The Company has received subpoenas from the New York Attorney General’s Office and the Connecticut Attorney General’s Office requesting information relating to the Company’s group annuity products, including single premium group annuities used in maturity or terminal funding programs. These subpoenas seek information about how various group annuity products are sold, how the Company selects mutual funds offered as investment options in certain group annuity products, and how brokers selling the Company’s group annuity products are compensated. The Company continues to cooperate fully with these regulators in these matters.
Recorded reserves for workers’ compensation, net of reinsurance, are $5.0 billion, across Business Insurance and Specialty Commercial. The two most important assumptions for workers’ compensation reserves are loss development factors and loss cost trends, particularly medical cost inflation. Loss development patterns are dependent on medical cost inflation. Approximately half of the workers’ compensation net reserves are related to future medical costs. A review of National Council on Compensation Insurance (“NCCI”) data suggests that the annual growth in industry medical claim costs has varied from -2% to +12% since 1991. Across the entire reserve base, a 1 point change in calendar year medical inflation would change the estimated net reserve by $600, in either direction.
Evaluation of both the insureds’ estimated liabilities and the Company’s exposure to the insureds depends heavily on an analysis of the relevant legal issues and litigation environment. This analysis is conducted by the Company’s lawyers and is subject to applicable privileges.
The Company performs analyses with respect to the potential impact of an unlock. To illustrate the effects of an unlock, assume the Company had concluded that a revision to previously projected account values and the related EGPs was required as of December 31, 2005. If the Company assumed a separate account return assumption of 7.6% for all U.S. product cohorts and 5.0% for all Japanese product cohorts and used its current best estimate assumptions for mortality and lapses, for all products, to project account values forward from the current account value to reproject future EGPs, the estimated decrease to amortization (an increase to net income) for all business would be approximately $10-$15, after-tax. If, instead, the Company assumed a separate account return assumption of 8.6% in the U.S. (6.0% in Japan) or 6.6% in the U.S. (4.0% in Japan), the estimated after-tax change in amortization for all business would have been a decrease of $55-$60 and an increase (a decrease to net income) of $30-$35, respectively.
equity market. As of December 31, 2005, the Company believed U.S. individual and Japan individual variable annuity separate account assets could fall, through a combination of negative market returns, lapses and mortality, by at least 39% and 60%, respectively, before portions of its DAC asset would be unrecoverable.
An increase in Property & Casualty net income of $326, driven primarily by improved underwriting results in the Personal Lines and Other Operations segments, increased net investment income, and a reduction in other expenses; partially offset by a decrease in net realized capital gains. The improved underwriting results in Personal Lines was driven primarily by a reduction in current year catastrophe losses, a reduction in net unfavorable prior accident year loss reserve development and earned premium growth. The improvement in underwriting results for Other Operations was primarily due to a reduction in net unfavorable prior accident year loss reserve development. The increase in net investment income was primarily due to higher assets under management resulting from increased cash flows from underwriting, higher investment yields on fixed maturity investments and an increase in income from limited partnership investments.
Life’s expenses essentially consist of interest credited to policyholders on general account liabilities, insurance benefits provided, amortization of the deferred policy acquisition costs, expenses related to the selling and servicing the various products offered by the Company, dividends to policyholders, and other general business expenses.
Slightly offsetting the positive earnings drivers for the year ended December 31, 2004 was the cumulative effect of accounting change from the Company’s adoption of SOP 03-1. (For further discussion of the impact of the Company’s adoption of SOP 03-1, see Note 1 of Notes to Consolidated Financial Statements).
The fixed annuity business contributed $66 of higher investment spread income in 2005 compared to 2004, excluding the cumulative effects of accounting change, due to improved investment spreads from the MVA products.
The effective tax rate decreased for the year ended December 31, 2005 compared to the prior year end due to an increase in the DRD benefit as a percentage of pre-tax income.
PPLI’s cost of insurance charges has decreased due to reductions in the face amount of certain cases. These face reductions have also resulted in lower death benefits. This impact combined with favorable mortality, which increases the provision for future experience rate credits has led to the year over year decrease in fee income and other.
Written pricing increase (decrease) over the comparable period of the prior year includes the impact of rate filings, the impact of changes in the value of the rating bases and individual risk pricing decisions. A number of factors impact written pricing increases (decreases) including expected loss costs as projected by the Company’s pricing actuaries, rate filings approved by state regulators, risk selection decisions made by the Company’s underwriters and marketplace competition. Written pricing changes reflect the property and casualty insurance market cycle. Prices tend to increase for a particular line of business when insurance carriers have incurred significant losses in that line of business in the recent past or the industry as a whole commits less of its capital to writing exposures in that line of business. Prices tend to decrease when recent loss experience has been favorable or when competition among insurance carriers increases. In 2005, written pricing in Personal Lines homeowners and small commercial continued to increase, but at a slower rate than in 2004. Written pricing for middle market continued to decrease in 2005 and written pricing for Personal Lines auto was flat.
As one of the factors used to determine pricing, the Company’s practice is to first make an overall assumption about claim frequency and severity for a given line of business and then, as part of the ratemaking process, adjust the assumption as appropriate for the particular state, product or coverage. Claim frequency represents the percentage change in the average number of reported claims per unit of exposure in the current accident year compared to that of the previous accident year. Claim severity represents the percentage change in the estimated average cost per claim in the current accident year compared to that of the previous accident year.
Net investment income earned on the Hartford Fire invested asset portfolio is allocated between Ongoing Operations and Other Operations based on the allocation of invested assets to each segment and the expected investment yields earned by each segment. Net investment income earned on the separate portfolios within Other Operations is recorded entirely within Other Operations. Based on
A $76 increase in net investment income, primarily driven by an increase in underwriting cash flow, partially offset by a decrease in the investment yield, and
Released reserves for workers’ compensation losses in Business Insurance on accident years 2003 and 2004 by $75. The latest evaluations of workers’ compensation claims indicate that underwriting actions of recent years and reform in California have had a greater impact in controlling loss costs than was originally estimated. The $75 reserve release represented 2% of the Company’s net reserves for workers’ compensation claims as of December 31, 2004.
For property catastrophe losses, the Company has a principal property catastrophe reinsurance program and other treaties that cover losses specific to a line of business. The Hartford’s principal property catastrophe reinsurance program for the treaty year effective January 1, 2005, provided coverage, on average, for 88% of $695 of losses incurred from a single catastrophe event in excess of a $125 retention. The exact amount and percentage of coverage varies by layer. Among the specific line of business treaties, the Company has two treaties covering losses on business written by the Specialty Commercial unit. For the treaty year effective January 1, 2005, one of the two specialty property treaties covered, on average, 95% of up to $290 of losses incurred from a single catastrophe event in excess of a $10 retention on excess and surplus property business. For the treaty year effective July 1, 2005, the other specialty property treaty covers 95% of up to $175 of losses incurred from a single catastrophe event in excess of a $10 retention on specialty property business written with national accounts. Property catastrophe losses incurred on specialty property business written with national accounts is also reimbursable under the principal catastrophe reinsurance program, subject to the overall program limits and retention.
The Company’s net reinsurance recoverables from various property and casualty reinsurance arrangements amounted to $5.6 billion and $5.2 billion as of December 31, 2005 and December 31, 2004, respectively. Of the total net reinsurance recoverables as of December 31, 2005, 8.9% relates to the Company’s mandatory participation in various involuntary assigned risk pools, which are backed by the financial strength of the property and casualty insurance industry. Of the remainder, $3.7 billion, or 73.0%, were rated by A.M. Best. Of the total rated by A.M. Best, 94.4% were rated A- (excellent) or better. The remaining $1.4 billion, or 27%, of net recoverables from reinsurers were comprised of the following: 5.7% related to voluntary pools, 3.7% related to captive insurance companies, and 17.6% related to companies not rated by A.M. Best.
A $62 decrease in other expenses, primarily due to $41 of severance costs in 2003 and a reduction in bad debt expense in 2004 due to improved collection efforts in Business Insurance.
A $20 strengthening of contract surety claim reserves in 2003 related to accident year 2002 and a $25 provision in 2003 related to the auto residual value business acquired from Reliance Group Holdings in 2000.
The improvement in current accident year non-catastrophe loss and loss adjustment expenses was primarily due to favorable claim frequency. The 0.9 point improvement in the expense ratio was principally due to the effect of earned premium growth and a shift to lower commission workers’ compensation business.
Net favorable reserve development of $67 in 2004, including a $175 release of September 11 reserves, partially offset by a $38 strengthening of small commercial package business reserves, a $25 strengthening of auto liability claim reserves and a $23 strengthening of construction defects claim reserves.
Casualty earned premiums increased $20, or 3%, primarily because of written premium growth in a single captive insurance program and high single-digit earned pricing increases, partially offset by a decrease in premium renewal retention. Of the total growth in earned premium for the year ended December 31, 2004, $75 was attributable to a single captive insurance program. The increase in earned premiums was partially offset by a $90 decrease in earned premiums under retrospectively-rated policies.
A $131 improvement in current accident year underwriting results, partially offset by
The Company held no securities of a single issuer that were at an unrealized loss position in excess of 6% and 5%, respectively, of the total unrealized loss amount as of December 31, 2005 and 2004.
Life is responsible for maximizing economic value within acceptable risk parameters, including the management of the interest rate sensitivity of invested assets while generating sufficient after-tax income to support policyholder and corporate obligations. Life’s fixed maturity portfolios and certain investment contracts and insurance product liabilities have material market exposure to interest rate risk. In addition, Life’s operations are significantly influenced by changes in the equity markets. Life’s profitability depends largely on the amount of assets under management, which is primarily driven by the level of sales, equity market appreciation and depreciation and the persistency of the in-force block of business. Life’s foreign currency exposure is primarily related to non-U.S. dollar denominated fixed income securities, the investment in the Japanese Life operation and certain foreign currency based individual fixed annuity contracts, and its GMDB and GMIB benefits associated with its Japanese variable annuities.
Based on the fair values of Life’s non-U.S. dollar denominated investments and derivative instruments (including its yen based individual fixed annuity product) as of December 31, 2005 and 2004, management estimates that a 10% unfavorable change in exchange rates would decrease the fair values by an after-tax total of $6 and $9, respectively. The estimated impact was based upon a 10% change in December 31 spot rates. The selection of the 10% unfavorable change was made only for hypothetical illustration of the potential impact of such an event and should not be construed as a prediction of future market events. Actual results could differ materially from those illustrated above due to the nature of the estimates and assumptions used in the above analysis.
The Hartford’s total capitalization increased $925 as of December 31, 2005 as compared with December 31, 2004. This increase was due to a $1.1 billion increase in equity partially offset by a $162 decrease in debt. The increase in total stockholders’ equity is primarily due to net income of $2.3 billion, partially offset by other comprehensive loss of $1.3 billion and repayments of debt of $250.
AOCI - AOCI decreased by $1.3 billion as of December 31, 2005 compared with December 31, 2004. The decrease in AOCI is primarily due to the other comprehensive loss from change in unrealized gain/loss on fixed maturities available-for-sale and minimum pension adjustment.