The Hartford, like other insurance companies, categorizes and tracks its insurance reserves for its segments by “line of business”, such as property, auto physical damage, auto liability, commercial multi-peril package business, workers’ compensation, general liability professional liability and fidelity and surety. Furthermore, The Hartford regularly reviews the appropriateness of reserve levels at the line of business level, taking into consideration the variety of trends that impact the ultimate settlement of claims for the subsets of claims in each particular line of business. In addition, within the Other Operations segment, the Company has reserves for asbestos and environmental (“A&E”) claims. Adjustments to previously established reserves, which may be material, are reflected in the operating results of the period in which the adjustment is determined to be necessary. In the judgment of management, information currently available has been properly considered in the reserves established for losses and loss adjustment expenses. Incurred but not reported (“IBNR”) reserves represent the difference between the estimated ultimate cost of all claims and the actual reported loss and loss adjustment expenses (“reported losses”). Reported losses represent cumulative loss and loss adjustment expenses paid plus case reserves for outstanding reported claims. Company actuaries evaluate the total reserves (IBNR and case reserves) on an accident year basis. An accident year is the calendar year in which a loss is incurred, or, in the case of claims-made policies, the calendar year in which a loss is reported.
Expected loss ratio techniques are useful for early periods of maturity on long-tailed lines of business, where very little paid or reported loss information is available.
Property & Casualty net income decreased by $12 for the year ended December 31, 2007. Ongoing Operations’ net income decreased by $77 for the year while Other Operations improved its results by $65, primarily due to a reduction in unfavorable loss reserve development.
Retail offers individual variable and fixed market value adjusted (“MVA”) annuities, retail mutual funds, 529 college savings plans. Canadian and offshore investment products.
Institutional primarily offers institutional investment products (“IIP”), including stable value products (which includes investor notes) and institutional annuities (primarily terminal funding cases), as well as variable Private Placement Life Insurance (“PPLI”) owned by corporations and high net worth individuals. Institutional also offers mutual funds to institutional investors. Furthermore, Institutional offers additional individual products including structured settlements, consumer notes and single premium immediate annuities and longevity assurance.
Retail insurance expenses, net of deferrals, increased due to increasing trail commissions on growing variable annuity assets as well as increasing non-deferrable commissions on strong mutual fund deposits.
Retail losses on GMWB rider embedded derivatives increased $251 primarily due to liability model assumption updates and modeling refinements made in 2007, including those for dynamic lapse behavior and correlations of market returns across underlying indices, as well as those to reflect newly reliable market inputs for volatility.
As the “baby boom” generation approaches retirement, management believes these individuals will seek investment and insurance vehicles that will give them steady streams of income throughout retirement. IIP has launched new products in 2006 and 2007 to provide solutions that deal specifically with longevity risk. Longevity risk is defined as the likelihood of an individual outliving their assets. IIP is also designing innovative solutions to corporations’ defined benefit liabilities.
Competition has continued to increase in the Japanese market from both domestic and foreign insurers. This increase in competition could potentially impact future deposit levels. The Company continues to focus its efforts on strengthening our distribution relationships and improving our wholesaling and servicing efforts. In addition, the Company continues to evaluate product designs that meet customers’ needs while maintaining prudent risk management. In February 2007, the Company successfully launched a new variable annuity product called “3 Win” to complement its existing variable annuity product offerings. The new product has been favorably received by the market with the new product accounting for 42% of Japan’s sales for the year ended December 31, 2007. The success of the Company’s enhanced product offerings will ultimately be based on customer acceptance in an increasingly competitive environment.
Primarily driving the $121 increase in net investment income was a larger investment base due to increased cash flows from underwriting as well as an increase in interest rates and a change in asset mix (i.e., a greater share of investments in mortgage loans and limited partnerships).
Excluding the change in Citizens assessments and catastrophe treaty reinstatement premium, Ongoing Operations’ current accident year underwriting results before catastrophes were down $10 from 2005 to 2006. The current accident year loss and loss adjustment expense ratio before catastrophes of 62.4 for Ongoing Operations was relatively flat from 2005 to 2006 as a lower current accident year loss and loss adjustment expense ratio for workers’ compensation business in Small Commercial was largely offset by an increase in non-catastrophe property loss costs in Middle Market and Personal Lines homeowners.
The lower growth rate in Personal Lines was primarily due to unfavorable changes in earned pricing and the effect of higher property catastrophe treaty reinsurance costs. Partially offsetting the lower growth rate was the effect of $31 of catastrophe treaty reinstatement premium recorded as a reduction of earned premium in 2005 and an increase in new business written premium in auto and homeowners. During 2006, there was a decline in earned pricing increases in homeowners and a change from slight earned pricing increases for auto in 2005 to flat earned pricing for auto in 2006.
A rollforward of liabilities for unpaid losses and loss adjustment expenses by segment for Property & Casualty for the year ended December 31, 2007 follows:
Includes reserve discount accretion of $31, including $6 in Small Commercial, $8 in Middle Market, $11 in Specialty Commercial and $6 in Other Operations.
Released Small Commercial workers’ compensation reserves related to accident years 2000 and prior by $33. The severity of workers’ compensation medical claims for these accident years has emerged favorably to previous expectations. As the continued development of these claims has resulted in a sustained favorable trend, management released reserves in the fourth quarter of 2007. The $33 reserve release represented 2% of the Company’s net reserves for Small Commercial workers’ compensation claims as of December 31, 2006.
Released prior accident year reserves for allocated loss adjustment expenses by $120, largely as the result of cost reduction initiatives implemented by the Company to reduce allocated loss adjustment expenses for both legal and non-legal expenses as well as improved actuarial techniques. The improved actuarial techniques included an analysis of claims involving legal expenses separate from claims that do not involve legal expenses. This analysis included a review of the trends in the number of claims involving legal expenses, the average expenses incurred and trends in legal expenses. The release of $95 in Personal Lines represented 5% of Personal Lines net reserves as of December 31, 2004.
In the fourth quarter of 2005, the Company accrued an estimated $46 for regular assessments based on estimates of the deficits in each account at the time. In the second quarter of 2006, the Florida legislature approved the use of $715 of state tax revenues to partially offset the deficits in Citizens’ High Risk, Commercial Lines and Personal Lines accounts. During the second quarter of 2006, Citizens’ management also finalized its estimate of the 2004 and 2005 hurricane losses that would be used in calculating the deficits in each account. In the third quarter of 2006, the Board of Governors of Citizens approved a final assessment for the 2005 account year and the Company received the assessment notice during the fourth quarter of 2006. The estimates of the deficits in the Personal Lines account and Commercial Lines account were lower than previously anticipated by the Company. As a result of these changes in estimates, during 2006, the Company reduced its accrual for Citizens’ assessments by $41, from $46 to $5. The reduction in the amount of the estimated regular assessment also reduces the amount of surcharges that will be billed to policyholders to recoup the assessments in the future.
The 2.2 point decrease in the current accident year loss and loss adjustment expense ratio before catastrophes in Specialty Commercial was primarily due to a lower loss and loss adjustment ratio on directors and officers insurance in professional liability, partially offset by a higher loss and loss adjustment expense ratio on casualty business.
A change from $19 of realized capital gains in 2005 to $17 of net realized capital losses in 2006
Earned premiums increased $129, or 3%, primarily due to earned premium growth in both AARP and Agency, partially offset by a reduction in Other earned premium.
AARP earned premium grew $170, or 7%, reflecting growth in the size of the AARP target market and the effect of direct marketing programs to increase premium writings of both auto and homeowners.
Net favorable reserve development of $75 in 2006 included a $33 reduction in allocated loss adjustment expense reserves, primarily for workers’ compensation and package business related to accident years 2003 to 2005, and a $22 reduction in prior accident year catastrophe reserves in 2006 related to hurricanes Katrina, Rita and Wilma in 2005 and hurricanes Charley, Frances and Jeanne in 2004.
A combined ratio before catastrophes and prior accident year development of 86.0 to 89.0
Underwriting results decreased by $58, with a corresponding 3.7 point increase in the combined ratio, to 100.4, due to:
Amortization of deferred policy acquisition costs increased by $20, due largely to lower ceding commissions on professional liability business. The decrease in earned premium on casualty business did not have a commensurate reduction in amortization of deferred policy acquisition costs because deferred acquisition cost amortization related to a single, non-renewed captive insurance program was not significant. Insurance operating costs decreased by $69, largely because of an increase in ceding commissions on captive business.
To summarize, management’s outlook in Specialty Commercial for the 2008 full year is:
Net investment income, excluding securities held for trading, increased $313, or 10%, for the year ended December 31, 2007, compared to the prior year period. The increase in net investment income was primarily due to a higher average invested asset base and a higher total portfolio yield. The increase in the average invested assets base as compared to the prior year, was primarily due to positive operating cash flows, investment contract sales such as retail and institutional notes, and universal life-type product sales. Limited partnerships and other alternative investments contributed to the increase in income compared to the prior year period, despite a lower yield, due to a greater allocation of investments to this asset class. While the limited partnership and other alternative investment yield continues to exceed the overall portfolio yield, it decreased for the current year ended compared to the prior year ended primarily due to the market performance of Life’s hedge fund investments largely due to disruptions in the credit market associated with structured securities. Also included in limited partnerships and other alternative assets was a decrease in value of $11 on a real estate joint venture due to the decline of the real estate market in which the property was located. Based upon market expectation of future interest rates
Relates to impairments for which the Company has current concerns regarding the issuers ability to pay future interest and principal amounts based upon the securities contractual terms or the depression in security value is primarily related to significant issuer specific or sector credit spread widening.
Gross gains on the sale of fixed maturities for the year ended December 31, 2006 were concentrated in the corporate, foreign government and municipal sectors. Certain sales were made to reposition the portfolio to a shorter duration due to the flatness of the yield curve and the lack of market compensation for longer duration assets. Also, certain sales were made as the Company continues to reposition the portfolio to higher quality fixed maturity investments and increase investments in mortgage loans and limited partnerships. The gains on sales were primarily the result of changes in interest rates from the date of purchase.
The fair value includes cash payments received at the inception of certain contracts of $201. The net loss for the year ended December 31, 2007, was $92, before-tax.
The AAA rated securities include monoline insured securities with an amortized cost and fair value of $49 at December 31, 2007 and $45 at December 31, 2006. Additionally, approximately 11% of the auto consumer loan-backed securities were issued by lenders whose primary business is to sub-prime borrowers.
Does not include estimated voluntary contribution of $200 to the Company’s pension plan in 2008.
For additional information on stockholders’ equity, AOCI, net of tax, and pension and other postretirement plans see Notes 15, 16 and 17, respectively, of Notes to Consolidated Financial Statements.