For professional liability business within Specialty Commercial, the Company expects its losses from the fallout of the sub-prime mortgage market and the broader credit crisis to be manageable based on several factors. Principal among them is the diversified nature of the Company’s product and customer portfolio, with a majority of the Company’s total in-force professional liability net written premium derived from policyholders with privately-held ownership and, therefore, relatively low shareholder class action exposure. Reinsurance substantially mitigates the net limits exposed per policy and no single industry segment comprises 15% or more of the Company’s professional liability book of business by net written premium. About half of the Company’s limits exposed to federal shareholder class action claims filed in 2008 and 2009 are under Side-A D&O insurance policies that provide protection to individual directors and officers only in cases where their company cannot indemnify them. In addition, 88% of the exposed limits are on excess policies rather than primary policies. Regarding the Madoff and Stanford alleged fraud cases which continue to evolve, based on a detailed ground-up review of all claims notices received to date and an analysis of potentially involved parties noted in press reports, the Company anticipates only a limited number of its policies and corresponding net limits to be exposed. The Company expects its losses from the sub-prime mortgage and credit crisis, as well as its exposure to the Madoff and Stanford cases, to be within its expected loss estimates.
Released workers’ compensation reserves primarily related to accident years 2000 to 2007 by $156. These reserve releases are a continuation of favorable developments first recognized in 2005 and recognized in both 2006 and 2007. The reserve releases in 2008 resulted from a determination that workers’ compensation losses continue to develop even more favorably from prior expectations due, in part, to state legal reforms, including in California and Florida, and underwriting actions as well as cost reduction initiatives first instituted in 2003. In particular, the state legal reforms and underwriting actions have resulted in lower than expected medical claim severity. The $156 reserve release represented 3% of the Company’s net reserves for workers’ compensation claims as of December 31, 2007.
Strengthened reserves for Specialty Commercial general and products liability claims by $34, primarily related to the 1987 to 1997 accident years. Reported losses on general and products liability claims have been emerging unfavorably to previous expectations and loss adjustment expenses have been higher than expected on late emerging claims. The $34 reserve strengthening represented 3% of the Company’s net reserves for Specialty Commercial general liability claims as of December 31, 2006.
Gross of reinsurance, asbestos and environmental reserves, including liabilities in Ongoing Operations, were $2,484 and $367, respectively, as of December 31, 2009, $2,498 and $309, respectively, as of December 31, 2008, and $2,707 and $290, respectively, as of December 31, 2007.
The following table displays gross asbestos reserves and other statistics by policyholder category as of December 31, 2009.
Retirement Plans reduced its estimate of future fees as plans met contractual size limits (“breakpoints”), causing a lower fee schedule to apply, and the Company increased its assumption for future deposits by existing plan participants.
Management evaluates the rates of return various businesses can provide as an input in determining where additional capital should be invested to increase net income and shareholder returns. The Company uses the return on assets for the Individual Annuity, Retirement Plans and Institutional businesses for evaluating profitability. In Group Benefits and Individual Life, after-tax margin is a key indicator of overall profitability.
• The change to a 5% earned premium decline in 2009 was primarily attributable to lower earned audit premium on workers’ compensation business and the effect of non-renewals outpacing new business in package business and commercial auto.
• Other, net losses for the year ended December 31, 2008 were primarily due to net losses of $291 related to transactional foreign currency losses predominately on the internal reinsurance of the Japan variable annuity business, which is offset in AOCI, resulting from appreciation of the Yen, as well as credit derivative losses of $312 due to significant credit spread widening. Also included were derivative related losses of $46 due to counterparty default related to the bankruptcy of Lehman Brothers Holdings Inc.
Includes policyholders’ balances for investment contracts and reserves for future policy benefits for insurance contracts.
• The income tax benefit is primarily due to the pre-tax losses driven by the factors discussed previously. 2009 included a higher DRD benefit than 2008. The difference from a 35% tax rate is primarily due to the recognition of tax benefits associated with the DRD and foreign tax credits.
• Fee income and other decreased $360 primarily as a result of lower variable annuity fee income due to a decline in average account values. The decrease in average variable annuity account values can be attributed to market depreciation of $38.2 billion and net outflows of $6.2 billion during the year. Net outflows were driven by surrender activity resulting from the aging of the variable annuity in-force block of business; increased competition, particularly competition related to guaranteed living benefits, and volatility in the equity markets. Also contributing to the decrease in fee income was lower mutual fund fees due to declining assets under management primarily driven by market depreciation of $20.1 billion, partially offset by $2.8 billion of net flows.
• The general insurance expense ratio increased due to the impact of a declining asset base on relatively consistent expenses.
• Income tax expense increased as a result of improved earnings before income taxes primarily due to lower net realized capital losses. The effective tax rate for 2009 differs from the statutory rate of 35% primarily due to investments in tax exempt securities.
• Premiums and other considerations increased largely due to business growth driven by new sales and persistency over the last twelve months.
• The income tax benefit increased compared to the prior year primarily due to a decline in income before taxes primarily due to increased realized capital losses.
• The increases in renewal earned pricing during 2009 were primarily a reflection of written pricing changes over the last two years. Renewal written pricing in 2009 increased in auto by 3% due to rate increases and the effect of policyholders purchasing newer vehicle models in place of older models. Homeowners’ renewal written pricing increased by 5% due to rate increases and increased coverage amounts reflecting higher rebuilding costs. For both auto and home, the Company has increased rates in certain states for certain classes of business to maintain profitability in the face of rising loss costs.
Net favorable reserve development was $18 lower in 2009. Net favorable reserve development of $33 in 2009 included, among other reserve changes, a $77 release of auto liability reserves principally related to AARP business for the 2006 through 2008 accident years, partially offset by an $18 strengthening of reserves for homeowners’ claims for the 2005 through 2008 accident years. Net favorable reserve development of $51 in 2008 included a $46 release of auto liability reserves, primarily related to accident years 2005 to 2007 and a $24 release of reserves for extra-contractual liability claims under non-standard personal auto policies.
AARP earned premium grew $97, reflecting modest renewal earned pricing increases for both auto and homeowners and the effect of new business premium outpacing non-renewals in the last nine months of 2007. New business offset non-renewals in 2008 and new business in 2008 was driven by growth in the size of the AARP target market, the effect of direct marketing programs and the effect of cross-selling homeowners insurance to insureds who have auto policies.
Insurance operating costs and expenses decreased by $9, primarily due to lower compensation-related and servicing costs, partially offset by an estimated $7 of TWIA assessments in 2008. Amortization of deferred policy acquisition costs was relatively flat consistent with the change in earned premium. The expense ratio decreased slightly in 2008, driven by the decrease in insurance operating costs and expenses.
Current accident year catastrophe losses decreased by $84 as losses in 2008 from hurricane Ike and tornadoes and thunderstorms in the South and Midwest were higher than losses in 2009 from hail and windstorms in Colorado, the Midwest and Southeast.
Current accident year catastrophe losses of $116 in 2008 were higher than current accident year catastrophe losses of $15 in 2007, primarily due to losses from hurricane Ike and tornadoes and thunderstorms in the South and Midwest.
Prior accident year reserve development in 2007 consisted primarily of a $47 strengthening of workers’ compensation loss and loss adjustment expense reserves for accident years 1987 to 2001, a $34 strengthening of general liability reserves, primarily related to accident years 1987 to 1997, and a $25 strengthening of general liability reserves for accident years more than 20 years old. Partially offsetting the unfavorable reserve development in 2007 was a $22 release of reserves for surety business for accident years 2003 to 2006.
A $196 increase in net realized capital losses, primarily due to realized losses in 2008 from impairments of subordinated fixed maturities and preferred equity securities in the financial services sector as well as of securitized assets.
• The increase in interest expense was primarily due to the issuance of $1.75 billion 10.0% junior subordinated debentures on October 17, 2008, partially offset by a reduction from debt repayments of $955 in 2008. For further discussion on the Company’s debt see Note 14 of the Notes to Consolidated Financial Statements.
• The additional interest expense was primarily due to $106 related to total debt issuances in 2008 of $3.25 billion, partially offset by a reduction of $23 from debt repayments of $955 and $300 in 2008 and 2007, respectively. See Note 14 of the Notes to Consolidated Financial Statements for a further discussion on the Company’s debt.
Gross unrealized gains represent gains of $1,474, $633, and $6 for Life, Property & Casualty, and Corporate, respectively, as of December 31, 2009 and $860, $526, and $1, respectively, as of December 31, 2008. Gross unrealized losses represent losses of $5,592, $1,491, and $4 for Life, Property & Casualty, and Corporate, respectively, as of December 31, 2009 and $10,766, $3,835, and $8, respectively, as of December 31, 2008.
The credit qualities above include downgrades that have shifted the portfolio from higher rated assets to lower rated assets since December 31, 2008.
Legal Proceedings - For a discussion regarding contingencies related to The Hartford’s legal proceedings, please see the information contained under “Litigation” and “Asbestos and Environmental Claims,” in Note 12 of the Notes to Consolidated Financial Statements, which is incorporated herein by reference.
Tax proposals and regulatory initiatives which have been or are being considered by Congress and/or Treasury could have a material effect on the insurance business. These proposals and initiatives include, or could include, new taxes or assessments on large financial institutions, changes pertaining to the income tax treatment of insurance companies and life insurance products and annuities, repeal or reform of the estate tax and comprehensive federal tax reform, and changes to the regulatory structure for financial institutions. The nature and timing of any Congressional or regulatory action with respect to any such efforts is unclear.