As of December 31, 2013, The Hartford owned building space of approximately 2.8 million square feet, of which approximately 2.5 million square feet comprised its Hartford, Connecticut location and other properties within the greater Hartford, Connecticut area. In addition, as of December 31, 2013, The Hartford leased approximately 2.2 million square feet, throughout the United States of America, and approximately 56 thousand square feet, in other countries. All of the properties owned or leased are used by one or more of all six reporting segments, depending on the location. For more information on reporting segments, see Part I, Item 1, Business - Reporting Segments. The Company believes its properties and facilities are suitable and adequate for current operations.
The Hartford provides projections and other forward-looking information in the following discussions, which contain many forward-looking statements, particularly relating to the Company’s future financial performance. These forward-looking statements are estimates based on information currently available to the Company, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and are subject to the cautionary statements set forth on pages 3 and 4 of this Form 10-K and the risk factors set forth under Item 1A and other similar information contained in this Form 10-K and in other filings made from time to time by the Company with the SEC. Actual results are likely to differ, and in the past have differed, materially from those forecast by the Company, depending on the outcome of various factors, including, but not limited to, those set forth in each discussion below and in Item 1A, Risk Factors. The Company undertakes no obligation to publicly update any forward-looking statements, whether as a result of new information, future developments or otherwise.
Certain reclassifications have been made to prior year financial information presented in Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) to conform to the current year presentation. The Hartford defines increases or decreases greater than or equal to 200% as “NM” or not meaningful.
The profitability of the Company's property and casualty insurance businesses over time is greatly influenced by the Company’s underwriting discipline, which seeks to manage exposure to loss through favorable risk selection and diversification, its management of claims, its use of reinsurance, the size of its in force block, actual mortality and morbidity experience, and its ability to manage its expense ratio which it accomplishes through economies of scale and its management of acquisition costs and other underwriting expenses. Pricing adequacy depends on a number of factors, including the ability to obtain regulatory approval for rate changes, proper evaluation of underwriting risks, the ability to project future loss cost frequency and severity based on historical loss experience adjusted for known trends, the Company’s response to rate actions taken by competitors, and expectations about regulatory and legal developments and expense levels. The Company seeks to price its insurance policies such that insurance premiums and future net investment income earned on premiums received will cover underwriting expenses and the ultimate cost of paying claims reported on the policies and provide for a profit margin. For many of its insurance products, the Company is required to obtain approval for its premium rates from state insurance departments.
Current accident year losses and loss adjustment expenses before catastrophes of $6.3 billion, before tax, in 2013, decreased from $6.6 billion, before tax, in 2012. The decrease was primarily driven by lower loss and loss adjustment expenses in Property and Casualty Commercial workers’ compensation business due to favorable severity and frequency.
An increase of $853 in the Unlock charge, before tax, in 2013 compared to an Unlock benefit of $47, before tax, in 2012. The Unlock charge in 2013 was primarily due to Japan hedge cost assumption changes associated with expanding the Japan variable annuity hedging program in 2013, partially offset by actual separate account returns being above our aggregated estimated returns during the period. The Unlock benefit in 2012 was driven primarily by actual separate account returns above our aggregated estimated return, partially offset by assumption changes in connection with the annual policyholder behavior assumption study. For further discussion of Unlocks, see MD&A - Critical Accounting Estimates, Estimated Gross Profits Used in the Valuation and Amortization of Assets and Liabilities Associated with Variable Annuity and Other Universal Life-Type Contracts and MD&A - Talcott Resolution.
The decrease in net income from 2011 to 2012 was primarily due to the following items:
Net realized capital losses increased primarily due to losses in 2012 on the international variable annuity hedge program, compared to gains in 2011. The losses resulted from rising equity markets and weakening of the yen. Certain hedge assets generated realized capital losses on rising equity markets and weakening of the yen and are used to hedge liabilities that are not carried at fair value. In addition, 2012 includes intent-to-sell impairments relating to the sales of the Retirement Plans and Individual Life businesses.
Income (loss) from discontinued operations, after-tax, decreased due to a realized gain on the sale of Specialty Risk Services of $150, after-tax, which was partially offset by a loss of $74, after-tax, from the disposition of Federal Trust Corporation.
Differences between the Company's effective income tax rate and the U.S. statutory rate of 35% are due primarily to tax-exempt interest earned on invested assets and the dividends received deduction ("DRD"). The $108 increase in the income tax benefit in 2012 compared with the income tax benefit in 2011 was primarily due to the $781 decrease in income (loss) from continuing operations, before tax. The income tax benefit of $481and $373 in 2012 and 2011, respectively, includes separate account DRD benefits of $140 and $201, respectively. The income tax benefit in 2011 includes a release of $86, or 100%, of the valuation allowance associated with realized capital losses, as well as a tax benefit of $52 as a result of a resolution of a tax matter with the IRS for the computation of DRD for years 1998, 2000 and 2001.
Current accident year catastrophe losses of $706, before tax, in 2012 compared to $745, before tax, in 2011. The losses in 2012 primarily include Storm Sandy, as well as multiple thunderstorm, hail, and tornado events across various U.S. geographic regions in both 2012 and 2011.
The Company recorded reserve releases of $61, before tax, in 2012, compared to reserve strengthening of $48, before tax, in 2011, in its property and casualty insurance prior accident years development, excluding asbestos and environmental reserves. For additional information regarding prior accident years development, see MD&A - Critical Accounting Estimates.
A $112, before tax charge in 2011 related to the write-off of capitalized costs associated with a policy administration software project that was discontinued.
[2] As of December 31, 2013 and 2012, approximately $19.7 billion and $27.1 billion, respectively, of equity securities, trading, support Japan variable annuities. Those equity securities, trading, were invested in mutual funds, which, in turn, invested in the following asset classes as of December 31, 2013 and 2012, respectively: Japan equity 22% and 20%, Japan fixed income (primarily government securities) 15% and 15%, global equity 22% and 21%, global government bonds 40% and 43%, and cash and other 1% and 1%.
Total investments decreased since December 31, 2012, principally due to the sale of the Retirement Plans and Individual Life businesses resulting in the transfer of fixed maturities, AFS, fixed maturities, FVO, equity securities, AFS, mortgage loans, and policy loans with a total carrying value of $17.3 billion in January 2013. In addition, the sale of the U.K. variable annuity business, HLIL, in the fourth quarter of 2013 resulted in a decline in the carrying value of fixed maturities, AFS and equity securities, trading of $469 and $1.7 billion, respectively. Refer to Note 2 - Business Dispositions of Notes to Consolidated Financial Statements for further discussion of these transactions. The remaining decrease in total invested assets is primarily due to a decrease in equity securities, trading, fixed maturities, AFS, other investments, and short-term investments. The decline in equity securities, trading was primarily due to variable annuity policy surrenders, the depreciation of the Japanese Yen as compared to the U.S. dollar, partially offset by equity market gains. The decrease in fixed maturities, AFS was due to a decline in valuations due to an increase in interest rates, a reduction in assets levels in Talcott Resolution associated with dollar rolls and repurchase agreements, and capital management actions, including debt repayments and share repurchases. The decline in other investments was largely due to a decline in derivative market value primarily resulting from an increase in interest rates and the depreciation of the Japanese yen in comparison to the euro and U.S dollar. The decrease in short-term investments is primarily attributable to a decline in derivative collateral held due to decreases in derivative market values.
Total net investment income increased largely due to equity securities, trading, resulting from market appreciation of the underlying investment funds supporting the Japanese variable annuity products. Total net investment income, excluding equity securities, trading, declined primarily due to lower returns on limited partnerships and other alternative investments. This decline was partially offset by the Company reallocating assets from fixed maturities to higher yielding assets, such as mortgage loans and limited partnerships and other alternative investments.
Primarily consists of transactional foreign currency re-valuation associated with the internal reinsurance of the Japan variable annuity business, which is primarily offset in AOCI, and gains and losses on non-qualifying derivatives.
See Other-Than-Temporary Impairments within the Investment Portfolio Risks and Risk Management section of the MD&A.
For the year ended December 31, 2013 the gain on U.S. GMWB related derivatives, net, was primarily related to gains of $203 from revaluing the liability for living benefits largely driven by favorable policyholder behavior related to increased surrenders and gains of $38 due to liability assumption updates for lapses and withdrawal rates. The loss on the U.S. macro hedge program for the year ended December 31, 2013 was primarily driven by losses of $114 due to an improvement in domestic equity markets, losses of $56 related to an increase in interest rates, and losses of $31 related to a decrease in equity market volatility. The loss on the international program for the year ended December 31, 2013 was primarily driven by losses of $1.1 billion related to an improvement in global equity markets and losses of $608 largely related to depreciation of the Japanese yen in relation to the euro.
For the year ended December 31, 2011 the loss on U.S. GMWB related derivatives, net, was primarily due to a decrease in long-term interest rates that resulted in a loss of $283 and higher interest rate volatility that resulted in a loss of $84. The loss on the U.S. macro hedge program for the year ended December 31, 2011 was primarily driven by the passage of time and a decrease in equity market volatility since the purchase date of certain options during the fourth quarter. The gain associated with the international program for the year ended December 31, 2011 was primarily driven by the Japanese yen strengthening, a decline in global equity markets, and a decrease in interest rates.
Other, net gain for the year ended December 31, 2013 was partially related to gains of $239 on transactional foreign currency re-valuation primarily associated with the internal reinsurance of the Japan variable annuity business, which is offset in AOCI, due to depreciation of the Japanese yen versus the U.S. dollar. Gains of $71 on interest derivatives were primarily associated with fixed rate bonds sold as part of the Individual Life and Retirement Plans business dispositions. For further information on the business dispositions, see Note 2 of Notes to Consolidated Financial Statements. Additional gains included $69 on interest rate derivatives primarily due to an increase in U.S. interest rates and $42 of gains on credit derivatives due to credit spreads tightening.
Long-Tailed General Liability, Fidelity and Surety and Large Deductible Workers’ Compensation. For these long-tailed lines of business, the Company generally relies on the expected loss ratio and reported development techniques. The Company generally weights these techniques together, relying more heavily on the expected loss ratio method at early ages of development and more on the reported development method as an accident year matures.
Professional Liability. Reported and paid loss developments patterns for this line tend to be volatile. Therefore, the Company typically relies on frequency and severity techniques.
For a discussion of changes to reserve estimates recorded in 2013, see Reserve Roll-forwards and Development included below in this section.
In Consumer Markets, reserving estimates are generally less variable than for the Company’s other property and casualty segments because of the coverages having relatively shorter periods of loss emergence. Estimates, however, can still vary due to a number of factors, including interpretations of frequency and severity trends and their impact on recorded reserve levels. Severity trends can be impacted by changes in internal claim handling and case reserving practices in addition to changes in the external environment. These changes in claim practices increase the uncertainty in the interpretation of case reserve data, which increases the uncertainty in recorded reserve levels. In addition, the introduction of new products has led to a different mix of business by type of insured than the Company experienced in the past. Such changes in mix increase the uncertainty of the reserve projections, since historical data and reporting patterns may not be applicable to the new business.
In standard commercial lines, workers’ compensation is the Company’s single biggest line of business and the line of business with the longest pattern of loss emergence. Medical costs make up more than 50% of workers’ compensation payments. As such, reserve estimates for workers’ compensation are particularly sensitive to changes in medical inflation, the changing use of medical care procedures and changes in state legislative and regulatory environments. In addition, a changing economic environment can affect the ability of an injured worker to return to work and the length of time a worker receives disability benefits.
In specialty lines, many lines of insurance are “long-tail”, including large deductible workers’ compensation insurance; as such, reserve estimates for these lines are more difficult to determine than reserve estimates for shorter-tail lines of insurance. Estimating required reserve levels for large deductible workers’ compensation insurance is further complicated by the uncertainty of whether losses that are attributable to the deductible amount will be paid by the insured; if such losses are not paid by the insured due to financial difficulties, the Company would be contractually liable. Auto severity trends can be impacted by changes in internal claim handling and case reserving practices in addition to changes in the external environment. These changes in claim practices increase the uncertainty in the interpretation of case reserve data, which increases the uncertainty in recorded reserve levels. Another example of reserve variability relates to reserves for directors’ and officers’ insurance. There is potential volatility in the required level of reserves due to the continued uncertainty regarding the number and severity of class action suits, including uncertainty regarding the Company’s exposure to losses arising from the collapse of the sub-prime mortgage market. Additionally, the Company’s exposure to losses under directors’ and officers’ insurance policies is primarily in excess layers, making estimates of loss more complex. The financial market turmoil that began in 2008 and 2009 increased the number of shareholder class action lawsuits against our insureds or their directors and officers and this trend could continue for some period of time.
Recorded reserves for auto liability, net of reinsurance, are $2.1 billion across all lines, $1.4 billion of which is in Consumer Markets. Personal auto liability reserves are shorter-tailed than other lines of business (such as workers’ compensation) and, therefore, less volatile. However, the size of the reserve base means that future changes in estimates could be material to the Company’s results of operations in any given period. The key indicator for Consumer Markets auto liability is the annual loss cost trend, particularly the severity trend component of loss costs. A 2.5 point change in annual severity for the two most recent accident years would change the estimated net reserve need by $80, in either direction. A 2.5 point change in annual severity is within the Company’s historical variation.
In the opinion of management, based upon the known facts and current law, the reserves recorded for the Company’s property and casualty insurance products at December 31, 2013 represent the Company’s best estimate of its ultimate liability for losses and loss adjustment expenses related to losses covered by policies written by the Company. However, because of the significant uncertainties surrounding reserves, and particularly asbestos and environmental exposures, it is possible that management’s estimate of the ultimate liabilities for these claims may change and that the required adjustment to recorded reserves could exceed the currently recorded reserves by an amount that could be material to the Company’s results of operations or cash flows.
“Prior accident years development (pts)” represents the ratio of prior accident years development to earned premiums.
Release in workers’ compensation is the net of releases for accident year 2009 and prior reflecting favorable development in average severity, the result of a speed up in settlements and the result of moving to an enhanced state-level analysis of loss experience, offset by strengthening workers’ compensation for accident years 2010 through 2012 reflecting the emergence of a higher mix of more severe claims.
Included within prior accident years development for the year ended December 31, 2012 were the following loss and loss adjustment expense reserve strengthenings (releases):
During 2012, the Company’s re-estimates of prior accident years reserves included the following significant reserve changes:
Strengthened reserves for professional liability directors and officers claims for accident years 2011 and prior as a result of higher severity, primarily for mid- and large-sized accounts.
Released reserves in package business liability coverages and general liability, primarily for accident years 2006 through 2011. Claim severity emergence for these years was lower than expected and management has placed more weight on the emerged experience. In addition, older years have improved due to favorable emergence of larger claims.
Reserve releases on certain prior year catastrophes, primarily related to 2001 World Trade Center worker's compensation claims.
[1] Amounts represent an aggregation of multiple catastrophes across multiple U.S. geographic regions.
Released reserves for personal auto liability claims, primarily for accident years 2006 through 2010. Favorable trends in reported severity have persisted or improved over this time period.
“All Other” includes unallocated loss adjustment expense reserves. “All Other” also includes the Company’s allowance for uncollectible reinsurance. When the Company commutes a ceded reinsurance contract or settles a ceded reinsurance dispute, the portion of the allowance for uncollectible reinsurance attributable to that commutation or settlement, if any, is reclassified to the appropriate cause of loss.
Excludes amounts reported in Property & Casualty Commercial and Consumer Markets reporting segments (collectively “Ongoing Operations”) for asbestos and environmental net liabilities of $18 and $5 respectively, as of December 31, 2013, $15 and $7, respectively, as of December 31, 2012, and $15 and $8, respectively, as of December 31, 2011; total net losses and loss adjustment expenses incurred for the years ended December 31, 2013, 2012 and 2011 of $15, $13 and $27, respectively, related to asbestos and environmental claims; and total net losses and loss adjustment expenses paid for the years ended December 31, 2013, 2012 and 2011 of $14, $15 and $20, respectively, related to asbestos and environmental claims.
The one year and average three year net paid amounts for asbestos claims, including Ongoing Operations, were $201 and $191, respectively, resulting in a one year net survival ratio of 8.6 and a three year net survival ratio of 9.1. Net survival ratio is the quotient of the net carried reserves divided by the average annual payment amount and is an indication of the number of years that the net carried reserve would last (i.e., survive) if the future annual claim payments were consistent with the calculated historical average.
The following table sets forth, for the years ended December 31, 2013, 2012 and 2011, paid and incurred loss activity by the three categories of claims for asbestos and environmental.
In the fourth quarters of 2013, 2012 and 2011, the Company completed evaluations of certain of its non-asbestos and environmental reserves in Property & Casualty Other Operations, including its assumed reinsurance liabilities and in 2013, 2012, and 2011, the Company recognized no prior year development on these reserves.
During the second quarters of 2013 and 2012 and the third quarter of 2011, the Company completed its annual ground up environmental reserve evaluations. In each of these evaluations, the Company reviewed all of its open direct domestic insurance accounts exposed to environmental liability as well as assumed reinsurance accounts and its London Market exposures for both direct and assumed reinsurance. The Company found estimates for some individual account exposures increased based upon unfavorable litigation results and increased clean-up or expense costs, with the vast majority of this deterioration emanating from a limited number of insureds. The net effect of these account-specific changes as well as quarterly actuarial evaluations of new account emergence and historical loss and expense paid experience resulted in $12, $10 and $19 increases in net environmental liabilities in 2013, 2012 and 2011, respectively. In addition to the quarterly actuarial evaluations, the Company currently expects to continue to perform an evaluation of its environmental liabilities annually.
Non-Major Accounts are all other open direct asbestos accounts and largely represent smaller and more peripheral defendants. These exposures represented 1,125 accounts and contained approximately 44% of the Company's total Direct gross asbestos reserves as of June 30, 2013.
The one year gross paid amount for total asbestos claims is $253, resulting in a one year gross survival ratio of 8.6. The three year average gross paid amount for total asbestos claims is $247, resulting in a three year gross survival ratio of 8.8.
The Company provides an allowance for uncollectible reinsurance, reflecting management’s best estimate of reinsurance cessions that may be uncollectible in the future due to reinsurers’ unwillingness or inability to pay. During the second quarters of 2013, 2012 and 2011, the Company completed its annual evaluations of the collectability of the reinsurance recoverables and the adequacy of the allowance for uncollectible reinsurance associated with older, long-term casualty liabilities reported in the Property & Casualty Other Operations. In conducting this evaluation, the Company used its most recent detailed evaluations of ceded liabilities reported in the segment. The Company analyzed the overall credit quality of the Company’s reinsurers, recent trends in arbitration and litigation outcomes in disputes between cedants and reinsurers, and recent developments in commutation activity between reinsurers and cedants. The evaluation in the second quarters of 2013, 2012, and 2011 resulted in no adjustments to the allowance for uncollectible reinsurance. As of December 31, 2013, 2012, and 2011, the allowance for uncollectible reinsurance for Property & Casualty Other Operations totaled $202, $203, and $207 and is included in the "All other" category of net loss and loss adjustment expense reserves. The Company currently expects to perform its regular comprehensive review of Property & Casualty Other Operations reinsurance recoverables annually. Due to the inherent uncertainties as to collection and the length of time before reinsurance recoverables become due, particularly for older, long-term casualty liabilities, it is possible that future adjustments to the Company’s reinsurance recoverables, net of the allowance, could be required.
Consistent with the Company’s long-standing reserving practices, the Company will continue to review and monitor its reserves in the
The largest impacts of net reserve re-estimates are shown in the “2003 & Prior” accident years. The reserve deterioration is driven, in part, by deterioration of reserves for asbestos, environmental, assumed casualty reinsurance, workers’ compensation, and general liability claims. Numerous actuarial assumptions on assumed casualty reinsurance turned out to be low, including loss cost trends, particularly on excess of loss business, and the impact of deteriorating terms and conditions.
The reserve re-estimates during calendar year 2008 were largely driven by increases in asbestos, environmental and general liability reserves. The reserve re-estimates in calendar years 2009, 2010, 2011 and 2013 were largely due to increases in asbestos and environmental reserves, resulting from the Company’s annual evaluations of these liabilities. These reserve evaluations reflect deterioration in the litigation environment surrounding asbestos and environmental liabilities during this period.
Accident year 2009 remains reasonably close to original estimates. Modest favorable reserve re-estimates during calendar periods 2009 through 2013 are primarily related to liability lines of business. Unfavorable reserve re-estimates in calendar year 2011 on accident year 2010 are largely driven by workers' compensation. Loss cost trends were higher than initially expected as an increase in frequency outpaced a moderation of severity trends. Unfavorable reserve re-estimates in calendar year 2013 on accident year 2010 are primarily related to workers' compensation and commercial auto liability.
For additional information on DAC and SIA, see Note 8 - Deferred Policy Acquisition Costs and Present Value of Future Profits and Note 10 - Sales Inducements, respectively, of Notes to Consolidated Financial Statements.
URR associated with the Individual Life business is no longer included in EGP based balances due to the sale of this business in 2013. As of December 31, 2012, URR included approximately $1.8 billion related to the Individual Life business. For additional information regarding business dispositions, see Note 2 - Business Dispositions of Notes to Consolidated Financial Statements.
For additional information on death and other insurance benefit reserves, see Note 11 - Separate Accounts, Death Benefits and Other Insurance Benefit Features of Notes to Consolidated Financial Statements.
The Unlock charge for the year ended December 31, 2011 was driven primarily by policyholder assumption changes which reduced expected future gross profits including additional costs associated with implementing the Japan hedging strategy and the U.S. variable annuity macro hedge program, as well as actual separate account returns below our aggregated estimated return.
For most annuity contracts, the Company estimates gross profits over 20 years as EGPs emerging subsequent to that timeframe are immaterial. Products sold in a particular year are aggregated into cohorts. Future gross profits for each cohort are projected over the estimated lives of the underlying contracts, based on future account value projections for variable annuity. The projection of future account values requires the use of certain assumptions including: separate account returns; separate account fund mix; fees assessed against the contract holder’s account balance; surrender and lapse rates; interest margin; mortality; and the extent and duration of hedging activities and hedging costs. Changes in these assumptions and, in addition, changes to other policyholder behavior assumptions such as resets, partial surrenders, reaction to price increases, and asset allocations causes EGPs to fluctuate which impacts earnings.
The Company determines EGPs from a single deterministic reversion to mean (“RTM”) separate account return projection which is an estimation technique commonly used by insurance entities to project future separate account returns. Through this estimation technique, the Company’s DAC model is adjusted to reflect actual account values at the end of each quarter. Through consideration of recent market returns, the Company will unlock, or adjust, projected returns over a future period so that the account value returns to the long-term expected rate of return, providing that those projected returns do not exceed certain caps or floors. This Unlock for future separate account returns is determined each quarter. Under RTM, the expected long term weighted average rate of return is 8.3% and 5.9% for the U.S. and Japan, respectively.
An Unlock revises EGPs, on a quarterly basis, to reflect market updates of policyholder account value and the Company’s current best estimate assumptions. Modifications to the Company’s hedging programs may impact EGPs, and correspondingly impact DAC recoverability. 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. The margin between the DAC balance and the present value of future EGPs for U.S. individual variable annuities was 38% as of December 31, 2013. If the margin between the DAC asset and the present value of future EGPs is exhausted, then further reductions in EGPs would cause portions of DAC to be unrecoverable and the DAC asset would be written down to equal future EGPs.
The Company has a monitoring process overseen by a committee of investment and accounting professionals that identifies investments that are subject to an enhanced evaluation on a quarterly basis to determine if an other-than-temporary impairment (“impairment”) is present for available-for-sale ("AFS") securities or a valuation allowance is required for mortgage loans. This evaluation is a quantitative and qualitative process, which is subject to risks and uncertainties. For further discussion of the accounting policies, see the Significant Investment Accounting Policies Section in Note 1 - Basis of Presentation and Significant Accounting Policies of Notes to Consolidated Financial Statements. For a discussion of impairments recorded, see the Other-Than-Temporary Impairments within the Investment Portfolio Risks and Risk Management section of the MD&A.
Management’s determination of the fair value of each reporting unit incorporates multiple inputs into discounted cash flow calculations including assumptions that market participants would make in valuing the reporting unit. Assumptions include levels of economic capital, future business growth, earnings projections, assets under management for Mutual Funds, and the weighted average cost of capital used for purposes of discounting. Decreases in the amount of economic capital allocated to a reporting unit, decreases in business growth, decreases in earnings projections and increases in the weighted average cost of capital will all cause a reporting unit’s fair value to decrease.
In 2013, the Company completed the sale of its Retirement Plans business to Mass Mutual. Accordingly, the carrying value of the reporting unit's goodwill of $156 was eliminated and included in reinsurance loss on disposition in the Company's Consolidated Statements of Operations.
The annual goodwill assessment for the Mutual Funds, Group Benefits, and Consumer Markets reporting units was completed during the fourth quarter of 2013, which resulted in no write-downs of goodwill for the year ended December 31, 2013. All reporting units passed the first step of their annual impairment test with a significant margin.
The fair value of derivative instruments is determined using pricing valuation models for over-the-counter ("OTC") derivatives that utilize market data inputs, quoted market prices for exchanged-traded derivatives and transactions cleared through central clearing houses ("OTC-cleared"), or independent broker quotations. Excluding embedded and reinsurance related derivatives, as of December 31, 2013 and 2012, 97% of derivatives, based upon notional values, were priced by valuation models or quoted market prices. The remaining derivatives were priced by broker quotations. The derivatives are valued using mid-market level inputs that are predominantly observable in the market with the exception of the customized swap contracts that hedge GMWB liabilities. Inputs used to value derivatives include, but are not limited to, swap interest rates, foreign currency forward and spot rates, credit spreads and correlations, interest and equity volatility and equity index levels. For further discussion on derivative instrument valuation methodologies, see the Derivative Instruments, including embedded derivatives within the investments section in Note 5 of Notes to Consolidated Financial Statements. For further discussion on GMWB and other guaranteed living benefits, valuation methodologies, see the Living Benefits Required to be Fair Valued section in Note 5 of Notes to Consolidated Financial Statements.
The Company considers several measures and ratios to be the key performance indicators for its businesses. The following discussions include the more significant ratios and measures of profitability for the years ended December 31, 2013, 2012 and 2011. Management believes that these ratios and measures are useful in understanding the underlying trends in The Hartford’s businesses. However, these key performance indicators should only be used in conjunction with, and not in lieu of, the results presented in the segment discussions that follow in this MD&A. These ratios and measures may not be comparable to other performance measures used by the Company’s competitors.
The current accident year loss and loss adjustment expense ratio before catastrophes is a measure of the cost of non-catastrophe claims incurred in the current accident year divided by earned premiums. Management believes that the current accident year loss and loss adjustment expense ratio before catastrophes is a performance measure that is useful to investors as it removes the impact of volatile and unpredictable catastrophe losses and prior accident year reserve development.
The loss and loss adjustment expense ratio is affected by claim frequency and claim severity, particularly for shorter-tail property lines of business, where the emergence of claim frequency and severity is credible and likely indicative of ultimate losses. 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. 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. Among other factors, the loss and loss adjustment expense ratio needed for the Company to achieve its targeted return on equity fluctuates from year to year based on changes in the expected investment yield over the claim settlement period, the timing of expected claim settlements and the targeted returns set by management based on the competitive environment.
Includes servicing revenues of $112, $102, and $97 for the years ended December 31, 2013, December 31, 2012, and December 31, 2011 respectively.
The Company expects market conditions to continue to improve slowly driving a modest increase in exposures, while pricing, which should remain favorable in the near-term, is anticipated to moderate due to increased competition. As such, the Company expects low single-digit written premiums growth in 2014, as compared to 2013, driven by small commercial and middle market where the Company continues to develop comprehensive product solutions, deeper relationships with distribution partners, differentiating customer experiences and ease of doing business processes and technologies. In specialty lines, the Company expects written premiums to decline as the Company continues to streamline its programs business and adjusts the mix within professional liability. The Company expects the combined ratio before catastrophes and prior accident year development will be between approximately 90.0 and 92.0 for 2014, compared to 93.0 in 2013, due to continued margin expansion across all lines of business as expected earned pricing increases outpace loss costs.
Net income, as compared to the prior year period, increased in 2013 primarily due to improvements in underwriting results, driven by lower current accident year losses before catastrophes and lower current accident year catastrophe losses.
Current accident year catastrophe losses of $105, before tax, in 2013, compared to $325, before tax, in 2012. Losses in 2013 were primarily due to multiple thunderstorm, hail, and tornado events across various U.S. geographic regions. Losses in 2012 were primarily driven by $207 related to Storm Sandy and multiple thunderstorm, hail, and tornado events across various U.S. geographic regions. For additional information, see MD&A - Critical Accounting Estimates, Property and Casualty Insurance Product Reserves, Net of Reinsurance.
Net income, as compared to the prior year period, increased in 2012 primarily due to improvements in underwriting results, driven by an increase in earned premiums and lower unfavorable prior year development, and improvements in net realized capital gains (losses), mainly on derivatives. This was offset by the gain on sale of SRS which occurred in 2011.
Prior accident years reserve strengthening of $72, before tax, in 2012, compared to $125, before tax, in 2011. The decline in unfavorable prior year development was primarily due to lower strengthening on workers' compensation reserves. For additional information, see MD&A - Critical Accounting Estimates, Reserve Roll-forwards and Development.
The effective tax rate, in both periods, differs from the U.S. Federal statutory rate primarily due to permanent differences related to investments in tax exempt securities. In addition, due to the availability of additional tax planning strategies, the Company released the valuation allowance associated with investment realized capital losses in 2011. For further discussion of income taxes, see Note 14 - Income Taxes of Notes to Consolidated Financial Statements.
Net income, as compared to the prior year period, increased in 2013 primarily due to improvements in underwriting results, driven by lower current year catastrophes partially offset by lower favorable prior year development.
Earned premiums increased in 2013, reflecting new business written premium growth in auto and home, primarily from the AARP Direct and AARP through agents distribution channels and improved policy count retention in auto and home due to initiatives implemented over the last two years.
The effective tax rates in 2013 and 2012 differ from the U.S. Federal statutory rate of 35% primarily due to permanent differences related to investments in tax exempt securities. For further discussion of income taxes, see Note 14 - Income Taxes of Notes to Consolidated Financial Statements.
Earned premiums decreased in auto and were down modestly for homeowners, as a decline in renewal written premium more than offset an increase in new business written premium. Compared to 2011, the number of policies in-force decreased for both auto and home, driven by non-renewals. Policy count retention for auto and home increased as moderating renewal written price increases improved the Company's price competitiveness. Changes in underwriting practices and service operations have also contributed to the improvement in retention.
Auto and home new business written premium increased primarily due to more competitive new business pricing in AARP Direct and an increase in the sale of the AARP auto product through independent agents. The lower auto and homeowners renewal earned pricing in 2012 was primarily due to lower rate increases. For both auto and homeowners, an increase in earned pricing was partially offset by a shift in the mix of business by territory, class plan and pricing tier to policies with lower average earned premium, such that increases in average earned premium were less than the increases in earned pricing.
Losses and loss adjustment expenses reflect a decline in current accident year before catastrophes and current accident year catastrophes partially offset by favorable prior accident years development.
Net income, as compared to the prior year period, declined in 2013 primarily due to net asbestos and environmental reserve strengthening. As part of its annual ground-up asbestos and environmental reserve evaluations in 2013, the Company strengthened its associated reserves by $130 and $10, before tax, respectively. In 2012, the Company strengthened its net asbestos and environmental reserves by $48 and $3, before tax, respectively.
The Company expects premiums to decline for 2014 as compared to 2013 reflecting management actions to reduce the association business. Overall, the reduction in association business premiums is not expected to significantly impact the profitability of the Group Benefits segment. The Company expects Group Benefits' disability results to improve as a result of continued pricing actions, continued favorable claim recoveries and lower incidence. The Company expects Group Benefits' after-tax margin (excluding buyouts and realized gains) will be between approximately 4.5% and 5.0% for 2014 as compared to 4.3% in 2013.
Net income, as compared to the prior year period, increased in 2012. While realized capital gains improved in current year, this was partially offset by a decrease in fully insured ongoing premiums, due to the lower sales and persistency resulting from the Company's pricing initiatives as well as the competitive market environment.
The increase in after-tax margin (excluding buyouts), excluding realized gains (losses), was primarily due to lower insurance operating costs and other expenses, partially offset by the impact of lower premiums and other considerations due to lower sales and persistency.
Includes mutual funds offered within employee directed retirement plans including on-going business related to the Company's Retirement Plans and Individual Life businesses sold in January 2013.
The principal goal for Talcott Resolution is to reduce the size and risk associated with the Company's U.S. and international in-force variable annuities. As a result, the Company expects account values and consequently earnings to decline due to surrenders, policyholder initiatives or transactions with third parties that will reduce the size of this legacy book of business. Risk-reducing transactions may also cause a reduction in statutory capital and shareholders’ equity. The Company's international variable annuity business will also continue to be a significant driver of earnings variability due to hedge programs which generate mark to market gains and losses while the underlying international liabilities being hedged are not marked to market. This can result in unpredictable earnings volatility period to period.
The net loss for the year ended December 31, 2013 was primarily driven by Unlock charges of $806, before tax, during the current year period compared to an Unlock benefit of $47, before tax, in the prior year period. The Unlock charge for the year ended 2013 includes a charge of $887, before tax, for hedge cost assumption changes associated with expanding the Japan variable annuity hedging program in the first quarter of 2013. In addition, variable annuity hedge program losses for the year ended 2013 were $1,558, before tax, including international losses of $1,586, compared to losses of $1,288 before tax, including international losses of $1,467, for the prior year period.
The 2013 and 2012 effective tax rates differ from the U.S. Federal statutory rate of 35% primarily due to permanent differences related to investments in separate account DRD. For further discussion of income taxes, see Note 14 - Income Taxes of Notes to Consolidated Financial Statements.
The annualized full surrender rate on U.S. variable annuities rose to 16.7% for the year ended December 31, 2013 compared to 11.1% for the prior year period. The annualized full surrender rate on Japan variable annuities rose to 28.8% for the year ended December 31, 2013 compared to 3.4% for the prior year period. Surrender activity in Japan has increased significantly over the past nine months as market appreciation has resulted in an increased number of account values exceeding guaranteed amounts.
Net income (loss), as compared to the prior year period, decreased for the year ended December 31, 2012 primarily due to net realized capital losses as compared to net realized capital gains in the prior period and the estimated reinsurance loss on disposition of the Individual Life business, including an after tax goodwill impairment charge of $146. For related discussion of the goodwill impairment, see Note 9 - Goodwill and Other Intangible Assets of Notes to Consolidated Financial Statements. Restructuring costs of $44, after-tax in 2012 also contributed to the decrease in net income as compared to the prior year period as there were no restructuring costs in 2011. An Unlock benefit in 2012 partially offset the decrease in net income as compared to the prior year period. In addition, benefits, losses and loss adjustment expenses, decreased as compared to the prior year period, reflecting an improvement in equity market performance.
The net increase in realized capital losses was primarily due to losses in the variable annuity hedge program. Variable annuity hedge program losses for the year ended December 31, 2012 were $1,288 including international losses of $1,467, compared to gains of $78, including international gains of $691 for the prior year period. Net realized capital losses in 2012 also include intent-to-sell impairment losses of $177 related to the sales in January 2013 of the Retirement Plans and Individual Life businesses. Total net impairment losses, including intent-to-sell impairment losses, increased to $247 in 2012 as compared to $117 for the prior year period. For further discussion of investment results and the results of the variable annuity hedge program, see MD&A - Investment Results, Net Investment Income (Loss) and Net Realized Capital Gains (Losses) within Consolidated Results of Operations.
Net loss, as compared to the prior year period, decreased in 2013 primarily due to decreases in insurance operating costs and other expenses, the reinsurance loss on disposition, the loss on extinguishment of debt and interest expense. The net loss in 2013 was partially driven by net realized capital losses due to higher long-term interest rates and global credit hedging losses due to increases in the equity market as compared with net realized capital gains in 2012.
In 2013, the Company repurchased approximately $800 of senior notes at a premium to the face amount of the then outstanding debt. In 2012, the Company repurchased all outstanding 10% fixed-to-floating rate junior subordinated debentures due 2068 with a $1.75 billion aggregate principal amount held by Allianz. Loss on extinguishment of debt consists of the premium associated with repurchasing the debentures at an amount greater than the face amount, the write-off of the unamortized discount and debt issuance and other costs related to the repurchase transactions. For additional information regarding debt, see Note 13 - Debt of Notes to Consolidated Financial Statements.
Also in 2012, the Company recorded a reinsurance loss on disposition consisting of an impairment of goodwill related to the disposition of the Individual Life business. See Note 9 of Notes to Consolidated Financial Statements for additional information on the goodwill impairment.
At the same time, the Company has policies and procedures to manage concentrations or correlations of insurance risk, including ERM policies governing the risks related to natural and man-made property catastrophes such as hurricanes, earthquakes, tornado/hailstorms, winter storms, pandemics, terrorism, and casualty catastrophes. The Company establishes risk limits to control potential loss and actively monitors the risk exposures as a percent of statutory surplus. The Company also uses reinsurance to transfer insurance risk to well-established and financially secure reinsurers (see Reinsurance Section).
Natural catastrophe risk is defined as the exposure arising from natural phenomena (e.g., weather, earthquakes, wildfires, etc.) that create a concentration or aggregation of loss across the Company's insurance or asset portfolios. The Company uses both internal and third-party models to estimate the potential loss resulting from various catastrophe events and the potential financial impact those events would have on the Company's financial position and results of operations across the property-casualty, life, and asset management businesses. For natural catastrophe perils, the Company generally limits its estimated pre-tax loss as a result of natural catastrophes for property & casualty exposures from a single 250-year event to less than 30% of statutory surplus prior to reinsurance and to less than 15% of statutory surplus after reinsurance. The Company's modeled loss estimates are derived by averaging 21 modeled loss events representing a 250-year return period loss. For the peril of earthquake, the 21 events averaged to determine the modeled loss estimate include events occurring in California as well as the Northeastern, Southeastern, Northwestern, Midwestern and New Madrid regions of the United States with associated magnitudes ranging from 6.4 to 8.1 on the Moment Magnitude scale. For the peril of hurricane, the 21 events averaged to determine the modeled loss estimate include category 3, 4 and 5 events in Florida, as well as other Gulf, Mid Atlantic and Northeastern region landfalls.
In addition to the reinsurance protection provided by The Hartford's traditional property catastrophe reinsurance program described above, the Hartford has fully collateralized reinsurance coverage from Foundation Re III for losses sustained from qualifying hurricane loss events. Under the terms of the treaty, the Company is reimbursed for losses from hurricanes using a customized industry index contract designed to replicate The Hartford's own catastrophe losses, with a provision that the actual losses incurred by the Company for covered events, net of reinsurance recoveries, cannot be less than zero.
The following table summarizes the terms of the reinsurance treaty with Foundation Re III that was in place as of February 4, 2014:
At the time of the purchase, 67.5% of $200 in losses in excess of an index loss trigger equating to approximately $1.4 billion in losses to The Hartford
As of February 4, 2014, there have been no events that are expected to trigger a recovery under the Foundation Re III reinsurance program and, accordingly, the Company has not recorded any recoveries from the associated reinsurance treaty.
Among other items, TRIPRA required that the President's Working Group on Financial Markets (“PWG”) continue to perform an analysis regarding the long-term availability and affordability of insurance for terrorism risk. Among the findings detailed in the PWG's initial report, released October 2, 2006, were that the high level of uncertainty associated with predicting the frequency of terrorist attacks, coupled with the unwillingness of some insurance policyholders to purchase insurance coverage, makes predicting long-term development of the terrorism risk market difficult, and that there is likely little potential for future market development for NBCR coverage. The January 2011 PWG report notes some improvements in capacity and modeling, but also noted that take-up rates for terrorism coverage remained relatively flat over the past three years and that insurers remain uncertain about the ability of models to predict the frequency and severity of terrorist attacks. In 2013, the PWG requested comment on the long-term availability and affordability of insurance for terrorism risk but that report has not been released. With respect to NBCR coverage, a December 2008 study by the U.S. Government Accountability Office (“GAO”) found that property and casualty insurers still generally seek to exclude NBCR coverage from their commercial policies when permitted. However, while nuclear, pollution and contamination exclusions are contained in many property and liability insurance policies, the GAO report concluded that such exclusions may be subject to challenges in court because they were not specifically drafted to address terrorist attacks. Furthermore, workers compensation policies generally have no exclusion or limitations. The GAO found that commercial property and casualty policyholders, including companies that own high-value properties in large cities, generally reported that they could not obtain NBCR coverage. Commercial property and casualty insurers generally remain unwilling to offer NBCR coverage because of uncertainties about the risk and the potential for catastrophic losses.
As of December 31, 2013, the Company has reinsurance recoverables from MassMutual and Prudential of $9.5 billion and $9.9 billion, respectively. These reinsurance recoverables are secured by invested assets held in trust for the benefit of the Company in the event of a default by the reinsurers. As of December 31, 2013, the fair value of assets held in trust securing the reinsurance recoverables from MassMutual and Prudential were $9.5 billion and $7.5 billion, respectively. As of December 31, 2013, the net reinsurance recoverable from Prudential represents approximately 13% of the Company's consolidated stockholders' equity. As of December 31, 2013, the Company has no other reinsurance-related concentrations of credit risk greater than 10% of the Company’s stockholders’ equity.
The Hartford has an Operational Risk Management (“ORM”) function whose responsibility is to provide a comprehensive and enterprise-wide view of the Company's operational risk on an aggregate basis. The Company defines operational risk as the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. Operational risk is inherent in our business and functional areas. It includes legal risk and considers reputational risk as an impact. The Company has developed a library of operational risks which have been classified into the following seven risk categories:
An increase in interest rates from current levels is generally a favorable development for the Company. Interest rate increases are expected to provide additional net investment income, reduce the cost of the variable annuity hedging program, limit the potential risk of margin erosion due to minimum guaranteed crediting rates in certain Talcott Resolution products and, if sustained, could reduce the Company’s prospective pension expense. Conversely, a rise in interest rates will reduce the fair value of the investment portfolio and if long-term interest rates rise dramatically within a six to twelve month time period, certain Talcott Resolution businesses may be exposed to disintermediation risk. Disintermediation risk refers to the risk that policyholders will surrender their contracts in a rising interest rate environment requiring the Company to liquidate assets in an unrealized loss position. In conjunction with the interest rate risk measurement and management techniques, certain of Talcott Resolution's fixed income product offerings have market value adjustment provisions at contract surrender. An increase in interest rates may also impact the Company’s tax planning strategies and in particular its ability to utilize tax benefits to offset certain previously recognized realized capital losses.
A decline in interest rates results in certain mortgage-backed and municipal securities being more susceptible to paydowns and prepayments or calls. 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 risk, higher pension costs expense and possibly reduced profit margins associated with guaranteed crediting rates on certain Talcott Resolution products. Conversely, the fair value of the investment portfolio will increase when interest rates decline and the Company’s interest expense will be lower on its variable rate debt obligations.
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 may include the use of derivatives. The Company analyzes interest rate risk using various models including parametric models and cash flow simulation under various market scenarios of the liabilities and their supporting investment portfolios, which may include derivative instruments. Measures the Company uses to quantify its exposure to interest rate risk inherent in its invested assets and interest rate sensitive liabilities include duration, convexity and key rate duration. Duration is the price sensitivity of a financial instrument or series of cash flows to a parallel change in the underlying yield curve used to value the financial instrument or series of cash flows. For example, a duration of 5 means the price of the security will change by approximately 5% for a 100 basis point change in interest rates. Convexity is used to approximate how the duration of a security changes as interest rates change in a parallel manner. Key rate duration analysis measures the price sensitivity of a security or series of cash flows to each point along the yield curve and enables the Company to estimate the price change of a security assuming non-parallel interest rate movements.
The Company is also exposed to interest rate risk based upon the discount rate assumption associated with the Company’s 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 discounting pension and other postretirement benefit obligations, refer to Note 18 - Employee Benefit Plans of Notes to Consolidated Financial Statements. In addition, management evaluates performance of certain Talcott Resolution products based on net investment spread which is, in part, influenced by changes in interest rates. For further discussion, see the Talcott Resolution section of the MD&A.
The Company’s investment portfolios primarily consist of investment grade fixed maturity securities. The fair value of these investments was $63.2 billion and $87.0 billion at 2013 and 2012, respectively. The fair value of these and other invested assets fluctuates depending on the interest rate environment and other general economic conditions. The weighted average duration of the portfolio, including fixed maturities, commercial mortgage loans, derivatives, and cash equivalents, was approximately 5.3 and 5.6 years as of 2013 and 2012, respectively. As of December 31, 2012, the weighted average duration of the portfolio, excluding the Retirement Plans and Individual Life businesses, was approximately 5.4 years.
Included in the following table is the before-tax change in the net economic value of investment contracts (e.g., fixed annuity contracts) issued by the Company’s Talcott Resolution segment, as well as certain insurance product liabilities (e.g., disability contracts) issued by the Company’s Group Benefits segment, for which the payment rates are fixed at contract issuance and the investment experience is substantially absorbed by the Company’s operations, along with the corresponding invested assets. Also included in this analysis are the interest rate sensitive derivatives used by the Company to hedge its exposure to interest rate risk in the investment portfolios supporting these contracts. This analysis does not include the assets and corresponding liabilities of certain insurance products such as auto, property, whole and term life insurance, and certain life contingent annuities. Certain financial instruments, such as limited partnerships and other alternative investments, have been omitted from the analysis due to the fact that the investments generally lack sensitivity to interest rate changes. Separate account assets and liabilities, equity securities, trading and the corresponding liabilities associated with the variable annuity products sold in Japan are excluded from the analysis because gains and losses in separate accounts accrue to policyholders. The calculation of the estimated hypothetical change in net economic value below assumes a 100 basis point upward and downward parallel shift in the yield curve.
increase the Company’s net amount at risk for GMDB, GMWB and GMIB benefits;
The following tables summarize the account values of the Company’s U.S. and Japan variable annuities with guarantee features and the NAR split between various guarantee features (retained net amount at risk does not take into consideration the effects of the variable annuity hedge programs in place as of each balance sheet date):
Policies with a guaranteed living benefit (a GMWB in the U.S. or a GMIB in Japan) also have a guaranteed death benefit. The net amount at risk (“NAR”) for each benefit is shown; however these benefits are not additive. When a policy terminates due to death, any NAR related to GMWB or GMIB is released. Similarly, when a policy goes into benefit status on a GMWB or GMIB, its GMDB NAR is released.
The Company expects to incur GMDB payments in the future only if the policyholder has an “in the money” GMDB at their death. If the account value is reduced to a specified level, the contract holder will receive an annuity equal to the guaranteed remaining benefit (“GRB”). For the Company’s “life-time” GMWB products, this annuity can exceed the GRB. As the account value fluctuates with equity market returns on a daily basis and the “life-time” GMWB payments may exceed the GRB, the ultimate amount to be paid by the Company, if any, is uncertain and could be significantly more or less than the Company’s current carried liability. For additional information on the Company’s GMWB liability, see Note 5 - Fair Value Measurements of Notes to Consolidated Financial Statements.
Excludes certain non-GMIB living benefits of $2.2billion of account value and $0.0 billion of NAR.
These sensitivities are based on the following key market levels as of December 31, 2013: 1) S&P of 1848; 2) 10yr US swap rate of 3.25%; 3) S&P 10yr volatility of 25.14% and 4) FX rates of USDJPY @ 105.31 and EURJPY @ 144.73
The impact of elapsed time on liabilities or hedge assets, any non-parallel shifts in capital market factors, or correlated moves across the sensitivities.
Talcott Resolution previously issued non-U.S. dollar denominated funding agreement liability contracts. The Company hedged the foreign currency risk associated with these liability contracts with currency rate swaps. At December 31, 2013 and 2012, the derivatives used to hedge foreign currency exchange risk related to foreign denominated liability contracts had a total notional amount of $94 and $134 and a total fair value of $(1) and less than $1, respectively.
Hartford Life Insurance KK (“HLIKK”), a wholly-owned Japanese subsidiary of Hartford Life, Inc. (“HLI”), previously issued a yen-denominated fixed annuity product and subsequently reinsured it to Hartford Life Insurance Company, a U.S. dollar based wholly-owned indirect subsidiary of HLI. During 2009, the Company suspended new sales of the Japan business. The underlying investment strategy involves investing in the U.S. securities markets, which offer favorable credit spreads. The yen denominated fixed annuity product (“yen fixed annuities”) is recorded in the consolidated balance sheets with invested assets denominated in dollars while policyholder liabilities are denominated in yen and converted to U.S. dollars based upon the December 31 yen to U.S. dollar spot rate. The difference between U.S. dollar denominated investments and yen denominated liabilities exposes the Company to currency risk. The Company manages the currency risk associated with the yen fixed annuities primarily with pay variable U.S. dollar and receive fixed yen currency swaps.
As of December 31, 2013 and 2012, the notional value of the currency swaps was $1.4 billion and $1.7 billion and the fair value was $(6) and $224, respectively. The currency swaps are recorded at fair value, incorporating changes in value due to changes in forward foreign exchange rates, interest rates and accrued income. Included in net realized capital gains and losses was a before-tax net gain of $6, a net loss of $(36) and net gain of $3 for the years ended December 31, 2013, 2012 and 2011, respectively, which include the changes in value of the currency swaps, excluding net periodic coupon settlements, and the yen fixed annuity contract remeasurement.
Statutory surplus amounts and risk-based capital (“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:
The Company has reinsured approximately 20% of its risk associated with U.S. GMWB and 76% of its risk associated with the aggregate U.S. GMDB exposure. These reinsurance agreements serve to reduce the Company’s exposure to changes in the statutory reserves and the related capital and RBC ratios associated with changes in the capital markets. The Company also continues to explore other solutions for mitigating the capital market risk effect on surplus, such as external reinsurance solutions, modifications to our hedging program, changes in product design, increasing pricing and expense management.
Credit risk is defined as the risk of financial loss due to uncertainty of an obligor’s or counterparty’s ability or willingness to meet its obligations in accordance with contractually agreed upon terms. The majority of the Company’s credit risk is concentrated in its investment holdings but is also present in reinsurance and insurance portfolios. Credit risk is comprised of three major factors: the risk of change in credit quality, or credit migration risk; the risk of default; and the risk of a change in value of a financial instrument due to changes in credit spread that are unrelated to changes in obligor credit quality. A decline in creditworthiness is typically associated with an increase in an investment’s credit spread, potentially resulting in an increase in other-than-temporary impairments and an increased probability of a realized loss upon sale.
As of December 31, 2013, the Company's only exposure to any credit concentration risk of a single issuer or counterparty greater than 10% of the Company's stockholders' equity, other than the U.S. government and certain U.S. government securities, was the Government of Japan and Prudential. The Government of Japan securities represented $2.6 billion, or 14% of stockholders' equity, and 3% of total invested assets. For further discussion of concentration of credit risk, see the Concentration of Credit Risk section in Note 6 of Notes to Consolidated Financial Statements. The net unsecured reinsurance recoverable from Prudential of $2.4 billion represented approximately 13% of stockholders' equity. For further discussion of reinsurance recoverables, see Note 7 - Reinsurance of Notes to Consolidated Financial Statements.
The Company utilizes a variety of OTC, OTC-cleared 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 be permissible investments under the Company’s investment policies. For further information on the Company’s use of derivatives, see Note 6 of Notes to Consolidated Financial Statements.
Derivative activities are monitored and evaluated by the Company’s compliance and risk management teams and reviewed by senior management. Downgrades to the credit ratings of The Hartford’s 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, downgrades may give derivative counterparties for OTC derivatives the unilateral contractual right to cancel and settle outstanding derivative trades or require additional collateral to be posted. In addition, downgrades may result in counterparties becoming unwilling to engage in additional 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 Company’s operating subsidiaries could conduct hedging activity using a combination of cash, OTC-cleared and exchange-traded instruments, in addition to using the available OTC derivatives.
As of December 31, 2013 and 2012, the notional amount related to credit derivatives that purchase credit protection was $1.3 billion and $2.2 billion, respectively, while the fair value was $(10) and $21, respectively. As of December 31, 2013 and 2012, the credit derivatives that purchase credit protection included notional of $0.4 billion and fair value of $5 and $28, respectively, that are part of the international program hedging instruments. As of December 31, 2013 and 2012, the notional amount related to credit derivatives that assume credit risk was $1.9 billion and $2.7 billion, respectively, while the fair value was $33 and $(29), respectively. For further information on credit derivatives, see Note 6 of Notes to Consolidated Financial Statements.
The following table presents the Company’s AFS securities by type, as well as fixed maturities, FVO.
The following tables present the Company’s European securities included in the Securities by Type table above.
Includes amortized cost and fair value of $34 as of December 31, 2013 and $74 as of December 31, 2012 related to limited partnerships and other alternative investments, the majority of which is domiciled in the United Kingdom.
Includes a notional amount and fair value of $190 and $(1), respectively, as of December 31, 2013 and $384 and $(3), respectively, as of December 31, 2012 related to credit default swap protection. This includes a notional amount of $55 and $56 as of December 31, 2013 and December 31, 2012, respectively, related to single name corporate issuers in the financial services sector.
As of December 31, 2013 and 2012, the Company’s total credit default swaps that provide credit protection on European issuers had a notional amount of $190 and $384, respectively, and a fair value of $(1) and $(3), respectively. Included in those notional amounts as of December 31, 2013 and 2012 were $190 and $384, respectively, on credit default swaps that reference single name corporate and financial European issuers, of which $23 and $23, respectively, related to the higher risk countries. The maturity dates of credit defaults swaps are primarily consistent with the hedged bonds. For further information on the use of the Company’s credit derivatives and counterparty credit quality, see Derivative Instruments within the Credit Risk section of this MD&A.
In addition to the credit risk associated with the investment portfolio, the Company has $236 of reinsurance recoverables due from legal entity counterparties domiciled within Europe. For a more detail discussion of the Company's reinsurance arrangements, see Note 7 of Notes to the Consolidated Financial Statements.
Included in the Company’s equity securities, trading, portfolio are investments in World Government Bond Index Funds (“WGBI funds”). The fair value of the WGBI funds at December 31, 2013 and 2012 was $7.6 billion and $11.8 billion, respectively. Because several of these funds are managed by third party asset managers, the Company does not have access to detailed holdings; however, the WGBI funds' investment mandate follows the Citigroup non-Japan World Government Fund Index (“the index”) and includes allocations to certain European sovereign debt. The estimated fair value of the European allocation based upon the index benchmark allocation was $3.3 billion and $5.0 billion as of December 31, 2013 and 2012, respectively. Included in this estimated European exposure were investments in Ireland, Italy, Portugal and Spain with an estimated fair value of $1.2 billion and $1.6 billion as of December 31, 2013 and 2012, respectively. The index guidelines allow investment in issuers rated BBB- or higher by Standard and Poor's or Baa3 or higher by Moody's. Should an issuer’s credit rating fall below both of these rating levels they will be removed from the Index and the holdings will be liquidated. Because these assets support the international variable annuity business, changes in the value of these investments are reflected in the corresponding policyholder liabilities. The Company’s indirect exposure to these holdings is through any guarantees issued on the underlying variable annuity policies. The Company has also entered into credit default swaps with a notional amount and fair value of $350 and $5 , respectively, to hedge certain sovereign credit risks.
The commercial real estate market continued to show signs of improving fundamentals such as firming property prices, increases in transaction volume and modestly easing financial conditions. While delinquencies still remain at elevated levels as compared to the previous cycle, they have improved since cycle highs. In addition, the availability of credit has increased and there is now less concern about the ability of borrowers to refinance as loans come due. In spite of improved fundamentals, credit spreads widened mid year due to concerns over potential tapering of quantitative easing. Credit spreads trended downward in the second half of the year and ended the year flat as compared to 2012.
In addition to CMBS bonds and CRE CDOs, 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 are primarily in the form of a whole loan, where the Company is the sole lender, or may include 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 December 31, 2013, loans within the Company’s mortgage loan portfolio that have had extensions or restructurings other than what is allowable under the original terms of the contract are immaterial.
The overall decrease in mortgage loans is attributed to the sales of the Retirement Plans and Individual Life businesses in January 2013. Refer to Note 2 - Business Dispositions of Notes to Consolidated Financial Statements for further discussion of these transactions. Since December 31, 2012, the Company funded $1.1 billion of commercial whole loans with a weighted average loan-to-value (“LTV”) ratio of 61% and a weighted average yield of 3.63%. The Company continues to originate commercial whole loans within primary markets, such as office, industrial and multi-family, focusing on loans with strong LTV ratios and high quality property collateral. As of December 31, 2013, the Company had mortgage loans held-for-sale with a carrying value and valuation allowance of $61 and $3, respectively, and $47 and $3, respectively, as of December 31, 2012.
The following table summarizes the amortized cost, fair value, and weighted average credit quality of the Company's investments in securities backed by states, municipalities and political subdivisions (“municipal bonds”).
The remaining $251 of gross unrealized losses were associated with securities depressed greater than 20%, which includes $2 associated with securities depressed over 50% for twelve months or more. The securities depressed more than 20% are primarily foreign government securities, floating rate corporate financial securities, and securities with exposure to commercial real estate that have market spreads that continue to be wider than the spreads at the securities' respective purchase dates. Unrealized losses on foreign government securities are primarily due to depreciation of the Japanese yen in relation to the U.S. dollar. Corporate financial securities are primarily depressed because the securities have floating-rate coupons and/or long-dated maturities. Unrealized losses on securities with exposure to commercial and residential real estate are largely due to the continued market and economic uncertainties surrounding the performance of certain structures or vintages. Based on the Company’s 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.
Excludes $177 of intent-to-sell impairments related to the sales of the Retirement Plans and Individual Life businesses.
Credit impairments were primarily concentrated in corporate and fixed-rate CMBS bonds. The corporate bonds were impaired due to two issuers that have experienced financial difficulty and either defaulted or are expected to default on contractually obligated principal and interest payments. The structured securities were impaired primarily due to actual performance or property-specific deterioration of the underlying collateral. The Company calculated these impairments utilizing both a top down modeling approach and a security-specific 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 period included current macroeconomic factors, such as the unemployment rate, as well as sector specific factors such as property values, delinquency levels, servicer behavior, and severity rates. The macroeconomic assumptions considered by the Company did not materially change during 2013 and, as such, the credit impairments recognized for the year ended December 31, 2013 were primarily driven by actual or expected collateral deterioration, largely as a result of the Company’s security-specific collateral review.
For the year ended December 31, 2012, the change in valuation allowances on mortgage loan reversals of $14 was largely driven by recovery of the property collateralizing a B-Note. The valuation allowance was reversed due to an increase in the valuation of the underlying collateral as a result of improved occupancy rates and performance of the property.
Pursuant to an intercompany note agreement between WRR and HFSG Holding Company, WRR may borrow up to $1 billion from the HFSG Holding Company in order to maintain certain statutory capital levels required by its plan of operations and which can be used by WRR to settle outstanding intercompany payables with HLAI. WRR has borrowed $655 under the intercompany note agreement as of December 31, 2013. The effects of this intercompany arrangement are eliminated in consolidation. In the first half of 2014, the Company expects to dissolve WRR and recapture all reinsured risks to HLAI. The Company will take appropriate action to ensure that its life insurance subsidiaries are adequately capitalized. This transaction is subject to regulatory approvals.
Expected liquidity requirements of the HFSG Holding Company for the next twelve months include interest on debt of approximately $380 and common stockholder dividends, subject to the discretion of the Board of Directors, of approximately $270.
On February 27, 2014, The Hartford’s Board of Directors declared a quarterly dividend of $0.15 per common share payable on April 1, 2014 to common shareholders of record as of March 10, 2014. There are no current restrictions on the HFSG Holding Company's ability to pay dividends to its shareholders. For a discussion of restrictions on dividends to the HFSG Holding Company from its insurance subsidiaries, see "Dividends from Insurance Subsidiaries" below. For a discussion of potential restrictions on the HFSG Holding Company's ability to pay dividends, see the risk factor "Our ability to declare and pay dividends is subject to limitations".
While the Company has significant discretion in making voluntary contributions to the U. S. qualified defined benefit pension plan, the Employee Retirement Income Security Act of 1974, as amended by the Pension Protection Act of 2006, the Worker, Retiree, and Employer Recovery Act of 2008, the Preservation of Access to Care for Medicare Beneficiaries and Pension Relief Act of 2010, the Moving Ahead for Progress in the 21st Century Act of 2012 (MAP-21) and Internal Revenue Code regulations mandate minimum contributions in certain circumstances. The Company made contributions to the U. S. qualified defined benefit pension plan of $100, $200 and $200 in 2013, 2012 and 2011, respectively. No contributions were made to the other postretirement plans in 2013, 2012 and 2011. The Company’s 2013, 2012 and 2011 required minimum funding contributions were immaterial. The Company does not have a 2014 required minimum funding contribution for the U.S. qualified defined benefit pension plan and the funding requirements for all pension plans are expected to be immaterial. The Company has not determined whether, and to what extent, contributions may be made to the U. S. qualified defined benefit pension plan in 2014. The Company will monitor the funded status of the U.S. qualified defined benefit pension plan during 2014 to make this determination.
Dividends to the HFSG Holding Company from its insurance subsidiaries are restricted by insurance regulation. The payment of dividends by Connecticut-domiciled insurers is limited under the insurance holding company laws of Connecticut. These laws require notice to and approval by the state insurance commissioner for the declaration or payment of any dividend, which, 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 income (or net gain from operations, if such company is a life insurance company) for the twelve-month period ending on the thirty-first day of December last preceding, in each case determined under statutory insurance accounting principles. 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 insurance holding company laws of the other jurisdictions in which The Hartford’s insurance subsidiaries are incorporated (or deemed commercially domiciled) generally contain similar (although in certain instances somewhat more restrictive) limitations on the payment of dividends. Dividends paid to HFSG Holding Company by its life insurance subsidiaries are further dependent on cash requirements of HLI and other factors. In addition to statutory limitations on paying dividends, the Company also takes other items into consideration when determining dividends from subsidiaries. These considerations include, but are not limited to expected earnings and capitalization of the subsidiary, regulatory capital requirements and liquidity requirements of the individual operating company.
The Company’s property-casualty insurance subsidiaries are permitted to pay up to a maximum of approximately $1.5 billion in dividends to HFSG Holding Company in 2014 without prior approval from the applicable insurance commissioner. Before considering the transactions discussed below, the domestic life insurance subsidiaries' dividend limitation under the holding company laws of Connecticut is $560 in 2014. In 2014, HFSG Holding Company anticipates receiving approximately $800 in dividends from its property-casualty insurance subsidiaries, net of dividends to fund interest payments on an intercompany note between Hartford Holdings, Inc. and Hartford Fire Insurance Company and no ordinary dividends from the life insurance subsidiaries. During 2013, the Company initiated a plan to make HLA the single nationwide underwriting company for its Group Benefits business by capitalizing it to support the Group Benefits business and separating it from the legal entities supporting the Talcott Resolution operating segment. On January 30, 2014, the Company received approval from the State of Connecticut Insurance Department ("CTDOI") to dividend approximately $800 of cash and invested assets from HLAI and HLIC to HLA and then distribute those subsidiaries to Hartford Life Inc. leaving HLA and HLIC with no remaining ordinary dividend capacity for the twelve months following this transaction. Any additional dividends from HLA and HLIC in 2014 would be extraordinary in nature and require prior approval from the CTDOI. The Company believes this initiative will allow for greater operational efficiencies and financial transparency to Group Benefits' customers. In addition, HFSG Holding Company is expecting to receive a dividend from HLIKK in the second half of 2014.
The Hartford is party to a put option agreement that provides The Hartford with the right to require the Glen Meadow ABC Trust, a Delaware statutory trust, at any time and from time to time, to purchase The Hartford’s junior subordinated notes in a maximum aggregate principal amount not to exceed $500. Under the Put Option Agreement, The Hartford will pay the Glen Meadow ABC Trust premiums on a periodic basis, calculated with respect to the aggregate principal amount of notes that The Hartford had the right to put to the Glen Meadow ABC Trust for such period. The Hartford has agreed to reimburse the Glen Meadow ABC Trust for certain fees and ordinary expenses. The Company holds a variable interest in the Glen Meadow ABC Trust where the Company is not the primary beneficiary. As a result, the Company did not consolidate the Glen Meadow ABC Trust. As of December 31, 2013, The Hartford has not exercised its right to require Glen Meadow ABC Trust to purchase the Notes. As a result, the notes remain a source of capital for the HFSG Holding Company.
HLIKK has four revolving credit facilities in support of operations. Two of the credit facilities have no amounts drawn as of December 31, 2013 with borrowing limits of approximately ¥5 billion, or $48 each, and individually have expiration dates of January 5, 2015 and September 30, 2014. In December 2013, HLIKK entered into two new revolving credit facility agreements with two Japanese banks in order to finance certain withholding taxes on mutual fund gains, that are subsequently credited when HLIKK files its’ income tax returns. At December 31, 2013, HLIKK had drawn the total borrowing limits of ¥5 billion, or $48, and ¥20 billion, or $190 on these credit facilities. The ¥5 billion credit facility accrues interest at a variable rate based on the one month Tokyo Interbank Offering Rate (TIBOR) plus 3 bps, which as of December 31, 2013 the interest rate was 15 bps, and the ¥20 billion credit facility accrues interest at a variable rate based on TIBOR plus 3 bps, or the actual cost of funding, which as of December 31, 2013 the interest rate was 20 bps. Both of the credit facilities expire on September 30, 2014.
Certain of the Company’s 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 entity’s 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 entity’s 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 December 31, 2013 was $1.2 billion. Of this $1.2 billion the legal entities have posted collateral of $1.4 billion in the normal course of business. In addition, the Company has posted collateral of $44 associated with a customized GMWB derivative. Based on derivative market values as of December 31, 2013, a downgrade of one level below the current financial strength ratings by either Moody’s or S&P could require approximately an additional $12 to be posted as collateral. Based on derivative market values as of December 31, 2013, a downgrade by either Moody’s or S&P of two levels below the legal entities’ current financial strength ratings could require approximately an additional $33 of assets 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 would post, if required, would be primarily in the form of U.S. Treasury bills, U.S. Treasury notes and government agency securities.
As of December 31, 2013, Property & Casualty Operations’ fixed maturities, short-term investments, and cash are summarized as follows:
Liquidity requirements that are unable to be funded by Property & Casualty Operation’s short-term investments would be satisfied with current operating funds, including premiums received or through the sale of invested assets. A sale of invested assets could result in realized losses.
As of December 31, 2013, Life Operations’ fixed maturities, short-term investments, and cash are summarized as follows:
Capital resources available to fund liquidity, upon contractholder surrender, are a function of the legal entity in which the liquidity requirement resides. Generally, obligations of Group Benefits will be funded by Hartford Life and Accident Insurance Company. Obligations of Talcott Resolution will generally be funded by Hartford Life Insurance Company and Hartford Life and Annuity Insurance Company, while obligations of the Company’s international annuity subsidiaries will generally be funded by Hartford Life Insurance KK. Contractholder obligations of the former Retirement Plans business were funded by Hartford Life Insurance Company and of the former Individual Life business were funded by both Hartford Life Insurance Company and Hartford Life and Annuity Insurance Company. See Note 2 - Business Dispositions of Notes to the Consolidated Financial Statements as to the sale of the Retirement Plans and Individual Life businesses and related transfer of invested assets in January 2013.
GICs 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. Generally, the market value adjustment reflects changes in interest rates and credit spreads. As a result, the market value adjustment feature in the GIC serves to protect the Company from interest rate risks and limit Life Operations’ liquidity requirements in the event of a surrender.
The Company has unfunded commitments to purchase investments in limited partnerships, private placements and mortgage loans of approximately $703 as disclosed in Note 15 of Notes to Consolidated Financial Statements.
See Note 2 - Business Dispositions of Notes to Consolidated Financial Statements for further information as to Retirement Plans and Individual Life reinsurance transactions.
Represents revolving credit facility agreements in order to finance certain withholding taxes on mutual fund gains, that are subsequently refunded when HLIKK files its’ income tax returns. Both of the credit facilities expire on September 30, 2014. See Note 13 of Notes to Consolidated Financial Statements for additional discussion of revolving credit facilities.
Includes $703 in commitments to purchase investments including approximately $531 of limited partnership, $7 of private placements and $165 of mortgage loans. Outstanding commitments under these limited partnerships and mortgage loans are included in payments due in less than 1 year since the timing of funding these commitments cannot be reliably estimated. The remaining commitments to purchase investments primarily represent payables for securities purchased which are reflected on the Company’s consolidated balance sheet.
Also included in purchase obligations is $757 relating to contractual commitments to purchase various goods and services such as maintenance, human resources, information technology, and transportation in the normal course of business. Purchase obligations exclude contracts that are cancelable without penalty or contracts that do not specify minimum levels of goods or services to be purchased.
Includes cash collateral of $180 which the Company has accepted in connection with the Company’s derivative instruments. Since the timing of the return of the collateral is uncertain, the return of the collateral has been included in the payments due in less than 1 year.
Total debt of the Company excludes $84 and $161 of consumer notes as of December 31, 2013 and December 31, 2012, respectively.
Cash used for financing activities in 2013 primarily consists of net outflows on investment and universal life-type contracts of $2.1 billion, decrease in securities loaned or sold under agreements to repurchase of $1.9 billion, repayment of long term debt of $ 1.3 billion and treasury stock acquired of $600. Cash used for financing activities in 2012 primarily consists of net outflows on investment and universal life-type contracts of $1.4 billion, repurchase of warrants of $300, as well as share repurchases and dividends paid on common and preferred stock. These were partially offset by net increases in securities loaned or sold of $1.9 billion.
Cash used for financing activities in 2012 primarily consists of net outflows on investment and universal life-type contracts of $1.4 billion, repurchase of warrants of $300, as well as share repurchases and dividends paid on common and preferred stock. These were partially offset by net increases in securities loaned or sold of $1.9 billion. Cash used for financing activities in 2011 primarily consists of repayment of long-term debt and dividends paid on common and preferred stock, partially offset by net inflows on investment and universal life-type contracts.
Statutory capital and surplus for the U.S. life insurance subsidiaries, including domestic captive insurance subsidiaries, increased by $229, primarily due to net income from non-variable annuity business of $2 billion including statutory gains from the sales of the Retirement Plans and Individual Life businesses, change in affiliated subsidiaries carrying values of $361, change in other invested assets carrying values of $250, net deferred gain on inforce reinsurance of $77, partially offset by decreases in other surplus changes of $30, letter of credit decreases of $269, deferred income tax of $311, variable annuity surplus impacts of approximately $349, and net returns of capital of $1.5 billion.
The Company also holds regulatory capital and surplus for its operations in Japan. Under the accounting practices and procedures governed by Japanese regulatory authorities, the Company’s statutory capital and surplus was $1.2 billion and $1.1 billion as of December 31, 2013 and 2012, respectively.
The Company’s stockholders’ equity, as prepared using U.S. generally accepted accounting principles (“U.S. GAAP”) was $18.9 billion as of December 31, 2013. The Company’s estimated aggregate statutory capital and surplus, as prepared in accordance with the National Association of Insurance Commissioners’ Accounting Practices and Procedures Manual (“U.S. STAT”) was $14.7 billion as of December 31, 2013. Significant differences between U.S. GAAP stockholders’ equity and aggregate statutory capital and surplus prepared in accordance with U.S. STAT include the following:
Similar to the RBC ratios that are employed by U.S. insurance regulators, regulatory authorities in the international jurisdictions in which The Hartford operates generally establish minimum solvency requirements for insurance companies. All of The Hartford's international insurance subsidiaries have solvency margins in excess of the minimum levels required by the applicable regulatory authorities. The solvency margin ratio for The Hartford's insurance subsidiary in Japan as of its last fiscal year end, March 31, 2013, was in excess of three times the amount of capital that would require corrective action.
For a discussion of terrorism reinsurance legislation and how it affects The Hartford, see “Terrorism” under the Insurance Risk Management section of the MD&A.
On December 26, 2007, the President signed TRIPRA extending the Terrorism Risk Insurance Act of 2002 (“TRIA”) through the end of 2014. The Company's principal reinsurance protection against large-scale terrorist attacks is the coverage currently provided through TRIPRA, as private sector catastrophe reinsurance is extremely limited and generally unavailable for terrorism losses caused by attacks with nuclear, biological, chemical or radiological weapons. TRIPRA is due to expire at the end of 2014 unless Congress takes legislative action to reauthorize it. If Congress fails to act, the Company may be required to take actions to reduce its exposure to terrorism risks, which could negatively impact its business. Even if Congress extends TRIPRA beyond 2014, it could make changes that would negatively impact the Company. For example, past reauthorizations of TRIA have narrowed the insurance lines that are covered under the program. For additional information on TRIPRA see “Terrorism” under the Insurance Risk Management section of the MD&A.
For a discussion regarding Guaranty Fund and Other Insurance-related Assessments, see Note 13 of Notes to Consolidated Financial Statements.