Certain of the statements contained herein or in Part I of the Company's Form 10-K, other than statements of historical fact, are forward-looking statements. These statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and include estimates and assumptions related to economic, competitive and legislative developments. These forward-looking statements are subject to change and uncertainty which are, in many instances, beyond Hartford Life's control and have been made based upon management's expectations and beliefs concerning future developments and their potential effect on the Company. There can be no assurance that future developments will be in accordance with management's expectations or that the effect of future developments on Hartford Life will be those anticipated by management. Actual results could differ materially from those expected by the Company, depending on the outcome of certain factors, including the possibility of general economic and business conditions that are less favorable than anticipated, legislative developments, changes in interest rates or the stock markets, stronger than anticipated competitive activity and those factors described in such forward-looking statements.
Hartford Life's profitability depends largely on the amount of assets under management, the level of fully insured premiums, the adequacy of product pricing and underwriting discipline, claims management and operating efficiencies, and its ability to earn target spreads between earned investment rates on general account assets and credited rates to customers.
On June 27, 2000, The Hartford Financial Services Group, Inc. ("The Hartford") acquired all of the outstanding shares of Hartford Life that it did not already own. (For additional information, see the Capital Resources and Liquidity section under "Common Stock Acquired by The Hartford".)
On January 25, 2001, The Hartford, through Hartford Life, agreed to acquire the U.S. individual life insurance, annuity and mutual fund businesses of Fortis, Inc. (operating as Fortis Financial Group and referred to as "Fortis"). This transaction is expected to be completed in the second quarter of 2001. (For additional information, see the Capital Resources and Liquidity section under "Subsequent Event".)
Management believes that it has developed and implemented strategies to maintain and enhance its position as a market leader within the financial services industry, to continue the Company's growth in assets under management and fully insured premium growth and to maximize shareholder value. Hartford Life is well positioned to assist individuals in meeting their financial goals as they increasingly save and plan for retirement, protect themselves and their families against disability or death and prepare their estates for an efficient transfer of wealth between generations. Hartford Life's strong market position in its primary businesses, which align with these growing markets, will provide opportunities to increase sales of the Company's products and services.
The Investment Products segment focuses on the savings and retirement needs of the growing number of individuals who are preparing for retirement or have already retired through the sale of individual variable and fixed annuities, mutual funds, retirement plan services and other investment products. The Company was ranked the number one writer of individual variable annuities in the United States for 2000 according to Variable Annuity and Research Data Service (VARDS) and the number one seller of individual variable annuities through banks, according to Kenneth Kehrer Associates (a leading consultant to banks). In addition, The Hartford Mutual Funds, Inc. reached $10 billion in assets faster than any other retail-oriented mutual fund family in history, according to Strategic Insight. Also, eight of the fourteen retail mutual funds have Morningstar ratings and, as of December 31, 2000, all eight have three-, four- or five-star ratings.
Due to the continued growth in this segment, particularly the individual annuity and retail mutual fund operations, total benefits, claims and expenses increased $229, or 15%. This increase was driven by amortization of deferred policy acquisition costs and operating expenses, which grew $86, or 20%, and $43, or 15%, respectively, primarily related to growth in the individual annuity operation. Additionally, non-deferred commissions increased $83, or 59%, principally related to growth in the retail mutual fund operation.
The Group Benefits segment sells group life and group disability insurance as well as other products, including stop loss and supplementary medical coverage to employers and employer sponsored plans, accidental death and dismemberment, travel accident and other special risk coverages to employers and associations. The Company also offers disability underwriting, administration, claims processing services and reinsurance to other insurers and self-funded employer plans. According to the latest results published by the Life Insurance Marketing and Research Association (LIMRA), the Company was the third largest provider of group disability insurance and the fourth largest writer of group term life insurance, based on sales, in the United States for the nine months ended September 30, 2000.
Revenues increased $183, or 9%, driven primarily by growth in fully insured premiums, excluding buyouts, which increased $182, or 10%, principally due to favorable persistency of the in force block of business, as well as new sales. Also contributing to the revenue growth was an increase in net investment income of $31, or 16%.
Hartford Life is a leader in the COLI market, which includes life insurance policies purchased by a company on the lives of its employees, with the company or a trust sponsored by the company named as beneficiary under the policy. Until the Health Insurance Portability and Accountability Act of 1996 (HIPA Act of 1996), the Company sold two principal types of COLI business, leveraged and variable products. Leveraged COLI is a fixed premium life insurance policy owned by a company or a trust sponsored by a company. The HIPA Act of 1996 phased out the deductibility of interest on policy loans under leveraged COLI through the end of 1998, virtually eliminating all future sales of this product. Variable COLI continues to be a product used by employers to fund non-qualified benefits or other postemployment benefit liabilities.
The focus of this segment is variable COLI, which continues to be a product generally used by employers to fund non-qualified benefits or other postemployment benefit liabilities. The leveraged COLI product has been an important contributor to Hartford Life's profitability in recent years and will continue to contribute to the profitability of Hartford Life in the future, although the level of profit from leveraged COLI is expected to decline. COLI is subject to a changing legislative and regulatory environment that could have a material adverse effect on its business.
The persistency of Hartford Life's annuity and other interest-sensitive life insurance reserves is enhanced by policy restrictions on the withdrawal of funds. Withdrawals in excess of allowable penalty-free amounts are assessed a surrender charge during a penalty period, which is usually at least seven years. Such surrender charge is initially a percentage of either the accumulation value or considerations received, which varies by product, and generally decreases gradually during the penalty period. Surrender charges are set at levels to protect Hartford Life from loss on early terminations and to reduce the likelihood of policyholders terminating their policies during periods of increasing interest rates, thereby lengthening the effective duration of policy liabilities and improving the Company's ability to maintain profitability on such policies.
Hartford Life's investments are managed by its investment strategy group, which consists of a risk management unit and a portfolio management unit and reports directly to senior management of the Company. The risk management unit is responsible for monitoring and managing the Company's asset/liability profile and establishing investment objectives and guidelines. The portfolio management unit is responsible for determining, within specified risk tolerances and investment guidelines, the appropriate asset allocation, duration, and convexity characteristics of the Company's general account and guaranteed separate account investment portfolios. Hartford Investment Management Company, a wholly-owned subsidiary of The Hartford Financial Services Group, Inc., executes the investment plan of the investment strategy group, including the identification and purchase of securities that fulfill the objectives of the strategy group.
Net investment income, excluding policy loan income, increased $113, or 10%. The increase was primarily due to higher yields earned on the investment cash flow from operations and reinvestment of proceeds from sales and maturities of fixed maturity securities in a higher interest rate environment. Policy loan income decreased $83, or 21%, due to the decrease in leveraged COLI business.
Changes in interest rates can potentially impact Hartford Life's profitability. Under certain circumstances of interest rate volatility, the Company could be exposed to disintermediation risk and reduction in net interest rate spread or profit margins. The Company analyzes interest rate risk using various models, including multi-scenario cash flow projection models that forecast cash flows of the liabilities and their supporting investments, including derivative instruments. For non-guaranteed separate accounts, the Company's exposure is not significant, as the policyholder assumes substantially all the investment risk.
The table below provides information as of December 31, 2000 and 1999 on debt obligations and reflects principal cash flows and related weighted average effective interest rate by maturity year.
The Company employs several risk management tools to quantify and manage market risk arising from its investments and interest sensitive liabilities. For certain portfolios, management monitors the changes in present value between assets and liabilities resulting from various interest rate scenarios using integrated asset/liability measurement systems and a proprietary system that simulates the impacts of parallel and non-parallel yield curve shifts. Based on this current and prospective information, management implements risk reducing techniques to improve the match between assets and liabilities.
Anticipatory Hedging -- For certain liabilities, the Company commits to the price of the product prior to receipt of the associated premium or deposit. Anticipatory hedges are executed to offset the impact of changes in asset prices arising from interest rate changes pending the receipt of premium or deposit and the subsequent purchase of an asset. These hedges involve taking a long position in interest rate futures or entering into an interest rate swap with duration characteristics equivalent to the associated liabilities or anticipated investments. The notional amounts of anticipatory hedges as of December 31, 2000 and 1999 were $144 and $314, respectively.
Liability Hedging -- Several products obligate the Company to credit a return to the contractholder which is indexed to a market rate. To hedge risks associated with these products, the Company enters into various derivative contracts. Interest rate swaps are used to convert the contract rate into a rate that trades in a more liquid and efficient market. This hedging strategy enables the Company to customize contract terms and conditions to customer objectives and satisfies Hartford Life's asset/liability matching policy. Interest rate swaps are also used to convert certain fixed contract rates into floating rates, thereby allowing them to be appropriately matched against floating rate assets. Additionally, interest rate caps are used to hedge against the risk of contractholder disintermediation in a rising interest rate environment. The notional amounts of derivatives used for liability hedges as of December 31, 2000 and 1999 were $2.0 billion and $3.3 billion, respectively.
Asset Hedging -- To meet the various policyholder obligations and to provide cost effective prudent investment risk diversification, the Company may combine two or more financial instruments to achieve the investment characteristics of a fixed maturity security or that match an associated liability. The use of derivative instruments in this regard effectively transfers unwanted investment risks or attributes to others. The selection of the appropriate derivative instruments depends on the investment risk, the liquidity and efficiency of the market, and the asset and liability characteristics. The notional amounts of asset hedges as of December 31, 2000 and 1999 were $5.4 billion and $4.8 billion, respectively.
Portfolio Hedging -- The Company periodically compares the duration and convexity of its portfolios of assets to its corresponding liabilities and enters into portfolio hedges to reduce any difference to desired levels. Portfolio hedges reduce the mismatch between assets and liabilities and offset the potential impact to cash flows caused by changes in interest rates. The notional amounts of portfolio hedges as of December 31, 2000 and 1999 were $1.0 billion and $1.2 billion, respectively.
The following tables provide information as of December 31, 2000, with comparative totals for December 31, 1999, on derivative instruments used in accordance with the aforementioned hedging strategies. For interest rate swaps, caps and floors, the tables present notional amounts with weighted average pay and receive rates for swaps and weighted average strike rates for caps and floors by maturity year. For interest rate futures, the table presents contract amount and weighted average settlement price by expected maturity year.
While interest rate risk associated with these insurance products has been reduced through the use of market value adjustment features and surrender charges, the primary risk associated with asset accumulation products is that the spread between investment return and credited rate may not be sufficient to earn targeted returns.
Fixed Rate -- Products in this category require the Company to pay a fixed rate for a certain period of time. The cash flows are not interest sensitive because the products are written with a market value adjustment feature and the liabilities have protection against the early withdrawal of funds through surrender charges. Product examples include fixed rate annuities with a market value adjustment and fixed rate guaranteed investment contracts. Contract duration is dependent on the policyholder's choice of guarantee period.
Long-Term Pay Out Liabilities -- Products in this category are long term in nature and may contain significant actuarial (including mortality and morbidity) pricing and cash flow risks. The cash flows associated with these policy liabilities are not interest rate sensitive but do vary based on the timing and amount of benefit payments. The primary risks associated with these products are that the benefits will exceed expected actuarial pricing and/or that the actual timing of the cash flows will differ from those anticipated resulting in an investment return lower than that assumed in pricing. Product examples include structured settlement contracts, on-benefit annuities (i.e., the annuitant is currently receiving benefits thereon) and long-term disability contracts. Contract duration is generally five to ten years.
The capital structure of Hartford Life consists of debt and equity, and is summarized as follows:
The Company's total capitalization, excluding net unrealized capital gains (losses) on securities, net of tax, increased $525, or 15%, in 2000. The increase was primarily the result of net income of $575 partially offset by dividends declared of $56. As a result, both the debt to equity and debt to capitalization ratios (both exclude net unrealized capital gains (losses) on securities, net of tax) decreased to 28% and 22% as of December 31, 2000, respectively, from 34% and 25% as of December 31, 1999, respectively. Net unrealized capital gains (losses) on securities, net of tax, increased $376 as December 31, 2000, as compared to December 31, 1999, primarily due to the impact of decreased interest rates on the Company's fixed maturity portfolio.
For a discussion of Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trust Holding Solely Parent Junior Subordinated Debentures, see Note 8 of Notes to Consolidated Financial Statements.
As a holding company, Hartford Life, Inc. has no significant business operations of its own and, therefore, relies mainly on the dividends from its insurance company subsidiaries, which are primarily domiciled in Connecticut, as the principal source of cash to meet its obligations (predominantly debt obligations) and pay stockholder dividends. The Company's direct regulated life insurance subsidiary, Hartford Life and Accident Insurance Company, declared and paid to the Company dividends of $121 in 2000. Statutory net income and statutory capital and surplus, key determinants in the amount of dividend capacity available in the insurance company subsidiaries, has grown significantly over the past several years. Statutory net income in 2000 was $399, an 81% increase over 1999, however, excluding realized losses on certain securities recorded in 1999, statutory net income increased 38%. Statutory capital and surplus as of December 31, 2000 was $2.4 billion, a 9% increase over December 31, 1999.
During the first six months ended June 30, 2000, to make shares available to employees pursuant to stock based benefit plans, the Company repurchased 40,000 shares of its Class A Common Stock in the open market at a total cost of $2. Shares repurchased in the open market were carried at cost and reflected as a reduction to stockholders' equity. Treasury shares reissued were reduced from treasury stock on a weighted average cost basis.
As a result of The Hartford Acquisition during the second quarter of 2000, the Company canceled the remaining 80,152 treasury shares with a cost basis of $4.
The following table summarizes Hartford Life's significant U.S. member companies' financial ratings from the major independent rating organizations as of February 28, 2001:
Dividends to Hartford Life, Inc. from its direct subsidiary, Hartford Life and Accident Insurance Company (HLA), as an insurance company domiciled in Connecticut, are subject to restriction as prescribed in the insurance holding company laws of Connecticut. HLA adheres to these laws, which require notice to and approval by the state insurance commissioner for the declaration or payment of any dividend that, together with other dividends or distributions made within the preceding twelve months, exceeds the greater of (i) 10% of the insurer's policyholder surplus as of December 31 of the preceding year or (ii) net gain from operations for the twelve month period ending on the thirty-first day of December last preceding, in each case determined under statutory insurance accounting policies. In addition, if any dividend of a Connecticut-domiciled insurer exceeds the insurer's earned surplus, it requires the prior approval of the Connecticut Insurance Commissioner. The total amount of statutory dividends which may be paid by the insurance subsidiaries of the Company without prior approval in 2001 is estimated to be $310.
The primary uses of funds are to pay claims, policy benefits, operating expenses and commissions, and to purchase new investments. Hartford Life carries a significant short-term investment position and accordingly does not anticipate selling intermediate- and long-term fixed maturity investments to meet any liquidity needs. For a discussion of the Company's investment objectives and strategies, see the Investments and Capital Markets Risk Management sections.
The National Association of Insurance Commissioners (NAIC) has regulations establishing minimum capitalization requirements based on Risk-Based Capital (RBC) formulas for life insurance companies. The requirements consist of formulas which identify companies that are undercapitalized and require specific regulatory actions. The RBC formula for life insurance companies establishes capital requirements relating to insurance, business, asset and interest rate risks. The RBC ratios for each of the life insurance subsidiaries are in excess of 200% as of December 31, 2000, which are greater than the minimum threshold.
The business of insurance is primarily regulated by the states and is also affected by a range of legislative developments at the state and federal levels. The 1999 Gramm-Leach-Bliley Act (the Financial Services Modernization Act), which allows affiliations among banks, insurance companies and securities firms, did not precipitate any significant changes in ownership in 2000. The provisions of the Act requiring the development of a formal privacy policy by each financial institution have created a number of administrative issues, but the enforcement date has been delayed until July 1, 2001. Insurance companies are subject to privacy regulation issued by the federal regulators and by state regulators who will adopt and implement privacy regulations during 2001. New medical privacy regulations expected to be issued by the Department of Health and Human Services will also impact the Company where medical information is used both in the application process and in the claims process.
Under insurance guaranty fund laws in each state, the District of Columbia and Puerto Rico, insurers licensed to do business can be assessed by state insurance guaranty associations for certain obligations of insolvent insurance companies to policyholders and claimants. Part of the assessments paid by the Company's insurance subsidiaries pursuant to these laws may be used as credits for a portion of the Company's insurance subsidiaries' premium taxes. There were no guaranty fund assessment payments (net of refunds) in 2000. The Company paid guaranty fund assessments (net of refunds) of approximately $2 and $9 in 1999 and 1998, respectively, of which $1 and $4, respectively, were estimated to be creditable against future premium taxes.
The NAIC adopted the Codification of Statutory Accounting Principles (Codification) in March 1998. The effective date for the statutory accounting guidance was January 1, 2001. Each of Hartford Life's domiciliary states has adopted Codification, and the Company has made the necessary changes in its statutory reporting required for implementation. The Company has determined that the overall impact of applying the new guidance will result in a one-time statutory cumulative transition benefit of approximately $75 in statutory surplus.