
reinsurance, 69% is internally reinsured with an affiliated captive reinsurer. Under certain of
these reinsurance agreements, the reinsurers exposure is subject to an annual cap. The Companys
net exposure (i.e. after reinsurance), referred to as the retained net amount at risk, is $3.2
billion and $2.6 billion, as of June 30, 2010 and December 31, 2009. For additional information on
the Companys GMDB liability, see Note 7 of Notes to Condensed Consolidated Financial Statements.
The Company enters into various reinsurance agreements to reinsure GMDB benefits issued by HLIKK, a
Japan affiliate of the Company. In the second quarter of 2009, the Company suspended new product
sales in the Companys Japan affiliate and, in the fourth quarter, the company reinsured 100% of
the assumed benefits to an affiliated captive reinsurer. See Note 10, Transactions with Affiliates
for further discussion.
Equity Product Risk Management
Market Risk Exposures
The following table summarizes the broad Variable Annuity Guarantees offered by the Company and the
market risks to which the guarantee is most exposed from a U.S. GAAP accounting perspective.
Variable Annuity Guarantee [1] | U.S. GAAP Treatment [1] | Market Risk Exposures [1] | ||
U.S. GMDB
|
Accumulation of fees received less accumulation of claims paid | Equity Market Levels | ||
Japan GMDB (Assumed)
|
Accumulation of fees received less accumulation of claims paid | Equity Market Levels/ Interest Rates / Foreign Currency |
||
GMWB
|
Fair Value | Equity Market Levels/ Implied Volatility/ Interest Rates |
||
For Life Component of GMWB
|
Accumulation of fees received less accumulation of claims paid | Equity Market Levels | ||
Japan GMIB (Assumed)
|
Fair Value | Equity Market Levels/Interest Rate/Foreign Currency | ||
GMAB (Assumed)
|
Fair Value | Equity Market Levels/ Implied Volatility/ Interest Rates |
||
[1] | Each of these guarantees and the related U.S. GAAP accounting volatility will also be influenced by actual and estimated policyholder behavior. |
Risk Management
The
Company carefully analyzes market risk exposures arising from: GMDB,
GMWB, GMIB, GMAB; equity market, interest rate risks, implied volatility, foreign currency exchange
risk and correlation between these market risk exposures. The Company evaluates these risks both
individually and, in the aggregate, to determine the financial risk of its products and to judge
their potential impacts on U.S. GAAP earnings and statutory surplus. The Company manages the equity
market, interest rate, implied volatility and foreign currency exchange risks embedded in its
products through reinsurance, customized derivatives, and dynamic hedging and macro hedging
programs. The Company recently launched a new variable annuity product with reduced equity risk and
has increased GMWB rider fees on new sales of the Companys legacy variable annuities and the
related in-force policies, as contractually permitted. Depending upon competitors reactions with respect to
products and related rider charges, the Companys strategy of reducing product risk and increasing
fees has and may continue to result in a decline in market share.
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The following table depicts the type of risk management strategy being used by the Company to
either partially or fully mitigate market risk exposures displayed above by variable annuity
guarantee as of June 30, 2010:
Customized | Dynamic | Macro | ||||||
Variable Annuity Guarantee | Reinsurance [1] | Derivative | Hedging [2] | Hedging [3] | ||||
GMDB |
ü | ü | ||||||
GMDB (Assumed) |
ü | ü | ||||||
GMWB |
ü | ü | ü | ü | ||||
For Life Component of GMWB |
ü | ü | ||||||
GMIB (Assumed) |
ü | ü | ||||||
GMAB (Assumed) |
ü | ü |
[1] | the Company cedes the GMDB and GMWB including for life component of GMWB, written by HLAI, and GMDB, GMIB and GMAB assumed by HLAI from HLIKK, to an affiliated captive reinsurer. See Note 10 Transactions with Affiliates for further discussion. | |
[2] | through the 2Q 2010, the Company continued to maintain a reduced level of dynamic hedge protection on U.S. GAAP earnings while placing a greater relative emphasis on the protection of statutory surplus through the inclusion of a macro hedging program. This portion of the GMWB hedge strategy may include derivatives with maturities of up to 10 years. U.S. GAAP fair value volatility will be driven by a reduced level of dynamic hedge protection and macro program positions. | |
[3] | As described below, the Companys macro hedging program is not designed to provide protection against any one variable annuity guarantee program, but rather is a broad based hedge designed to provide protection against multiple guarantees and market risks, primarily focused on statutory liability and surplus volatility. |
Third Party Reinsurance
The Company uses third-party reinsurance for a portion of U.S. contracts issued with GMWB riders
prior to the third quarter of 2003 and GMWB risks associated with a block of business sold between
the third quarter of 2003 and the second quarter of 2006. The Company also uses third party
reinsurance for a majority of the GMDB issued in the U.S.
Derivative
Hedging Strategies
The Company maintains derivative hedging strategies for its product guarantee risk to meet multiple,
and in some cases, competing risk management objectives, including providing protection against
tail scenario market events, providing resources to pay product guarantee claims, and
minimizing U.S. GAAP earnings volatility, statutory surplus volatility and other economic metrics.
Customized Derivatives
The Company holds customized derivative contracts to provide protection from certain capital market
risks for the remaining term of specified blocks of non-reinsured GMWB riders. These customized
derivative contracts are based on policyholder behavior assumptions specified at the inception of
the derivative contracts. The Company retains the risk for
differences between assumed and actual policyholder behavior and
between the performance of the actively managed funds underlying the
separate accounts and their respective indices.
Dynamic Hedging
The Companys dynamic hedging program uses derivative instruments to manage the U.S. GAAP earnings
volatility associated with variable annuity product guarantees including equity market declines,
equity implied volatility, and declines in interest rates (See Market Risk on Statutory Capital below). The Company uses hedging instruments
including: interest rate futures and swaps, variance swaps, S&P 500, NASDAQ and EAFE index put
options and futures contracts. During the first quarter and early in the second quarter of 2010,
the Company added additional volatility protection. While the Company actively manages this
dynamic hedging program, increased U.S. GAAP earnings volatility may result from factors including,
but not limited to: policyholder behavior, capital markets, divergence between the performance of
the underlying funds and the hedging indices, changes in hedging positions, and the relative emphasis placed on various risk
management objectives.
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Macro Hedging
The Companys macro hedging program uses derivative instruments like options, futures, and forwards
that may exist on equities, interest rates, and currencies to partially hedge the statutory tail
scenario risk arising from U.S., U.K. and Japan GMWB, GMDB, GMIB and GMAB statutory liabilities, on
the Companys statutory surplus and the associated target RBC ratios (see Capital Resources and
Liquidity). During the second quarter, the Company extended its equity macro hedge coverage through
2011, while maintaining the 2010 coverage as well as added additional currency protection. The
macro hedge program will result in additional cost and U.S. GAAP earnings volatility in times of
market increases as changes in the value of the macro hedge derivatives, which is designed to
reduce statutory reserve and capital volatility, may not be closely aligned to changes in U.S. GAAP
liabilities.
Hedging Impact
During the
quarter ended June 30, 2010, U.S. GMWB liabilities, net of the
dynamic and macro hedging programs, reported a net realized
pre-tax gain of $585 primarily driven by the transfer of the decrease of $576 in GMWB liabilities to an affiliated reinsurer, decreases in U.S. equity markets of approximately 12%, a strengthened Yen of approximately 5% and 14% against USD and the Euro, partially offset by decreases in interest rates of approximately 82 basis points and increases in volatility of approximately 7%. See Note 10 Transactions with Affiliates for further discussion.
pre-tax gain of $585 primarily driven by the transfer of the decrease of $576 in GMWB liabilities to an affiliated reinsurer, decreases in U.S. equity markets of approximately 12%, a strengthened Yen of approximately 5% and 14% against USD and the Euro, partially offset by decreases in interest rates of approximately 82 basis points and increases in volatility of approximately 7%. See Note 10 Transactions with Affiliates for further discussion.
Market Risk on Statutory Capital
Statutory surplus amounts and RBC ratios may
increase or decrease in any period depending
upon a variety of factors and may be compounded in extreme scenarios or if multiple factors occur
at the same time. At times the impact of changes in certain market factors or a combination of
multiple factors on RBC ratios can be counterintuitive. Factors include:
| In general, as equity market levels and interest rates decline, the amount and volatility of both our actual potential obligation, as well as the related statutory surplus and capital margin for death and living benefit guarantees associated with U.S. variable annuity contracts can be materially negatively effected, sometimes at a greater than linear rate. Other market factors that can impact statutory surplus, reserve levels and capital margin include differences in performance of variable subaccounts relative to indices and/or realized equity and interest rate volatilities. In addition, as equity market levels increase, generally surplus levels will increase. RBC ratios will also tend to increase when equity markets increase. However, as a result of a number of factors and market conditions, including the level of hedging costs and other risk transfer activities, reserve requirements for death and living benefit guarantees and RBC requirements could increase with rising equity markets, resulting in lower RBC ratios. Non-market factors, which can also impact the amount and volatility of both our actual potential obligation, as well as the related statutory surplus and capital margin, include actual and estimated policyholder behavior experience as it pertains to lapsation, partial withdrawals, and mortality. The Company cedes the GMDB and GMWB, written by HLAI, to an affiliated captive reinsurer. See Note 10 Transactions with Affiliates for further discussion. | |
| Similarly, for guaranteed benefits (GMDB and GMIB) reinsured from our Japanese operations, the amount and volatility of both our actual potential obligation as well as the related statutory surplus and capital margin can be materially affected by a variety of factors, both market and non-market. Market factors include declines in various equity market indices and interest rates, changes in value of the Yen versus other global currencies, difference in the performance of variable subaccounts relative to indices, and increases in implied and/or realized equity, interest rate, and currency volatilities. Non-market factors include actual and estimated policyholder behavior experience as it pertains to lapsation, withdrawals, mortality, and annuitization. Risk mitigation activities, such as hedging, may also result in material and sometimes counterintuitive impacts on statutory surplus and capital margin. Notably, as changes in these market and non-market factors occur, both our potential obligation and the related statutory reserves and/or required capital can increase or decrease at a greater than linear rate. The company cedes the GMDB and GMIB assumed by HLAI from HLIKK, to an affiliated captive reinsurer. See Note 10 Transactions with Affiliates for further discussion. | |
| As the value of certain fixed-income and equity securities in our investment portfolio decreases, due in part to credit spread widening, statutory surplus and RBC ratios may decrease. | |
| As the value of certain derivative instruments that do not get hedge accounting decreases, statutory surplus and RBC ratios may decrease. | |
| The Companys exposure to foreign currency exchange risk exists with respect to non-U.S. dollar denominated assets and liabilities. Assets and liabilities denominated in foreign currencies are accounted for at their U.S. dollar equivalent values using exchange rates at the balance sheet date. As foreign currency exchange rates vary in comparison to the U.S. dollar, the remeasured value of those non-dollar denominated assets or liabilities will also vary causing an increase or decrease to statutory surplus, respectively. | |
| Our statutory surplus is also impacted by widening credit spreads as a result of the accounting for the assets and liabilities in our fixed market value adjusted (MVA) annuities. Statutory separate account assets supporting the fixed MVA annuities are recorded at fair value. In determining the statutory reserve for the fixed MVA annuities, we are required to use current crediting rates in the U.S.. In many capital market scenarios, current crediting rates in the U.S. are highly correlated with market rates implicit in the fair value of statutory separate account assets. As a result, the change in statutory reserve from period to period will likely substantially offset the change in the fair value of the statutory separate account assets. However, in periods of volatile credit markets, such as we are now experiencing, actual credit spreads on investment assets may |
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increase sharply for certain sub-sectors of the overall credit market, resulting in statutory separate account asset market value losses. As actual credit spreads are not fully reflected in the current crediting rates in the U.S. the calculation of statutory reserves will not substantially offset the change in fair value of the statutory separate account assets resulting in reductions in statutory surplus. This has resulted and may continue to result in the need to devote significant additional capital to support the product. |
Most of these factors are outside of the Companys control. The Companys financial strength and
credit ratings are significantly influenced by the statutory surplus amounts and RBC ratios of our
insurance company subsidiaries. In addition, rating agencies may implement changes to their
internal models that have the effect of increasing or decreasing the amount of statutory capital we
must hold in order to maintain our current ratings.
See Note 4 of Notes to Condensed Consolidated Financial Statements for additional information on
hedging derivatives.
Derivative Instruments
The Company utilizes a variety of derivative instruments, including swaps, caps, floors, forwards,
futures and options through one of four Company-approved objectives: to hedge risk arising from
interest rate, equity market, credit spread including issuer default, price or currency exchange
rate risk or volatility; to manage liquidity; to control transaction costs; or to enter into
replication transactions.
Further downgrades to the credit ratings of the Companys insurance operating companies may have
adverse implications for its use of derivatives including those used to hedge benefit guarantees of
variable annuities. In some cases, further downgrades may give derivative counterparties the
unilateral contractual right to cancel and settle outstanding derivative trades or require
additional collateral to be posted. In addition, further downgrades may result in counterparties
becoming unwilling to engage in additional over-the-counter (OTC) derivatives or may require
collateralization before entering into any new trades. This will restrict the supply of derivative
instruments commonly used to hedge variable annuity guarantees, particularly long-dated equity
derivatives and interest rate swaps. Under these circumstances, the Companys operating
subsidiaries could conduct hedging activity using available OTC derivatives, as well as a
combination of cash and exchange-traded instruments.
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CAPITAL RESOURCES AND LIQUIDITY
Capital resources and liquidity represent the overall strength of Hartford Life Insurance Company
and its ability to generate strong cash flows from each of the business segments, borrow funds at
competitive rates and raise new capital to meet operating and growth needs over the next twelve
months.
Capital Purchase Program
On March 31, 2010, The Hartford repurchased all 3.4 million shares of Series E Preferred Stock
issued to the U.S. Treasury (the Treasury) for an aggregate purchase price of $3.4 billion. The
Hartford used approximately $423 of the net proceeds from the debt issuance, $1.6 billion from the
common stock issuance, $556 from the preferred stock issuance together with available funds at the
HFSG Holding Company to repurchase the Series E Preferred Stock. The Company recorded a $440
charge to retained earnings representing the acceleration of the accretion of the remaining
discount on the preferred stock. Treasury continues to hold warrants to purchase approximately 52
million shares of the Companys common stock at an exercise price of $9.79 per share. During The
Hartfords participation in the Capital Purchase Program (CPP), The Hartford was subject to
numerous additional regulations, including restrictions on the ability to increase the common stock
dividend, limitations on the compensation arrangements for senior executives and additional
corporate governance standards. As a result of the redemption of Series E Preferred Stock, The
Hartford believes it is no longer subject to these regulations other than certain reporting and
certification obligations to U.S. regulating agencies.
Derivative Commitments
Certain of the Companys derivative agreements contain provisions that are tied to the financial
strength ratings of the individual legal entity that entered into the derivative agreement as set
by nationally recognized statistical rating agencies. If the legal entitys financial strength
were to fall below certain ratings, the counterparties to the derivative agreements could demand
immediate and ongoing full collateralization and in certain instances demand immediate settlement
of all outstanding derivative positions traded under each impacted bilateral agreement. The
settlement amount is determined by netting the derivative positions transacted under each
agreement. If the termination rights were to be exercised by the counterparties, it could impact
the legal entitys ability to conduct hedging activities by increasing the associated costs and
decreasing the willingness of counterparties to transact with the legal entity. The aggregate fair
value of all derivative instruments with credit-risk-related contingent features that are in a net
liability position as of June 30, 2010, is $320. Of this $320, the legal entities have posted
collateral of $349 in the normal course of business. Based on derivative market values as of June
30, 2010, a downgrade of one level below the current financial strength ratings by either Moodys
or S&P could require approximately an additional $4 to be posted as collateral. These collateral
amounts could change as derivative market values change, as a result of changes in our hedging
activities or to the extent changes in contractual terms are negotiated. The nature of the
collateral that we may be required to post is primarily in the form of U.S. Treasury bills and U.S.
Treasury notes.
The table below presents the aggregate notional amount and fair value of derivative relationships
that could be subject to immediate termination in the event of further rating agency downgrades.
As of June 30, 2010 | ||||||||
Ratings levels | Notional Amount | Fair Value | ||||||
Either BBB+ or Baa1 [1] |
$ | 13,450 | $ | 798 | ||||
[1] | The notional and fair value amounts include a customized GMWB derivative with a notional amount of $4.7 billion and a fair value of $258, for which the Company has a contractual right to make a collateral payment in the amount of approximately $52 to prevent its termination. |
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Insurance Operations
As of June 30, 2010, the Companys total assets under management were $295.2 billion. Of the total
assets under management, approximately $219.5 billion is held in separate accounts, within mutual
funds or were held in international statutory separate accounts. Mutual funds are not recorded on
the Companys balance sheet. The remaining $75.8 billion was held in the Companys general account
supported by the Companys general account invested assets of $58.3 billion including a significant
short-term investment position to meet liquidity needs. As of June 30, 2010 and December 31, 2009,
the Company held total fixed maturity investments of $49.6 billion and $45.5 billion,
respectively. As of June 30, 2010, the Companys cash and short-term investments of $5.0 billion,
included $1.5 billion of collateral received from, and held on behalf of, derivative counterparties
and $101 of collateral pledged to derivative counterparties. The Company also held $3.5 billion of
treasury securities, of which $349 had been pledged to derivative counterparties.
In the event customers elect to surrender separate account assets, international statutory separate
accounts or retail mutual funds, the Company will use the proceeds from the sale of the assets to
fund the surrender and the Companys liquidity position will not be impacted. In many instances
the Company will receive a percentage of the surrender amount as compensation for early surrender
(surrender charge), increasing the Companys liquidity position. In addition, a surrender of
variable annuity separate account or general account assets (see below) will decrease the Companys
obligation for payments on guaranteed living and death benefits.
Capital resources available to fund liquidity, upon contract holder surrender, are a function of
the legal entity in which the liquidity requirement resides. Obligations of Individual Annuity and
Individual Life will be generally be funded by both the Hartford Life Insurance Company and the
Hartford Life and Annuity Insurance Company; obligations of Retirement and Institutional will
generally be funded by the Hartford Life Insurance Company; and obligations of the Companys
European insurance operations will generally be funded by the legal entity in the country in which
the obligation was generated.
As of June 30, 2010, $10.9 billion of contract holder obligations relate to the Companys Global
Annuity U.S. Fixed MVA annuities that are held in a statutory separate account, but under U.S.
GAAP are recorded in the general account as Fixed MVA annuity contract holders are subject to the
Companys credit risk. In the statutory separate account, the Company is required to maintain
invested assets with a fair value equal to the market value adjusted surrender value of the Fixed
MVA contract. In the event assets decline in value at a greater rate than the market value
adjusted surrender value of the Fixed MVA contract, the Company is required to contribute
additional capital to the statutory separate account. The Company will fund these required
contributions with operating cash flows and short-term investments. In the event that operating
cash flows or short-term investments are not sufficient to fund required contributions, the Company
may have to sell other invested assets at a loss, potentially resulting in a decrease to statutory
surplus. As the fair value of invested assets in the statutory separate account are generally
equal to the market value adjusted surrender value of the Fixed MVA contract, surrender of Fixed
MVA annuities will have an insignificant impact on the liquidity requirements of the Company.
As of June 30, 2010, $1.1 billion in GIC contracts are subject to discontinuance provisions which
allow the policyholders to terminate their contracts prior to scheduled maturity at the lesser of
the book value or market value. The market value adjustment feature in the GIC contract serves to
protect the Company from interest rate risks and limit the Companys liquidity requirements in the
event of a surrender.
Surrenders of, or policy loans taken from, as applicable, the remaining $12.5 billion of general
account liabilities, which include the general account option for Global Annuity U.S.s
individual variable annuities and Individual Lifes variable life contracts, the general account
option for Retirement Plan annuities and universal life contracts sold by Individual Life may be
funded through operating cash flows of the Company, available short-term investments, or the
Company may be required to sell fixed maturity investments to fund the surrender payment. Sales of
fixed maturity investments could result in the recognition of significant realized losses and
insufficient proceeds to fully fund the surrender amount. In this circumstance, the Company may
need to acquire additional liquidity from the HFSG Holding Company or take other actions, including
enforcing certain contract provisions which could restrict surrenders and/or slow or defer payouts.
Surrenders of term life and group benefits contracts will have no current effect on the Companys
liquidity requirements.
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Ratings
Ratings impact the Companys cost of borrowing and its ability to access financing and are an
important factor in establishing the competitive position in the insurance and financial services
marketplace. There can be no assurance that the Companys ratings will continue for any given
period of time or that they will not be changed. In the event the Companys ratings are downgraded,
the Companys cost of borrowing and the ability to access financing as well as its level of
revenues, or the persistency of its business may be adversely impacted.
On March 16, 2010, Fitch affirmed the financial strength ratings of the Company and maintained the
negative outlook for all ratings.
On March 17, 2010, S&P affirmed the financial strength ratings of the Company and revised the
outlook to negative from stable.
On March 17, 2010, Moodys affirmed the financial strength ratings of the Company and maintained
the stable outlook for all ratings.
On March 24, 2010, A.M. Best affirmed the financial strength ratings of the Company and revised the
outlook to stable from negative.
The following table summarizes Hartford Life Insurance Companys significant member companies
financial ratings from the major independent rating organizations as of July 30, 2010:
Standard & | ||||||||||||||||
A.M. Best | Fitch | Poors | Moodys | |||||||||||||
Insurance Financial Strength Ratings |
||||||||||||||||
Hartford Life Insurance Company |
A | A- | A | A3 | ||||||||||||
Hartford Life and Annuity Insurance Company |
A | A- | A | A3 |
These ratings are not a recommendation to buy or hold any of the Companys securities and they may
be revised or revoked at any time at the sole discretion of the rating organization.
The agencies consider many factors in determining the final rating of an insurance company. One
consideration is the relative level of statutory surplus necessary to support the business written.
Statutory surplus represents the capital of the insurance company reported in accordance with
accounting practices prescribed by the applicable state insurance department.
The Companys aggregate statutory capital and surplus, as prepared in accordance with the National
Association of Insurance Commissioners Accounting Practices and Procedures Manual (US STAT) was
$5.6 billion as of June 30, 2010 and $5.4 billion as of December 31, 2009, respectively. The
statutory surplus amount as of December 31, 2009 is based on actual statutory filings with the
applicable regulatory authorities. The statutory surplus amount as of June 30, 2010, is an
estimate, as the 2010 statutory filings have not yet been made.
Equity Markets
For a discussion of the potential impact of the equity markets on capital and liquidity, see the
Capital Markets Risk Management section under Market Risk above.
Contingencies
Legal Proceedings For a discussion regarding contingencies related to the Companys legal
proceedings, please see Part II, Item 1, Legal Proceedings.
Legislative Developments
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
The
Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
(the Dodd-Frank Act) was enacted into law on July 21,
2010, and will introduce sweeping changes to the regulation of the
financial services industry. Most of these will not become effective
immediately, and many will require further regulatory action before
they become effective. Nonetheless, we anticipate that the Dodd-Frank
Act may affect our operations and governance in ways that could
significantly affect our financial condition and results of
operations.
In particular, the Dodd-Frank Act vests a newly created Financial Services Oversight Council with
the power to designate systemically important institutions, which will be subject to special
regulatory supervision and other provisions intended to prevent, or mitigate the impact of, future
disruptions in the U.S. financial system. If The Hartford is designated as a systemically important
institution, it will be subject to heightened prudential standards imposed by The Federal
Reserve, as well as to post-event assessments imposed by the FDIC to recoup the costs associated
with the orderly resolution of systemically important institutions in the event one or more such
institutions fails. The Dodd-Frank Act creates a new resolution authority for systemically important
institutions. Although insurance companies will not be subject to
the special liquidation procedures in the Dodd-Frank Act, it contains
back-up authority for the FDIC to force insurance companies into
liquidation under state law if their state regulators fail to act.
Other provisions will require central clearing of, and/or impose new
margin and capital requirements on, derivatives transactions, which
we expect will increase the costs of our hedging program.
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A number
of provisions of the Dodd-Frank Act affect The Hartford solely due to
its status as a savings & loan holding company. For example,
under the Dodd-Frank Act, the OTS will be dissolved. The Federal
Reserve will assume regulatory authority over our holding company,
and The Hartfords thrift subsidiary, Federal Trust Bank, will
be regulated by the OCC. The Dodd-Frank Act may also restrict The
Hartford as a savings and loan holding company or systemically
important institution from sponsoring and investing in private equity
and hedge funds, which could limit our discretion in managing our
general account. In addition, the Dodd-Frank Act prohibits
proprietary trading by any entity that is not a licensed insurance
company. The Dodd-Frank Act will also impose new
minimum capital standards on a consolidated basis for holding
companies that, like The Hartford, control insured depository
institutions.
Other changes in the Dodd-Frank Act include: the possibility that regulators could break up firms
that are considered too big to fail or mandate certain barriers between their activities in order
to allow for the orderly resolution of failing financial institutions; a new Federal Insurance
Office within Treasury to, among other things, conduct a study of how to improve insurance
regulation in the United States; new means for regulators to limit the activities of financial
firms; discretionary authority for the SEC to impose a harmonized standard of care for investment
advisers and broker-dealers who provide personalized advice about securities to retail customers;
additional regulation of compensation in the financial services industry; and enhancements to
corporate governance, especially regarding risk management.
Given the significance of the changes and the additional regulatory action required for many of the
new provisions, we cannot predict all of the ways or the degree to which our business, financial
condition and results of operations may be affected by the Dodd-Frank Act, once it is fully
implemented.
FY
2011, Budget of the United States Government
On February 1, 2010, the Obama Administration released its FY 2011, Budget of the United States
Government (the Budget). Although the Administration has not released proposed statutory
language, the Budget includes proposals which if enacted, would affect the taxation of life
insurance companies and certain life insurance products. In particular, the proposals would affect
the treatment of corporate owned life insurance (COLI) policies by limiting the availability of
certain interest deductions for companies that purchase those policies. The proposals would also
change the method used to determine the amount of dividend income received by a life insurance
company on assets held in separate accounts used to support products, including variable life
insurance and variable annuity contracts, that are eligible for the dividends received deduction
(DRD). The DRD reduces the amount of dividend income subject to tax and is a significant
component of the difference between the Companys actual tax expense and expected amount determined
using the federal statutory tax rate of 35%. If proposals of this type were enacted, the Companys
sale of COLI, variable annuities, and variable life products could be adversely affected and the
Companys actual tax expense could increase, reducing earnings. The Budget also included a
proposal to levy a $90 billion Financial Crisis Responsibility Fee on large financial
institutions, including The Hartford.
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IMPACTS OF NEW ACCOUNTING STANDARDS
For a discussion of accounting standards, see Note 1 of Notes to the Condensed Consolidated
Financial Statements included in the Companys 2009 Form 10-K Annual Report and Note 1 of Notes to
the Condensed Consolidated Financial Statements.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See Capital Markets Risk Management section of Managements Discussion and Analysis for a
discussion of the Companys market risk.
Item 4. CONTROLS AND PROCEDURES
Evaluation of disclosure controls and procedures
The Companys principal executive officer and its principal financial officer, based on their
evaluation of the Companys disclosure controls and procedures (as defined in Exchange Act Rule
13a-15(e)) have concluded that the Companys disclosure controls and procedures are effective for
the purposes set forth in the definition thereof in Exchange Act Rule 13a-15(e) as of June 30,
2010.
Changes in internal control over financial reporting
There was no change in the Companys internal control over financial reporting that occurred during
the Companys second fiscal quarter of 2010 that has materially affected, or is reasonably likely
to materially affect, the Companys internal control over financial reporting.
Part II. OTHER INFORMATION
Item 1. LEGAL PROCEEDINGS
For a
discussion of legal proceedings, see Litigation under
Note 8 of the Notes to Condensed Consolidated Financial Statements,
which is incorporated herein by reference.
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Item 1A. RISK FACTORS
Investing in The Hartford involves risk. In deciding whether to invest in The Hartford, you should
carefully consider the following risk factors, any of which could have a significant or material
adverse effect on the business, financial condition, operating results or liquidity of The
Hartford. This information should be considered carefully together with the other information
contained in this report and the other reports and materials filed by The Hartford with the SEC.
The risk factors set forth below update the risk factors section previously disclosed in Item 1A of
Part I of the Companys Annual Report on Form 10-K for the year ended December 31, 2009 and in Item
1A of Part II of the Companys Quarterly Report on Form 10-Q for the quarter ended March 31, 2010.
Our operating environment remains challenging in light of uncertainty about the timing and strength
of an economic recovery and the impact of governmental budgetary and regulatory initiatives. The
steps we have taken to realign our businesses and strengthen our capital position may not be
adequate to mitigate the financial, competitive and other risks associated with our operating
environment, particularly if economic conditions deteriorate from their current levels or
regulatory requirements change significantly, and we may be required to or we may seek to raise
additional capital or take other strategic or financial actions that could adversely affect our
business and results or trading prices for our capital stock.
Persistent volatility in financial markets and uncertainty about the timing and strength of a
recovery in the global economy adversely affected our business and results in 2009, and these
conditions continued to affect our operating environment in 2010. High unemployment, lower family
income, lower business investment and lower consumer spending in most geographic markets we serve
have adversely affected the demand for financial and insurance products, as well as their
profitability in some cases. Our results, financial condition and statutory capital remain
sensitive to equity and credit market performance, and we expect that market volatility will
continue to pressure returns in our life and property and casualty investment portfolios and that
our hedging costs will remain high. Until economic conditions become more stable and improve, we
also expect to experience realized and unrealized investment losses, particularly in the commercial
real estate sector where significant market illiquidity and risk premiums exist that reflect the
current uncertainty in the real estate market. Lower interest rates are also likely to continue to
adversely impact our fixed annuity sales and the cost and effectiveness of our GMWB hedging
program. Deterioration or negative rating agency actions with respect to our investments could
also indirectly adversely affect our statutory capital and risk-based capital (RBC) ratios, which
could in turn have other negative consequences for our business and results.
The steps we have taken to realign our businesses and strengthen our capital position may not
be adequate if economic conditions do not stabilize in line with our forecasts or if they
experience a significant deterioration. These steps include ongoing initiatives, particularly the
execution risk relating to the repositioning of our investment portfolios. In addition, we modified
our variable annuity product offerings and, in October 2009, launched a new variable annuity
product. However, the future success of this new variable annuity product will be dependent on
market acceptance. The level of market acceptance of this new product will directly affect the
level of variable annuity sales of the Company in the future. In addition, as the Company and
our distribution partners transition to the new product, there will be downward pressure on new
deposits, and management expects to continue to be in a net outflow position through 2010. If
our actions are not adequate, our ability to support the scale of our business and to absorb
operating losses and liabilities under our customer contracts could be impaired, which would in
turn adversely affect our overall competitiveness. We could be required to raise additional capital
or consider other actions to manage our capital position and liquidity or further reduce our
exposure to market and financial risks. We may also be forced to sell assets on unfavorable terms
that could cause us to incur charges or lose the potential for market upside on those assets in a
market recovery. We could also face other pressures, such as employee recruitment and retention
issues and potential loss of distributors for our products. Finally, trading prices for The
Hartfords common stock could decline as a result or in anticipation of sales of The Hartfords
common stock or equity-linked instruments.
Even if the measures we have taken (or take in the future) are effective to mitigate the risks
associated with our current operating environment, they may have unintended consequences. For
example, rebalancing our hedging program may better protect our statutory surplus, but also result
in greater U.S. GAAP earnings volatility. Actions we take may also entail impairment or other
charges or adversely affect our ability to compete successfully in an increasingly difficult
consumer market.
Regulatory developments relating to the recent financial crisis may also significantly affect our
operations and prospects in ways that we cannot predict. U.S. and overseas governmental and
regulatory authorities, including the SEC, the OTS, The Federal Reserve, the OCC, the New York
Stock Exchange, or NYSE, or the Financial Industry Regulatory Authority are considering enhanced or
new regulatory requirements intended to prevent future crises or otherwise stabilize the
institutions under their supervision. Such measures are likely to lead to stricter regulation of
financial institutions generally, and heightened prudential requirements for systemically important
companies in particular. Such measures could include taxation of financial transactions,
liabilities and employee compensation.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act) was
enacted into law on July 21, 2010, and will introduce sweeping changes to the regulation of the
financial services industry. Most of these will not become effective
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immediately, and many will
require further regulatory action before they become effective. Nonetheless, we anticipate that the
Dodd-Frank Act may affect our operations and governance in ways that
could significantly affect
our financial condition and results of operations.
In particular, the Dodd-Frank Act vests a newly created Financial Services Oversight Council with
the power to designate systemically important institutions, which will be subject to special
regulatory supervision and other provisions intended to prevent, or mitigate the
impact of, future disruptions in the U.S. financial system. If The Hartford is designated as a
systemically important institution, it would likely be subject to heightened prudential standards
imposed by The Federal Reserve, as well as to post-event assessments imposed by the FDIC to recoup
the costs associated with the orderly resolution of systemically important institutions in the
event one or more such institutions fails. The Dodd-Frank Act creates a new resolution authority for
systemically important institutions and restricts the ability of federal regulators to provide
emergency funding in the event of another financial crisis. Although insurance companies will not
be subject to the special liquidation procedures in the Dodd-Frank Act, it contains back-up
authority for the FDIC to force insurance companies into liquidation under state law if their state
regulators fail to act. Other provisions will require central clearing of, and/or impose new
margin and capital requirements on, derivatives transactions, which we expect will increase the
costs of our hedging program.
A number
of provisions of the Dodd-Frank Act affect The Hartford solely due to
its status as a savings & loan holding company. For example,
under the Dodd-Frank Act, the OTS will be dissolved. The Federal
Reserve will assume regulatory authority over our holding company,
and The Hartfords thrift subsidiary, Federal Trust Bank, will
be regulated by the OCC. The Dodd-Frank Act may also restrict The
Hartford as a savings and loan holding company or systemically
important institution from sponsoring and investing in private equity
and hedge funds, which could limit our discretion in managing our
general account. In addition, the Dodd-Frank Act prohibits
proprietary trading by any entity that is not a licensed insurance
company. The Dodd-Frank Act will also impose new
minimum capital standards on a consolidated basis for holding
companies that, like The Hartford, control insured depository
institutions.
Other changes in the Dodd-Frank Act include: the possibility that regulators could break up firms
that are considered too big to fail or mandate certain barriers between their activities in order
to allow for the orderly resolution of failing financial institutions; a new Federal Insurance
Office within Treasury to, among other things, conduct a study of how to improve insurance
regulation in the United States; new means for regulators to limit the activities of financial
firms; discretionary authority for the SEC to impose a harmonized standard of care for investment
advisers and broker-dealers who provide personalized advice about securities to retail customers;
additional regulation of compensation in the financial services industry; and enhancements to
corporate governance, especially regarding risk management.
Given the significance of the changes and the additional regulatory action required for many of the
new provisions, we cannot predict all of the ways or the degree to which our business, financial
condition and results of operations may be affected by the Dodd-Frank Act, once it is fully
implemented.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
HARTFORD LIFE INSURANCE COMPANY
/s/ Ernest M. McNeill Jr. | ||||
Ernest M. McNeill Jr. | ||||
Senior Vice President and Chief Accounting Officer | ||||
August 4, 2010 |
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HARTFORD LIFE INSURANCE COMPANY AND SUBSIDIARIES
FORM 10-Q
FOR THE SIX MONTHS ENDED June 30, 2010
EXHIBITS INDEX
Exhibit # | ||
12.01
|
Computation of Ratio of Earnings to Fixed Charges | |
15.01
|
Deloitte & Touche LLP Letter of Awareness | |
31.01
|
Certification of David N. Levenson pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
31.02
|
Certification of Glenn D. Lammey pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 | |
32.01
|
Certification of David N. Levenson pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 | |
32.02
|
Certification of Glenn D. Lammey pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
83