The Hartford owns the land and buildings comprising its Hartford location and other properties within the greater Hartford, Connecticut area which total approximately 1.6 million square feet. In addition, The Hartford leases approximately 6.4 million square feet throughout the United States and 32 thousand square feet in other countries. All of the properties owned or leased are used by one or more of all ten operating segments, depending on the location. (For more information on operating segments see Part 1, Item 1, Business of The Hartford - Reporting Segments.) The Company believes its properties and facilities are suitable and adequate for current operations.
Outlined in the table below are United States Industry Combined Ratios for each of the five years ended December 31:
Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") addresses the financial condition of The Hartford Financial Services Group, Inc. and its subsidiaries (collectively, "The Hartford" or the "Company") as of December 31, 2001, compared with December 31, 2000, and its results of operations for the three years ended December 31, 2001, 2000 and 1999. This discussion should be read in conjunction with the Consolidated Financial Statements and related Notes beginning on page.
Consolidated Results of Operations: Operating Summary 17 Life 20 Investment Products 21 Individual Life 23 Group Benefits 24 Corporate Owned Life Insurance (COLI) 25 Property & Casualty 26 Business Insurance 27 Affinity Personal Lines 28 Personal Insurance 29 Specialty Commercial 30 Reinsurance 31 Other Operations 32 Deferred Acquisition Costs 33 Reserves 33 Environmental and Asbestos Claims 34 Investments 35 Capital Markets Risk Management 38 Capital Resources and Liquidity 48 Regulatory Matters and Contingencies 52 Effect of Inflation 52 Accounting Standards 52
The Hartford defines "operating income" (defined in previous years as "core earnings") as after-tax operational results excluding, as applicable, net realized capital gains and losses, extraordinary items, the cumulative effect of accounting changes and certain other items. Operating income is an internal performance measure used by the Company in the management of its operations. Management believes that this performance measure delineates the results of operations of the Company's ongoing businesses in a manner that allows for a better understanding of the underlying trends in the Company's current business. However, operating income should only be analyzed in conjunction with, and not in lieu of, net income and may not be comparable to other performance measures used by the Company's competitors.
Operating income decreased $238, or 25%. Included in the Company's operating income for the year ended December 31, 2001, were $440 of losses, after-tax and net of reinsurance, related to September 11 and a $130 tax benefit at Hartford Life, Inc. ("HLI"), primarily the result of the favorable treatment of
certain tax matters related to separate account investment activity during the 1996-2000 tax years. Excluding the effects of September 11 and HLI tax benefit, operating income increased $72, or 7%. The increase reflected favorable operating performance in the Company's Business Insurance, Individual Life, Investment Products and Group Benefits segments, partially offset by higher loss costs in the Company's Affinity Personal Lines and Personal Insurance segments as well as adverse loss development in the Reinsurance segment.
2000 COMPARED TO 1999 -- Revenues increased $1.2 billion, or 9%, primarily as a result of strong growth in fee income in the Investment Products and Individual Life segments, along with premium growth in the Group Benefits segment and in all North American Property & Casualty underwriting segments.
For information on the Company's significant accounting policies, see the Deferred Acquisition Costs, Reserves and Investments sections and Note 1 of Notes to Consolidated Financial Statements.
The effective tax expense (benefit) rate for 2001, 2000 and 1999 was (55)%, 28% and 23%, respectively. Excluding the impacts of September 11 and the HLI federal tax benefits of $130 and $24 in 2001 and 2000, respectively, the effective tax rate for 2001 was 17% compared with 29% and 23%, respectively, for 2000 and 1999. Excluding the impact of September 11 and the HLI federal tax benefits, the decrease in the effective tax rate for 2001 was primarily due to an increase in the proportionate share of tax-exempt net investment income to total pre-tax income for 2001 compared to 2000 and taxes related to the gain on the sale of Zwolsche Algemeene N.V. ("Zwolsche") in 2000. The increase in the effective tax rate for 2000, excluding the $24 tax benefit at HLI, was primarily due to taxes related to the gain on the sale of Zwolsche. (For a further discussion on the sale of Zwolsche, see the Other Operations section and Note 18(b) of Notes to the Consolidated Financial Statements.)
Prior to the June 27, 2000 acquisition of all of the outstanding shares of HLI that The Hartford did not already own ("The HLI Repurchase"), the minority interest in the consolidated subsidiary's operating results represented approximately 19%. (For additional information, see the Capital Resources and Liquidity section under "Acquisitions" and Note 16 of Notes to Consolidated Financial Statements.)
Life is organized into four reportable operating segments: Investment Products, Individual Life, Group Benefits and Corporate Owned Life Insurance ("COLI"). Life also includes in an Other category its international operations, which are primarily located in Latin America and Japan, as well as corporate items not directly allocable to any of its reportable operating segments, principally interest expense.
net investment income. Property & Casualty includes operating income for North American and the Other Operations segment.
The following is a summary of operating income and net income.
An analysis of the operating results summarized above is included on the following pages. Reserves, Environmental and Asbestos Claims, and Investments are discussed in separate sections.
As discussed above, Life consists of the following reportable operating segments: Investment Products, Individual Life, Group Benefits and COLI. In addition, Life includes in an Other category its international operations, which are primarily located in Latin America and Japan, and corporate items not directly allocable to any of its reportable operating segments.
On April 2, 2001, The Hartford acquired the United States individual life insurance, annuity and mutual fund businesses of Fortis. (For further discussion, see "Acquisitions" in the Capital Resources and Liquidity section and Note 18(a) of Notes to Consolidated Financial Statements.) This transaction was accounted for as a purchase and, as such, the revenues and expenses generated by this business from April 2, 2001 forward are included in Life's consolidated results of operations.
under "Acquisitions" and Note 16 of Notes to Consolidated Financial Statements.)
2001 COMPARED TO 2000 -- Revenues increased $559, or 9%, primarily related to the growth across each of Life's primary operating segments, particularly the Individual Life and Group Benefits segments, where revenues increased $250, or 39%, and $300, or 14%, respectively. The revenue growth in the Individual Life segment was primarily due to higher earned fee income and net investment income resulting from the business acquired from Fortis. The Group Benefits segment experienced higher earned premiums due to strong sales and persistency. The Investment Products segment also contributed to the revenue increase as a result of higher fee income in the retail mutual fund business and higher net investment income in the institutional business. Revenues related to the Company's Individual Annuity business were down $46 or 3%, primarily due to lower fee income as a result of the lower equity markets in 2001. Additionally, COLI revenues were below prior year due to a decrease in variable COLI sales and the declining block of leveraged COLI business.
Operating income increased $168, or 27%, led by the Individual Life and Group Benefits segments where operating income increased $42, or 53% and $16, or 18%, respectively. In addition, the 2001 results include a $130 federal income tax benefit primarily related to separate account investment activity and a $20 charge associated with the impact of September 11. Additionally, 2000 results include a benefit of $32 also related to favorable tax items. Excluding these tax items and the impact of September 11, operating income increased $90, or 15%, for the year ended December 31, 2001, as each of the Company's operating segments experienced growth from a year ago.
2000 COMPARED TO 1999 -- Revenues increased $454, or 8%, primarily related to the growth across each of Life's primary operating segments, particularly the Investment Products and Group Benefits segments, where revenues increased $339, or 17%, and $183, or 9%, respectively. The revenue growth in the Investment Products segment was primarily due to higher fee income in the individual annuity and retail mutual fund operations as related average assets under management in 2000 were higher than 1999. The Group Benefits segment experienced higher earned premiums due to strong sales and persistency. The Individual Life segment also contributed to the revenue increase as a result of strong sales and favorable persistency. Partially offsetting the growth in revenues was the decrease in COLI revenues primarily related to the declining block of leveraged COLI business.
December 31, 2001, due to strong sales and the inclusion of the mutual fund assets acquired from Fortis. Net investment income from other investment products increased $113, or 20%, due mostly to growth in the institutional business, where account values were $9.1 billion at December 31, 2001, an increase of $1.4 billion, or 18%, from a year ago. The increase in revenues from other investment products was partially offset by individual annuity revenues, which decreased $46, or 3%. Fee income and net investment income from the individual annuity business acquired from Fortis helped to partially offset lower revenues in the individual annuity operation which was primarily associated with decreased account values resulting from the lower equity markets as compared to the prior year. Individual annuity account values at December 31, 2001 were $84.2 billion, a decrease of $3.1 billion, or 4%, from December 31, 2000.
Operating income increased $39, or 9%. These increases were driven by the growth in revenues in other investment products described above, the favorable impact of Fortis and the lower effective tax rate related to the individual annuity business.
Operating income increased $8, or 11%, primarily due to higher fee income as mortality experience (death claims as a percentage of net amount at risk) was consistent with prior year.
The Hartford is a leading provider of group benefits, and through this segment sells group life and group disability insurance as well as other products, including stop loss and supplementary medical coverages to employers and employer sponsored plans, accidental death and dismemberment, travel accident and other special risk coverages to employers and associations. The Company also offers disability underwriting, administration, claims processing services and reinsurance to other insurers and self-funded employer plans.
Total benefits, claims and expenses increased $279, or 13%, driven primarily by higher benefits and claims which increased $231, or 14%. These increases are consistent with the growth in the business described above as the loss ratios (defined as benefits and claims and claim adjustment expenses as a percentage of premiums and other considerations) have remained relatively consistent with the comparable prior year periods. In addition, expenses other than benefits and claims increased $48, or 11%, for the year ended December 31, 2001, also consistent with the overall growth in the segment.
Excluding the impact of September 11, underwriting results improved $53, with a corresponding 2.8 point decrease in the combined ratio. The improvement for the year was primarily due to strong pricing and decreased frequency loss costs as well as an improved expense ratio. The favorable expense ratio was the result of current year benefits of the 2000 field office reorganization and reorganization costs in 2000 not recurring in 2001.
Affinity Personal Lines provides automobile, homeowners and home-based business coverages to individuals across the United States. Affinity Personal Lines is organized to provide customized products and services to the following markets: the membership of AARP through a direct marketing operation; customers of Sears, Roebuck & Co. ("Sears") and Ford Motor Company and Ford Motor Credit Company (collectively, "Ford") as well as customers of financial institutions through an affinity center. Affinity Personal Lines also operates a member contact center for health insurance products offered through AARP's Health Care Options. The Hartford's exclusive licensing arrangement with AARP, which was renewed during the fourth quarter of 2001, continues through January 1, 2010 for automobile, homeowners and home-based business. The Health Care Options agreement continues through 2007.
2001 COMPARED TO 2000 -- Written premiums increased $180, or 11%, driven by growth in both the AARP program and Affinity business unit. AARP increased primarily as a result of strong new business growth and continued steady premium renewal retention. The improvement in the Affinity business unit continues to reflect increased new business from the Ford and Sears accounts.
2000 COMPARED TO 1999 -- Written premiums increased $132, or 9%, due primarily to policy count growth and improved renewal retention in the AARP program as well as growth in the Affinity business unit resulting from increased business from the Ford and Sears accounts.
Underwriting results decreased $2, with a slight improvement in the combined ratio. The decrease in underwriting results was primarily due to increased automobile losses, partially offset by strong improvement in the AARP homeowners line. The combined ratio improvement was primarily attributable to a decrease in the expense ratio, reflecting productivity gains from prior initiatives.
The personal lines industry is struggling to regain its momentum towards profitability as rising loss costs resulting from inflation in both medical and automobile repair costs have adversely impacted results. In addition, September 11 will likely have negative short-term implications to the industry as a result of lower investment yields and higher reinsurance rates. More severe catastrophes could also impact future results. Management does believe, however, that with increased rate activity, the personal lines industry will be positioned for recovery.
During the fourth quarter of 2001, The Hartford's exclusive licensing arrangement with AARP to offer personal insurance products to the over 34 million AARP members was renewed through January 1, 2010. This agreement provides the segment with an important competitive advantage. Favorable "baby boom" demographics as well as initiatives implemented to further strengthen the AARP relationship are expected to increase membership during this period.
Strategic actions being taken by the Personal Insurance segment include unprofitable agency closures in the standard lines and a continued shift in state mix away from poor loss performing states in non-standard automobile. Additionally, further investments in technology, continued efforts to reduce expenses and improve the product line, ease of doing business and customer service capability will position Personal Insurance to take advantage of future market conditions.
Specialty Commercial provides insurance through retailers and wholesalers to large commercial clients and insureds requiring a variety of specialized coverages. The segment's results also include the professional liability and bond lines as well as First State Management Group, a leading underwriter of excess and surplus lines business produced primarily through wholesale brokers. Agricultural and livestock products are also included in the property line of business in Specialty Commercial.
2001 COMPARED TO 2000 -- Written premiums decreased $84, or 8%, primarily due to a decrease in written premiums from sold or exited business lines which include farm, public entity and Canada. Partially offsetting the decrease was an increase in written premiums due to The Hartford's purchase, in the third quarter of 2000, of the in force, new and renewal financial products business as well as the majority of the excess and surplus lines business of Reliance Group Holdings, Inc. ("Reliance"), which resulted in $60 of additional written premiums as compared with 2000.
Excluding the impact of September 11, underwriting results improved $8, with a 1.2 point increase in the combined ratio. The improved underwriting results were primarily a result of favorable results in the property lines of business and lower losses and underwriting expenses from the sold or exited business lines. Partially offsetting the improvement was deteriorating underwriting results in risk management and a decrease in underwriting results related to Enron Corporation. The increase in the combined ratio was primarily due to an increase in the commission ratio as well as additional taxes, licenses and fees in the risk management and professional liability lines of business. The increase in the commission ratio was primarily a result of lower ceding commissions.
2000 COMPARED TO 1999 -- Written premiums increased $126, or 13%, primarily due to the purchase of Reliance's in force, new and renewal financial products business as well as the majority of the excess and surplus lines in 2000, which resulted in $108 of additional written premiums for the year. Higher written premiums in the casualty line of business also contributed to the increase.
The Hartford assumed reinsurance worldwide through its thirteen Hartford Reinsurance Company ("HartRe") offices and wrote treaty reinsurance through professional reinsurance brokers covering various property, casualty, specialty and marine classes of business until the fourth quarter of 2001. In October 2001, HartRe announced a centralization of all underwriting and claims operations in Hartford, Connecticut and an exit from all international lines except catastrophe, Alternative Risk Transfer ("ART") and marine. The exited international lines contributed $101 of written premiums in 2001.
2001 COMPARED TO 2000 -- Written premiums increased $92, or 11%, primarily due to growth in ART written premiums, driven primarily by a significant first quarter ART transaction. The achievement of double-digit pricing increases in traditional reinsurance was offset by underwriting discipline to maintain profitability targets.
2000 COMPARED TO 1999 -- Reinsurance written premiums increased $123, or 17%, primarily due to successful pricing increases in a firming pricing environment, as well as growth in new casualty programs business, and continued execution of new business development strategies in the ART line.
As a result of September 11, the reinsurance market has been transformed to an environment of some uncertainty. Net new capital, price increases and modifications in contract terms and conditions have contributed to the uncertainty. The property and casualty worldwide reinsurance market remains extremely competitive, although the pricing environment continued to improve in 2001. It is anticipated by management that rates and terms will continue to improve in 2002. HartRe's organizational realignment has created a centralized organization aimed at enhancing core functions consistent with the segment's return objectives. HartRe will be established as a specialized worldwide property catastrophe underwriting practice, blending technical underwriting expertise and state-of-the-art catastrophe modeling and risk portfolio analysis.
The Other Operations segment, formerly International and Other Operations, consists of certain property and casualty insurance operations of The Hartford which have discontinued writing new business. These operations primarily include First State Insurance Company, located in Boston, Massachusetts; Heritage Reinsurance Company, Ltd., headquartered in Bermuda; and Excess Insurance Company, Ltd, located in the United Kingdom. The main focus of these operations is the proper disposition of claims, resolving disputes and collecting reinsurance proceeds related largely to business underwritten and reinsured prior to 1985. Also included in Other Operations are the Company's international property and casualty businesses.
During the fourth quarter 2001, the Company finalized a new management structure within its Other Operations segment that consolidates the management and claims handling responsibility of the Company's environmental and asbestos exposures. In addition, the Company consolidated its environmental and asbestos reserves into one legal entity within Other Operations. The transaction was accomplished through the use of an intercompany reinsurance agreement, and resulted in $602 of reserves, primarily related to environmental and asbestos exposures from 1986 and prior, being ceded from the Specialty Commercial segment to Other Operations. There was no impact to the Company's consolidated financial condition or results of operations as a result of this transaction.
2001 COMPARED TO 2000 -- Revenues were down $434, or 72%, and operating income was down $11, or 65%, primarily due to the sale of Zwolsche.
Management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. One of the significant estimates made includes those used in determining deferred policy acquisition costs. Although some variability is inherent in these estimates, management believes the amounts provided are adequate.
The Property & Casualty operations also incur costs related to the acquisition of new and renewal insurance policies. These costs include agent and broker commissions, premium taxes and certain other underwriting expenses. These costs are deferred and amortized over policy terms. Estimates of the present value of future revenues, including net investment income and tax benefits, are compared to estimates of the present value of future costs, including amortization of policy acquisition costs, to determine if the deferred acquisition costs are recoverable, and if not, they are charged to expense.
The liability for policy benefits for universal life-type contracts and interest-sensitive whole life policies is equal to the balance that accrues to the benefit of policyholders, including credited interest, amounts that have been assessed to compensate the Company for services to be performed over future periods, and any amounts previously assessed against policyholders that are refundable on termination of the contract. Certain contracts include provisions whereby a guaranteed death benefit is provided in the event that the contractholder's account value at death is below the guaranteed value. Although the Company reinsures the majority of the death benefit guarantees associated with its in-force block of business, declines in the equity market may increase the Company's net exposure to death benefits under these contracts. The Company records the death benefit costs, net of reinsurance, as they are incurred. For investment contracts, policyholder liabilities are equal to the accumulated policy account values, which consist of an accumulation of deposit payments plus credited interest, less withdrawals and amounts assessed through the end of the period. For the Company's group disability policies, the level of reserves is based on a variety of factors including particular diagnoses, termination rates and benefit levels.
As a result of September 11, the Company established estimated gross reserves of $1.1 billion and estimated net reserves of $556 related to property and casualty operations. This loss estimate includes coverages related to property, business interruption, workers' compensation and other liability exposures, including those underwritten by the Company's assumed reinsurance operation. The Company based the loss estimate upon a review of insured exposures using a variety of assumptions and actuarial techniques, including estimated amounts for unknown and unreported policyholder losses and costs incurred in settling claims. Included in net reserves was an estimate of amounts recoverable under the Company's ceded reinsurance programs. As a result of the uncertainties involved in the estimation process, final claims settlement may vary from present estimates.
The Hartford continues to receive claims that assert damages from environmental exposures and for injuries from asbestos and asbestos-related products, both of which affect the Property & Casualty operation. Environmental claims relate primarily to pollution and related clean-up costs. With regard to these claims, uncertainty exists which impacts the ability of insurers and reinsurers to estimate the ultimate reserves for unpaid losses and related settlement expenses. The Hartford finds that conventional reserving techniques cannot estimate the ultimate cost of these claims because of inadequate development patterns and inconsistent emerging legal doctrine. The majority of environmental claims and many types of asbestos claims differ from any other type of contractual claims because there is almost no agreement or consistent precedent to determine what, if any, coverage exists or which, if any, policy years and insurers or reinsurers may be liable. Further uncertainty arises with environmental claims since claims are often made under policies, the existence of which may be in dispute, the terms of which may have changed over many years, which may or may not provide for legal defense costs, and which may or may not contain environmental exclusion clauses that may be absolute or allow for fortuitous events. Courts in different jurisdictions have reached disparate conclusions on similar issues and in certain situations have broadened the interpretation of policy coverage and liability issues. In light of the extensive claim settlement process for environmental and asbestos claims, which involves comprehensive fact gathering, subject matter expertise and intensive litigation, The Hartford established an environmental claims facility in 1992 to defend itself aggressively against unwarranted claims and to minimize costs.
Within the property and casualty insurance industry in the mid-1990s, progress was made in developing sophisticated, alternative methodologies utilizing company experience and supplemental databases to assess environmental and asbestos liabilities. Consistent with The Hartford's practice of using the best techniques to estimate the Company's environmental and asbestos exposures, a study was initiated in April 1996 based on known cases. The Hartford, utilizing internal staff supplemented by outside legal and actuarial consultants, completed the study in October 1996.
Fluctuations in interest rates affect the Company's return on, and the fair value of, fixed maturity investments, which comprised approximately 86% and 85% of the fair value of its invested assets as of December 31, 2001 and 2000, respectively. Other events beyond the Company's control could also adversely impact the fair value of these investments. Specifically, a downgrade of an issuer's credit rating or default of payment by an issuer could reduce the Company's investment return.
A significant decrease in the fair value of any investment that is deemed other than temporary could result in the Company's recognition of a loss in its financial results prior to the actual sale of the investment.
The Hartford's investment portfolios are divided between Life and Property & Casualty. The investment portfolios are
managed based on the underlying characteristics and nature of each operation's respective liabilities and within established risk parameters. (For a further discussion on The Hartford's approach to managing risks, see the Capital Markets Risk Management section.)
The investment portfolios of Life and Property & Casualty are managed by Hartford Investment Management Company ("HIMCO"), a wholly-owned subsidiary of The Hartford. HIMCO is responsible for monitoring and managing the asset/liability profile, establishing investment objectives and guidelines, and determining, within specified risk tolerances and investment guidelines, the appropriate asset allocation, duration, convexity and other characteristics of the portfolios. Security selection and monitoring are performed by asset class specialists working within dedicated portfolio management teams.
The following table identifies, by type, the fixed maturity securities held in the general account as of December 31, 2001 and 2000.
2001 COMPARED TO 2000 -- Net investment income, excluding policy loan income, increased $188, or 15%. The increase was primarily due to income earned on the previously discussed increase in fixed maturity investments, partially offset by lower yields on fixed maturities in the third and fourth quarters of 2001. Yields on overall average invested assets were flat.
Included in 2001 net realized capital losses were write-downs for other than temporary impairments on fixed maturities of $105, including a $37 loss related to securities issued by Enron Corporation. Also included in net realized capital losses is a $35 loss recognized on the sale of the Company's interest in an Argentine insurance joint venture, in addition to losses associated with the credit deterioration of certain investments in which the Company has an indirect economic interest. These losses were partially offset by gains from the sale of fixed maturities.
2000 COMPARED TO 1999 -- Net investment income, excluding policy loan income, increased $113, or 10%. The increase was primarily due to higher yields earned on the investment of cash flow from operations and reinvestment of proceeds from sales and maturities of fixed maturity securities in a higher interest rate environment. Policy loan income decreased $83, or 21%, due to the decrease in leveraged COLI business.
The investment objective for the majority of Property & Casualty is to maximize economic value while generating after-tax income and sufficient liquidity to meet corporate and policyholder obligations. For Property & Casualty's Other Operations segment, the investment objective is to ensure the full and timely payment of all liabilities. Property & Casualty's investment strategies are developed based on a variety of factors including business needs, regulatory requirements and tax considerations.
The following table identifies the invested assets by type held as of December 31, 2001 and 2000.
During 2001, fixed maturity investments increased slightly, as a result of an increase in operating and financing cash flow and an increase in fair value due to a lower interest rate environment, partially offset by a decline in fixed maturities due to sales of international subsidiaries.
2001 COMPARED TO 2000 -- Both before- and after-tax net investment income decreased 2% compared to the prior year. The decreases were primarily due to a reduction in investment income resulting from the sales of Zwolsche and Hartford Seguros, partially offset by higher income on taxable fixed maturities in the North American Property & Casualty operations. Yields on average invested assets declined slightly due to the lower interest rate environment.
Net realized capital losses were $103 compared to net realized capital gains of $234 for the prior year. The 2001 net realized capital losses included write-downs for other than temporary impairments of $61 on fixed maturities, including a $16 loss related to securities issued by Enron Corporation, and $30 on equities and other invested assets. An additional $7 of losses were sustained on sales of Enron Corporation common stock. Also included in 2001 net realized capital losses were losses generated from the sales of international subsidiaries of $54, in addition to losses associated with the credit deterioration of certain investments in which the Company has an indirect economic interest. These losses were partially offset by gains from the sale of fixed maturities.
2000 COMPARED TO 1999 -- Both before- and after-tax net investment income and yields were relatively flat compared to the prior year.
In connection with The HLI Repurchase, the carrying value of the purchased fixed maturity security investments was adjusted to fair market value as of the date of the repurchase. This adjustment was reported in Corporate. The amortization of the adjustment to the fixed maturity security investment's carrying values is reported in Corporate's net investment income. The total amount of before-tax amortization for the years ended December 31, 2001 and 2000 was $18 and $10, respectively. Also reported in Corporate as of December 31, 2001 and 2000 are $3 and $5, respectively, of fixed maturity security investments.
Investment objectives for non-guaranteed separate accounts vary by fund account type, as outlined in the applicable fund prospectus or separate account plan of operations. Non-guaranteed separate account products include variable annuities, variable life insurance contracts and variable COLI.
The Company is exposed to two primary sources of investment and asset/liability management risk: credit risk, relating to the uncertainty associated with the ability of an obligor or
As of December 31, 2001 and 2000, over 96% and 97%, respectively, of the fixed maturity portfolio was invested in securities rated investment grade (BBB and above). During 2001, the percentage of BBB rated fixed maturity investments increased due to the Fortis acquisition and the continued active management of the general account portfolios.
Downward movement in market interest rates during 2001 resulted in a significant increase in the unrealized appreciation of the fixed maturity security portfolio from 2000. However, The Hartford's asset allocation and its exposure to market risk as of December 31, 2001 have not changed materially from its position at December 31, 2000.
Life's general account and guaranteed separate account investment portfolios primarily consist of investment grade, fixed maturity securities, including corporate bonds, asset-backed securities, commercial mortgage-backed securities, tax-exempt municipal securities and collateralized mortgage obligations. The fair value of these and Life's other invested assets fluctuates depending on the interest rate environment and other general economic conditions. During periods of declining interest rates, paydowns on mortgage-backed securities and collateralized mortgage obligations increase as the underlying mortgages are prepaid. During such periods, the Company generally will not be able to reinvest the proceeds of any such prepayments at comparable yields. Conversely, during periods of rising interest rates, the rate of prepayments generally declines, exposing the Company to the possibility of asset/liability cash flow and yield mismatch. (For further discussion of the Company's risk management techniques to manage this market risk, see the "Asset and Liability Management Strategies Used to Manage Market Risk" discussed below.)
As described above, Life holds a significant fixed maturity portfolio that includes both fixed and variable rate securities. The following table reflects the principal amounts of Life's general and guaranteed separate accounts fixed and variable rate fixed maturity portfolios, along with the respective weighted average coupons by estimated maturity year at December 31, 2001. Comparative totals are included as of December 31, 2000.
Derivatives play an important role in facilitating the management of interest rate risk, creating opportunities to efficiently fund obligations, hedge against risks that affect the value of certain liabilities and adjust broad investment risk characteristics as a result of any significant changes in market risks. As an end-user of derivatives, Life uses a variety of derivatives, including swaps, caps, floors, forwards and exchange-traded financial futures and options, in order to hedge exposure primarily to interest rate risk on anticipated investment purchases or existing assets and liabilities. At December 31, 2001, notional amounts pertaining to derivatives totaled $9.9 billion ($8.2 billion related to insurance investments and $1.7 billion related to life insurance liabilities). Notional amounts pertaining to derivatives totaled $8.5 billion at December 31, 2000 ($6.5 billion related to insurance investments and $2.0 billion related to life insurance liabilities).
Anticipatory Hedging -- For certain liabilities, the Company commits to the price of the product prior to receipt of the associated premium or deposit. Anticipatory hedges are executed to offset the impact of changes in asset prices arising from interest rate changes pending the receipt of premium or deposit and the subsequent purchase of an asset. These hedges involve taking a long position (purchase) in interest rate futures or entering into an interest rate swap with duration characteristics equivalent to the associated liabilities or anticipated investments. The notional amounts of anticipatory hedges as of December 31, 2001 and 2000 were $320 and $144, respectively.
Liability Hedging -- Several products obligate the Company to credit a return to the contract holder which is indexed to a market rate. To hedge risks associated with these products, the Company enters into various derivative contracts. Interest rate swaps are used to convert the contract rate into a rate that trades in a more liquid and efficient market. This hedging strategy enables the Company to customize contract terms and conditions to customer objectives and satisfies the operation's asset/liability matching policy. In addition, interest rate swaps are used to convert certain variable contract rates to different variable rates, thereby allowing them to be appropriately
Asset Hedging -- To meet the various policyholder obligations and to provide cost-effective, prudent investment risk diversification, the Company may combine two or more financial instruments to achieve the investment characteristics of a fixed maturity security or that match an associated liability. The use of derivative instruments in this regard effectively transfers unwanted investment risks or attributes to others. The selection of the appropriate derivative instruments depends on the investment risk, the liquidity and efficiency of the market, and the asset and liability characteristics. The notional amounts of asset hedges as of December 31, 2001 and 2000 were $6.8 billion and $5.4 billion, respectively.
Change in Net Economic Value 2001 2000 ------------------------------------------ Basis point shift - 100 + 100 - 100 + 100 - ---------------------------------------------------------------------- Amount $ 6 $ (31) $ (15) $ (27) Percent of liability value 0.03% (0.16)% (0.09)% (0.16)% ======================================================================
securities. These estimates are developed using prepayment speeds contained in broker consensus data. Such estimates are derived from prepayment speeds previously experienced at interest rate levels projected for the underlying collateral. Actual prepayment experience may vary from these estimates. Financial instruments with certain leverage features have been included in each of the fixed maturity categories. These instruments have not been separately displayed, as they were immaterial to Property & Casualty's investment portfolio.
The following table reflects equity securities owned at December 31, 2001 and 2000, grouped by major market type.
As of December 31, 2001, Property & Casualty had immaterial currency exposures resulting from its international operations.
In addition to the contractual obligations above, The Hartford had certain unfunded commitments at December 31, 2001 to fund limited partnership investments totaling $375. These capital commitments can be called by the partnerships during
the commitment period (on average, 3-6 years) to fund working capital needs or the purchase of new investments. If the commitment period expires and the commitment has not been fully funded, The Hartford is not required to fund the remaining unfunded commitment but may elect to do so.
On June 27, 2000, The Hartford acquired all of the outstanding shares of HLI that it did not already own. The HLI Repurchase was recorded as a purchase transaction.
Issuance of: - ------------ Common stock from treasury (7.25 million shares @ $54.90 per share) $ 398 Long-term notes: $250 7.75% notes due June 15, 2005 244 $275 7.90% notes due June 15, 2010 272 Commercial paper 400 - ----------------------------------------------------------------------- Consideration raised 1,314 Other, including conversion of HLI employee stock options and restricted shares 102 - ----------------------------------------------------------------------- Total consideration $ 1,416 - -----------------------------------------------------------------------
For a further discussion of the HLI Repurchase, see Note 16 of Notes to Consolidated Financial Statements.
The Hartford's total capitalization, excluding unrealized gain (loss) on securities and other, net of tax, increased by $2.0 billion as of December 31, 2001 compared to December 31, 2000. This change was primarily the result of earnings and financing activities related to Fortis and September 11, partially offset by dividends declared.
The Hartford's total capitalization, excluding unrealized gain (loss) on securities and other, net of tax, increased by $1.3 billion as of December 31, 2000 compared to December 31, 1999. This change was primarily the result of earnings and financing activities related to The HLI Repurchase, partially offset by dividends declared and the effect of treasury stock acquired in the first quarter of 2000.
On May 15, 2001, HLI filed with the SEC a shelf registration statement for the potential offering and sale of up to $1.0 billion in debt and preferred securities. The registration statement was declared effective on May 29, 2001. As of December 31, 2001, HLI had $1.0 billion remaining on its shelf.
On November 9, 2000, The Hartford filed with the Securities and Exchange Commission a shelf registration statement and a prospectus, as amended on January 31, 2001, for the potential offering and sale of up to $2.6 billion in debt and equity securities. As of December 31, 2001, The Hartford had $1.1 billion remaining on its shelf.
The Hartford has a commercial paper program which allows the Company to borrow up to a maximum amount of $2.0 billion in short-term commercial paper notes. As of December 31, 2001, the Company had $299 of outstanding borrowings under the program.
HLI has a commercial paper program which allows it to borrow up to a maximum amount of $250 in short-term commercial paper notes. As of December 31, 2001, HLI had no outstanding borrowings under the program.
Issuance of common stock - As a result of September 11, on October 22, 2001, The Hartford issued 7.0 million shares of common stock pursuant to an underwritten offering for net proceeds of $400.
Treasury Stock - In October 1999, The Hartford's Board of Directors authorized the repurchase of up to $1.0 billion of the Company's outstanding common stock. This repurchase authorization was effective in November 1999 and covers a three-year period. On the first two trading days following September 11, The Hartford repurchased 0.1 million shares of its common stock in the open market at a total cost of $7. These were the Company's only repurchases in 2001. Since the inception of the 1999 repurchase program, The Hartford has repurchased 6.1 million shares at a total cost of $250. Certain of these repurchased shares have been reissued pursuant to certain stock-based benefit plans.
Unrealized Gain (Loss) and Other - Unrealized gain (loss) on securities and other, net of tax, increased by $172 as of December 31, 2001 compared to December 31, 2000. The change resulted primarily from the impact of decreased interest rates on the fixed maturity portfolio and the net gain on cash-flow hedging instruments.
The liquidity requirements of The Hartford have been and will continue to be met by funds from operations as well as the issuance of commercial paper, debt securities and borrowings from its credit facility. The principal sources of operating funds are premiums and investment income as well as maturities and sales of invested assets. The Hartford Financial Services Group, Inc. is a holding company which receives operating cash flow in the form of dividends from its subsidiaries, enabling it to service debt, pay dividends on its common stock and pay certain business expenses.
As of December 31, 2001, the maximum amount of statutory dividends which may be paid to The Hartford Financial Services Group, Inc. from its insurance subsidiaries in 2002, without prior regulatory approval, is $577.
2001 COMPARED TO 2000 -- The increase in cash from financing activities was the result of current year proceeds on investment type contracts versus the prior year disbursements for investment type contracts and financing activities related to Fortis and September 11. Cash provided by financing and operating activities accounted for the majority of the change in cash for investing activities. Cash flows from operating activities were comparable with prior year.
The National Association of Insurance Commissioners ("NAIC") has regulations establishing minimum capitalization requirements based on risk-based capital ("RBC") formulas for both life and property and casualty companies. The requirements consist of formulas, which identify companies that are undercapitalized and require specific regulatory actions. The RBC formula for life companies establishes capital requirements relating to insurance, business, asset and interest rate risks. RBC is calculated for property and casualty companies after adjusting capital for certain underwriting, asset, credit and off-balance sheet risks. As of December 31, 2001, each of The Hartford's insurance subsidiaries within Life and Property & Casualty had more than sufficient capital to meet the NAIC's RBC requirements.
The NAIC adopted the Codification of Statutory Accounting Principles ("Codification") in March 1998. The effective date for the statutory accounting guidance was January 1, 2001. Each of The Hartford's domiciliary states has adopted Codification, and the Company has made the necessary changes in its statutory reporting required for implementation. As of December 31, 2001, the impact of applying the new guidance resulted in a benefit of approximately $400 in statutory surplus.