(3)For financial reporting purposes, the Company has treated certain amounts previously allocated by The Hartford Financial Services Group, Inc. (The Hartford) to the Company's life insurance subsidiaries as allocated advances from parent. Cash received in respect of allocated advances from parent was used to support the growth of the life insurance subsidiaries.
(4)On June 29, 1998, Hartford Life Capital I, a special purpose Delaware trust formed by Hartford Life, issued 10,000,000, 7.2% Trust Preferred Securities, Series A (Series A Preferred Securities). The proceeds from the sale of the Series A Preferred Securities were used to acquire $250 of 7.2% Series A Junior Subordinated Deferrable Interest Debentures (Junior Subordinated Debentures) issued by Hartford Life. For additional information, see Note 8 of Notes to Consolidated Financial Statements.
Certain statements contained in this discussion, other than statements of historical fact, are forward-looking statements. These statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and include estimates and assumptions related to economic, competitive and legislative developments. These forward-looking statements are subject to change and uncertainty which are, in many instances, beyond the Company's control and have been made based upon management's expectations and beliefs concerning future developments and their potential effect on Hartford Life, Inc. and subsidiaries ("Hartford Life" or the "Company"). There can be no assurance that future developments will be in accordance with management's expectations or that the effect of future developments on Hartford Life will be those anticipated by management. Actual results could differ materially from those expected by the Company, depending on the outcome of certain factors, including the possibility of general economic, business and legislative conditions that are less favorable than anticipated, changes in interest rates or the stock markets, stronger than anticipated competitive activity and those described in the forward-looking statements.
Consolidated Results of Operations 14 Investment Products 16 Individual Life 17 Employee Benefits 18 Corporate Owned Life Insurance (COLI) 19 Reserves 20 Investments 20 Capital Markets Risk Management 22 Capital Resources and Liquidity 30 Regulatory Matters and Contingencies 33 Effect of Inflation 35 Accounting Standards 35
Hartford Life's expenses essentially consist of interest credited to policyholders on general account liabilities, insurance benefits provided, dividends to policyholders, costs of selling and servicing the various products offered by the Company, and other general business expenses.
Hartford Life has the following reportable operating segments: Investment Products, Individual Life, Employee Benefits and Corporate Owned Life Insurance (COLI). The Company reports corporate items not directly allocable to any of its segments, principally interest expense, as well as its international operations, which are primarily located in Latin America, in an "Other" category. For information regarding the Company's reportable segments, see Note 17 of Notes to Consolidated Financial Statements.
Total benefits, claims and expenses decreased $353, or 7%, primarily due to the declining block of leveraged COLI business. Excluding the COLI segment, total benefits, claims and expenses increased $394, or 11%, consistent with the revenue growth described above. Net income increased $81, or 21%, driven mostly by increased fee income associated with higher assets under management in the Investment Products segment, as well as continued growth across its other reportable segments.
Total benefits, claims and expenses increased $984, or 23%, principally due to costs associated with the recaptured MBL business as well as continued growth in the Company's other reportable segments. Net income increased $80, or 26%, most notably as a result of an increase in earnings in the Investment Products segment of $64 and in the Individual Life segment of $9, both of which were driven by higher fees associated with growth in assets under management. Additionally, earnings in the Employee Benefits segment increased $13 as group insurance revenue increased and the Company achieved favorable mortality and morbidity experience.
Certain proposed legislative initiatives which could impact Hartford Life are discussed in the Regulatory Matters and Contingencies section.
1998 COMPARED TO 1997 - Revenues increased $57, or 11%, resulting from higher fee income associated with the Company's growing block of variable life insurance. Variable life account values increased $651, or 61%, due to strong sales of $127, a 30% increase over prior year levels, as well as equity market appreciation, while variable life insurance in force increased $6.6 billion, or 67%. Total benefits, claims and expenses increased $43, or 10%, as a result of an increase in amortization of deferred policy acquisition costs of $21 and an increase in benefits, claims and claim adjustment expenses of $18 related to the growth in this segment. The growth in the Individual Life operation's account values and life insurance in force, particularly variable life, resulted in an increase in net income of $9, or 16%.
The Employee Benefits segment sells group life and group disability insurance as well as other products, including stop loss and supplementary medical coverage to employers and employer sponsored plans, accidental death and dismemberment, travel accident, long-term care insurance and other special risk coverages to employers and associations. The Company also offers disability underwriting, administration, claims processing services and reinsurance to other insurers and self-funded employer plans. According to the latest results published by the Life Insurance Marketing and Research Association (LIMRA), the Company was the third largest provider of group disability insurance and the fourth largest writer of group life insurance in the United States for the nine months ended September 30, 1999.
Total benefits, claims and expenses increased $211, or 12%, primarily due to higher benefits, claims and claim adjustment expenses, which, excluding buyouts, increased $187, or 11%, due to the growth in this segment. The ratio of benefits, claims and claim adjustment expenses as a percentage of premiums and other considerations (loss ratio), excluding buyouts, remained consistent at 82%, indicating a continuation of favorable mortality and morbidity experience. In addition, the ratio of amortization of deferred policy acquisition costs and other expenses as a percentage of premiums and other considerations (expense ratio), excluding buyouts, remained consistent at 24%.
The segment's effective income tax rate was reduced to 23% from 28% as a result of increasing the level of investment in tax-exempt securities. As a result of increased premium revenue, consistent loss and expense ratios and increased after-tax investment income, net income increased $8, or 11%.
Total benefits, claims and expenses increased $101, or 6%, primarily due to higher benefits, claims and claim adjustment expenses, which, excluding buyouts, increased $121 associated with this growing block of business. However, the ratio of benefits, claims and claim adjustment expenses as a percentage of premiums and other considerations, excluding buyouts, improved to 82% from 83%. This improvement was partially offset by an increase in other expenses of $66, whereby other expenses as a percentage of premiums and other considerations, excluding buyouts, increased to 24% from 22%. This trend is due to the Company's continued investment in claims management initiatives, which result in higher operating expenses but improve benefits, claims and claim adjustment expenses.
The segment's effective income tax rate was reduced to 28% from 36% as a result of increasing the level of investment in tax-exempt securities, which improved the after-tax investment yield to 5.2% from 5.0%. As a result of increased premium revenue, an improved after-tax investment yield and favorable mortality and morbidity experience, net income increased $13, or 22%.
The focus of this segment is variable COLI, which continues to be a product generally used by employers to fund non-qualified benefits or other postemployment benefit liabilities. The leveraged COLI product has been an important contributor to Hartford Life's profitability in recent years and will continue to contribute to the profitability of Hartford Life in the future, although the level of profit is expected to decline. COLI is subject to a changing legislative and regulatory environment that could have a material adverse affect on its business. Certain proposed legislative initiatives could impact COLI and are discussed in the Regulatory Matters and Contingencies section.
The Company's investments are managed by its investment strategy group, which consists of a risk management unit and a portfolio management unit and reports directly to senior management of the Company. The risk management unit is responsible for monitoring and managing the Company's asset/liability profile and establishing investment objectives and guidelines. The portfolio management unit is responsible for determining, within specified risk tolerances and investment guidelines, the appropriate asset allocation, duration, and convexity characteristics of the Company's general account and guaranteed separate account investment portfolios. The Hartford Investment Management Company, a wholly owned subsidiary of The Hartford Financial Services Group, Inc., executes the investment plan of the investment strategy group, including the identification and purchase of securities that fulfill the objectives of the strategy group.
The Company's separate accounts reflect two categories of risk assumption: non-guaranteed separate accounts totaling $101.8 billion and $80.6 billion as of December 31, 1999 and 1998, respectively, wherein the policyholder assumes substantially all the investment risk and reward, and guaranteed separate accounts totaling $8.9 billion and $10.0 billion as of December 31, 1999 and 1998, respectively, wherein Hartford Life contractually guarantees either a minimum return or account value to the policyholder. Non-
guaranteed separate account products include variable annuities, variable life insurance contracts and variable COLI. Guaranteed separate account products primarily consist of modified guaranteed individual annuities and modified guaranteed life insurance and generally include market value adjustment features to mitigate the risk of disintermediation.
The Company's general account consists of a diversified portfolio of investments. Although all the assets of the general account support the Company's general account liabilities, the Company's investment strategy group has developed separate investment portfolios for specific classes of product liabilities within the general account. The strategy group works closely with the business lines to develop specific investment guidelines, including duration targets, asset allocation and convexity constraints, asset/liability mismatch tolerances and return objectives for each product line in order to achieve each product line's individual risk and return objectives.
During 1999, the Company, in executing its investment strategy, increased its allocation to municipal tax-exempt securities with the objective of increasing after-tax yields, and also increased its allocation to mortgage backed and commercial mortgage backed securities. Holdings of short-term securities declined, primarily as a result of the funding of scheduled liability maturities.
Approximately 21.5% and 22.8% of the Company's fixed maturity portfolio was invested in private placement securities (including Rule 144A offerings) as of December 31, 1999 and 1998, respectively. Private placement securities are generally less liquid than public securities; however, covenants for private placements are designed to mitigate liquidity risk. Most of the private placement securities in the Company's portfolio are rated by nationally recognized rating organizations. For further discussion of the Company's investment credit policies, see the Capital Markets Risk Management section under "Credit Risk".
(1) Represents net investment income (excluding net realized capital losses) divided by average invested assets at cost (fixed maturities at amortized cost). In 1998, average invested assets were calculated assuming the recaptured MBL business proceeds were received on January 1, 1998.
1998 COMPARED TO 1997 - Total net investment income, before-tax, increased $419, or 27%, principally due to an increase in policy loan income of $364, which is primarily due to the recaptured MBL business. (For additional information on the MBL Recapture, see the Capital Resources and Liquidity section.) Yield on average invested assets, before-tax, increased to 7.9%, primarily due to the increase in policy loan income that resulted from the recaptured MBL business, as well as an increase in fixed maturities rated BBB. There were no net realized capital gains or losses for the years ended December 31, 1998 and 1997. During 1998, realized capital gains from the sale of fixed maturities and equity securities were offset by realized capital losses, including $21, after-tax, related to the other than temporary impairment charge associated with asset backed securities securitized and serviced by CFS.
The Company invests primarily in securities rated investment grade and has established exposure limits, diversification standards and review procedures for all credit risks including borrower, issuer and counterparty. Creditworthiness of specific obligors is determined by an internal credit evaluation supplemented by consideration of external determinants of creditworthiness, typically ratings assigned by nationally recognized ratings agencies. Obligor, asset sector and industry concentrations are subject to established limits and monitored at regular intervals.
The following table identifies fixed maturity securities for the Company's operations by credit quality. The ratings referenced in the tables are based on the ratings of nationally recognized rating organizations or, if not rated, assigned based on the Company's internal analysis of such securities.
As of December 31, 1999 and 1998, over 97% of the fixed maturity portfolio, including guaranteed separate accounts, was invested in investment grade securities.
Hartford Life's general and guaranteed separate account exposure to market risk relates to the market price and/or cash flow variability associated with changes in market interest rates. The following discussion focuses on the Company's exposure to interest rate risk, asset/liability management strategies utilized to manage this risk, and characteristics of the Company's insurance liabilities and their sensitivity to movements in interest rates.
Liability Hedging -- Several products obligate the Company to credit a return to the contractholder which is indexed to a market rate. To hedge risks associated with these products, the Company enters into various derivative contracts. Interest rate swaps are used to convert the contract rate into a rate that trades in a more liquid and efficient market. This hedging strategy enables the Company to customize contract terms and conditions to customer objectives and satisfies Hartford Life's asset/liability matching policy. Interest rate swaps are also used to convert certain fixed contract rates into floating rates, thereby allowing them to be appropriately matched against floating rate assets. Additionally, interest rate caps are used to hedge against the risk of contractholder disintermediation in a rising interest rate environment. The notional amount of derivatives used for liability hedges as of December 31, 1999 and 1998 was $3.3 billion and $5.2 billion, respectively.
of the market, and the asset and liability characteristics. The notional amount of asset hedges as of December 31, 1999 and 1998 was $4.8 billion and $3.8 billion, respectively.
Portfolio Hedging -- The Company periodically compares the duration and convexity of its portfolios of assets to their corresponding liabilities and enters into portfolio hedges to reduce any difference to desired levels. Portfolio hedges reduce the mismatch between assets and liabilities and offset the potential impact to cash flows caused by changes in interest rates. The notional amount of portfolio hedges as of December 31, 1999 and 1998 was $1.2 billion and $1.5 billion, respectively.
The following tables provide information as of December 31, 1999, with comparative totals for December 31, 1998, on derivative instruments used in accordance with the aforementioned hedging strategies. For interest rate swaps, caps and floors, the tables present notional amounts with weighted average pay and received rates for swaps and weighted average strike rates for caps and floors by maturity year. For interest rate futures, the table presents contract amount and weighted average settlement price by expected maturity year. The Company uses option contracts to hedge debt instruments that totaled $254 and $110 in notional amounts and $(50) and $(20) in carrying value as of December 31, 1999 and 1998, respectively.
Short-Term Pay Out Liabilities -- These liabilities are short term in nature with a duration of less than one year. The primary risks associated with these products are determined by the non-investment contingencies such as mortality or morbidity and the variability in the timing of the expected cash flows. Liquidity is of greater concern than for the long-term pay out liabilities. Products include individual and group term life insurance contracts and short-term disability contracts.
Management of the duration of investments with respective policyholder obligations is an explicit objective of the Company's management strategy. The estimated cash flows of insurance policy liabilities based upon internal actuarial assumptions as of December 31, 1999 are reflected in the table below by expected maturity year. Comparative totals are included for December 31, 1998.
For liabilities whose cash flows are not substantially affected by changes in interest rates (fixed liabilities) and where investment experience is substantially absorbed by the Company, the sensitivity of the net economic value (discounted present value of asset cash flows less the discounted present value of liability cash flows) of those portfolios to 100 basis point shifts in interest rates is shown in the table below. These fixed liabilities represent approximately 55% of the Company's general and guaranteed separate account liabilities at both December 31, 1999 and 1998. The remaining liabilities generally allow the Company significant flexibility to adjust credited rates to reflect actual investment experience and thereby pass through a substantial portion of actual investment experience to the policyholder. The fixed liability portfolios are managed and monitored relative to defined objectives and are analyzed regularly by management for internal risk management purposes using scenario simulation techniques, and evaluated annually consistent with regulatory requirements.
Capital resources and liquidity represent the overall financial strength of Hartford Life and its ability to generate strong cash flows from each of the business segments and borrow funds at competitive rates to meet operating and growth needs. The Company maintained cash and short-term investments totaling $1.4 billion, $2.2 billion and $1.5 billion as of December 31, 1999, 1998 and 1997, respectively. The capital structure of Hartford Life consists of debt and equity, and is summarized as follows:
(1) Excludes net unrealized capital gains (losses) on securities, net of tax.
(2) Excluding TruPS, the debt to equity ratios were 25% and 29%, and the debt to capitalization ratios were 18% and 21% as of December 31, 1999 and 1998, respectively.
The Company's total capitalization, excluding net unrealized capital gains (losses) on securities, net of tax, increased $412, or 13%, in 1999 and $523, or 20%, in 1998. In 1999, the increase was primarily the result of net income of $467 partially offset by dividends declared of $50. In 1998, the increase was primarily the result of net income of $386 and the issuance of TruPS of $250, which were partially offset by the retirement of $50 in commercial paper and dividends declared of $50. As a result, both the debt to equity and debt to capitalization ratios (both exclude net unrealized capital gains {losses} on securities, net of tax) decreased to 34% and 25% as of December 31, 1999, respectively, from 40% and 29% as of December 31, 1998, respectively. Net unrealized capital gains (losses) on securities, net of tax, decreased $599 as of December 31, 1999, as compared to December 31, 1998, primarily due to the impact of increased interest rates on the Company's fixed maturity portfolio.
For a discussion of Debt, see Note 7 of Notes to Consolidated Financial Statements.
During 1999, to make shares available to employees pursuant to stock based benefit plans, the Company repurchased 225,000 shares of its Class A Common Stock in the open market at a total cost of $10. Shares repurchased in the open market are carried at cost and reflected as a reduction to stockholders' equity. Treasury shares subsequently reissued are reduced from treasury stock on a weighted average cost basis. The Company currently intends to purchase additional shares of its Class A Common Stock to make shares available for its various employee stock based benefit plans.
Dividends to Hartford Life, Inc. from its direct subsidiary, Hartford Life and Accident Insurance Company (HLA), as an insurance company domiciled in Connecticut, are subject to restriction as prescribed in the insurance holding company laws of Connecticut. HLA adheres to these laws, which require notice to and approval by the state insurance commissioner for the declaration or payment of any dividend that, together with other dividends or distributions made within the preceding twelve months, exceeds the greater of (i) 10% of the insurer's policyholder surplus as of December 31 of the preceding year or (ii) net 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 policies. In addition, if any dividend of a Connecticut-domiciled insurer exceeds the insurer's earned surplus, it requires the prior approval of the Connecticut Insurance Commissioner. The total amount of statutory dividends which may be paid by the insurance subsidiaries of the Company without prior approval in 2000 is estimated to be $221.
The insurance holding company laws of the other jurisdictions in which Hartford Life's insurance subsidiaries are incorporated or deemed commercially domiciled generally contain similar limitations on the payment of dividends.
During 1999, the increase in cash provided by operating activities was primarily the result of an increase in net income as well as timing in the settlement of receivables and payables. The increase in cash provided by (used for) investing activities and the decrease in cash used for financing activities primarily related to the significant downsizing of the leveraged COLI block of business, as well as the decrease in the Company's guaranteed investment contract (GIC) business.
In conjunction with the MBL Recapture transaction, the Company also purchased the outstanding interest in International Corporate Marketing Group, Inc. (ICMG), which was previously 40% owned by MBL Life.
Enactment of Gramm-Leach-Bliley at the federal level has focused renewed attention on state regulation of insurance. Elements of the insurance industry are involved in a countrywide initiative to streamline regulatory procedures. Such measures could result in reduced transaction costs and improved speed to market.
Current and proposed federal measures which may significantly affect the life insurance business include tax law changes affecting the tax treatment of life insurance products and its impact on the relative desirability of various personal investment vehicles, medical testing for insurability, and proposed legislation to prohibit the use of gender in determining insurance and pension rates and benefits. In particular, President Clinton's 2001 federal budget proposal currently contains certain recommendations for modifying tax rules related to the treatment of COLI by contractholders which, if enacted as described, could have a material adverse impact on the Company's sales of these products. The budget proposal also includes provisions which would result in a significant increase in the "DAC tax" on certain of the Company's products and would apply a tax to the Company's policyholder surplus account. (For further discussion on policyholder surplus accounts and related tax treatment as of December 31, 1999, see Note 14 of Notes to Consolidated Financial Statements.) It is too early to determine whether these tax proposals will ultimately be enacted by Congress. Therefore, the potential impact to the Company's financial condition or results of operations cannot be reasonably estimated at this time.
Beginning in 1990, Hartford Life began working on making its IT systems Year 2000 ready, either through installing new programs or replacing systems. These efforts were substantially completed by the end of 1999, including the internal and external integrated testing of such systems. In addition, Hartford Life's Year 2000 efforts included assessing the potential impact on Hartford Life of third parties' Year 2000 readiness.
As of February 29, 2000, Hartford Life had not experienced any Year 2000 - related business interruptions arising either from its own systems or those of third parties. However, Hartford Life has developed certain contingency plans so that if, despite its Year 2000 efforts, Year 2000 problems ultimately arise, the impact of such problems may be avoided or minimized. The contingency planning process involved identifying reasonably likely business disruption scenarios that, if they were to occur, could create significant problems in the critical functions of each business segment. Each business segment has developed plans to respond to such problems so that critical business functions may continue to operate with minimal disruption. Contingency planning also included assessing the dependency of Hartford Life's critical business on third parties and their Year 2000 readiness. These plans were reviewed and simulated on an integrated basis, where appropriate, and will continue to be evaluated. Furthermore, in many contexts, Year 2000 issues are dynamic, and ongoing assessments of business functions, vulnerabilities and risks must be made. As such, new contingency plans may be needed in the future and/or existing plans may need to be modified as circumstances warrant.