The Company is a leading insurance and financial services organization that provides pre-retirement savings, estate planning and employee benefit products. The Company offers variable and fixed annuities, retirement plan services, mutual funds, and life and disability insurance on both a group and an individual basis.
The Company derives its revenues principally from: (a) asset management fees on separate accounts and mortality and expense fees; (b) net investment income on general account assets; and (c) certain other fees earned by the Company. Asset management fees and mortality and expense fees are primarily generated from separate account assets which are deposited with the Company through the sale of variable annuity and variable life products. The Company's operating expenses primarily 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. The Company's profitability depends largely on the amount of assets under management, the adequacy of product pricing and underwriting discipline, and its ability to earn target spreads between earned investment rates on general account assets and credited rates to customers.
Expenses decreased $144 in 1997 as compared to 1996. Excluding COLI and GIC for the reasons described above, expenses increased $255, or 20%, to $1.5 billion in 1997 as compared to $1.2 billion in 1996. Benefits, claims and expenses related to the Annuity segment increased $210, or 28%, in 1997 as compared to 1996. This increase was driven by increased amortization of deferred policy acquisition costs of $76, or 44%, due to strong sales in both 1997 and 1996, as well as increased operating expenses of $101, or 65%, reflective of the strong growth in this segment. In addition, Individual Life Insurance benefits, claims and expenses grew $30, or 8%, primarily related to amortization of deferred policy acquisition costs associated with this growing block of business.
Management believes that it has developed and implemented strategies to maintain and enhance its position as a market leader within the financial services industry, to continue the Company's asset growth, and to maximize Hartford Life's shareholder value. Hartford Life's strong market position in each of its primary businesses, coupled with the growth potential management believes exists in its markets, provides opportunities to increase sales of the Company's products and services as individuals increasingly save and plan for retirement, protect themselves and their families against disability or death and prepare their estates for an efficient transfer of wealth between generations.
Revenues increased $301, or 31%, to $1.3 billion in 1997 from $1.0 billion in 1996. This increase was principally the result of a $234 increase in premiums and other considerations, reflecting a substantial increase in aggregate fees earned due to the segment's growing block of separate account assets. The
A 33% growth in average account value in 1997, coupled with a reduction in individual annuity operating expenses as a percentage of total individual annuity account value to 25 basis points in 1997 from 28 basis points in 1996, contributed to the increase in net income of $58, or 39%, to $206 from $148 in 1996.
Revenues in 1997 increased $47, or 11%, to $487 from $440 in 1996. In the first quarter of 1996, a block of business was assumed from Investors Equity Life Insurance Company ("IEL") which increased 1996 revenues by $9. Excluding this transaction, 1997 revenues increased $56, or 13%, as compared to 1996, reflecting the impact of applying cost of insurance charges and variable life fees to a larger block of business. Account values increased $555, or 17%, to $3.8 billion in 1997 from $3.2 billion in 1996. Sales were $140 in 1997, an increase of 8% over 1996. Variable life product sales comprised 70%, or $98, of total 1997 sales and grew $23, or 31%, over 1996 levels.
Expenses increased $36, or 9%, to $432 in 1997 from $396 in 1996. Excluding IEL, expenses increased $45, or 12%, in 1997. This increase was primarily driven by an increase in amortization of DPAC of $23 in 1997 related to the growth in new variable life business.
The Employee Benefits segment consists of two areas of operation: Group Insurance and Specialty Insurance. Through Group Insurance, the Company offers products such as group life insurance products, group short-term and long-term disability and accidental death and dismemberment. Substantially all of the Group Insurance directly written by the Company is ceded to its direct parent, Hartford Life and Accident Insurance Company ("HLA"). Specialty Insurance primarily consists of the Company's COLI business.
Revenues decreased $394 to $972 in 1997, which was primarily attributable to the COLI business for which associated revenues decreased $380. The decrease in COLI revenues is primarily a result of the elimination of sales of leveraged COLI due to the HIPA Act of 1996, which phases out the deductibility of interest on policy loans under leveraged COLI by the end of 1998. The Company continues to sell variable COLI and recorded $3.6 billion of new deposits in 1997, increasing total account value to $12.3 billion at December 31, 1997 compared to $8.5 billion at December 31, 1996.
The GIC segment consists of guaranteed rate contract ("GRC") business that is supported by assets held in either the Company's general account or a guaranteed separate account and includes a closed block of guaranteed rate contracts ("Closed Book GRC"). Historically, a significant majority of these contracts were sold as general account contracts with fixed rates and fixed maturities. The Company decided in 1995, after a thorough review of its GRC business, that it would significantly de-emphasize general account GRC, choosing instead to focus its distribution efforts on other products sold through other segments and selling general account GRC primarily as an accommodation to customers. From 1992 to 1994, the GIC segment sold over $5 billion of GRC. In contrast, the GIC segment sold only $47 and $108 of general account GRC in 1997 and 1996, respectively. Consistent with management's expectations, the segment had no net income in 1997 and expects no material income or loss from the GIC segment in the future.
Closed Book GRC results in 1996 were negatively affected by lower investment rates and earnings in the related investment portfolio (primarily consisting of collateralized mortgage obligations and mortgage backed securities) due to prepayments experienced in excess of assumed and historical levels. Closed Book GRC was also affected by the interest rate rise in 1994 when the duration of its assets lengthened relative to that of the liabilities.
The Company's investments are managed by its investment strategy group which consists of a risk management unit and a portfolio management unit and directly reports 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 general asset allocation, duration, convexity and other 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, executes the investment plan of the investment strategy group including the identification and purchase of securities that fulfill the objectives of the strategy group.
During 1997, the Company continued to concentrate on reducing exposure to CMO's and reallocated the funds into public and private corporate bonds, commercial mortgage-backed securities and other nonresidential asset-backed securities. In general, commercial MBS and asset-backed securities, although subject to prepayment risk, are significantly less sensitive to changes in interest rates as compared to CMO's and MBS.
The table below summarizes the Company's results for the past two years.
For the year ended December 31, 1997, before-tax net investment income totaled $1.4 billion, unchanged from 1996. Before-tax yields on average invested assets decreased to 7.7% in 1997 from 7.8% in 1996. The decrease in before-tax yields was primarily attributable to declining market interest rates and a reduction in policy loan yields.
Net realized capital gains were $4 in 1997, as compared to net realized capital losses of $213 in 1996. The 1996 capital losses were primarily attributable to the writedown and sale of certain securities within Closed Book GRC.
The following table, which includes general and guaranteed separate accounts, reflects the principal amounts of the fixed and variable rate fixed maturity portfolio at December 31, 1997, along with the respective weighted average coupons by estimated maturity year. Expected maturities differ from contractual maturities due to call or prepayment provisions. The weighted average coupon on variable rate securities is based upon spot rates as of December 31, 1997, and is primarily based upon the London Interbank Offered Rate ("LIBOR"). Callable bonds and notes are distributed to either call dates or maturity depending on which date produces the most conservative yield. Asset backed securities, collateralized mortgage obligations and mortgage backed securities are distributed to maturity year based on estimates of the rate of future prepayments of principal over the remaining life of the securities. These estimates are developed using prepayment speeds provided in broker consensus data. Such estimates are derived from prepayment speeds previously experienced at the 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 because they were immaterial to the Company's investment portfolio.
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 typically enters into interest rate swaps 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. Additionally, interest rate swaps are used to convert certain fixed contract rates into floating rates, thereby allowing them to be appropriately matched against floating rate assets. The notional amount of derivatives used for liability hedging as of December 31, 1997 was $1.9 billion.
(1) AS OF DECEMBER 31, 1997, THE FAIR VALUE OF THE COMPANY'S INVESTMENT CONTRACTS INCLUDING GUARANTEED SEPARATE ACCOUNTS WAS $21.7 BILLION.
INDEXED ASSET ACCUMULATION VEHICLES -- Products in this category are similar to the fixed rate asset accumulation vehicles but require the Company to pay a rate that is determined by an external index. The amount and/or timing of cash flows will therefore vary based on the level of the particular index. The primary risks inherent in these products are similar to the fixed rate asset accumulation vehicles, with an additional risk that changes in the index may adversely affect profitability. Product examples include indexed-guaranteed investment contracts with an estimated duration of up to two years.
INTEREST CREDITED ASSET ACCUMULATION VEHICLES -- Products in this category credit interest to policyholders, subject to market conditions and minimum guarantees. Policyholders may surrender at book value but are subject to surrender charges for an initial period. Product examples include universal life contracts and the general account portion of the Company's variable annuity products. Liability duration is short to intermediate term.
LONG-TERM PAY OUT LIABILITIES -- Products in this category are long-term in nature and may contain significant actuarial (including mortality and morbidity) pricing and cash flow risks. The cash flows associated with these policy liabilities are not interest rate sensitive but do vary based on the timing and amount of benefit payments. The primary risks associated with these products are that the benefits will exceed expected actuarial pricing and/or that the actual timing of the cash flows differ from those anticipated resulting in an investment return lower than that assumed in pricing. Product examples include structured settlement contracts, on-benefit annuities (i.e., the annuitant is currently receiving benefits thereon) and long-term disability contracts. Contract duration is generally 6 to 10 years but, at times, exceeds 30 years.
Although the Federal government does not directly regulate the insurance business, Federal initiatives often have an impact on the insurance industry in a variety of ways. 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 1998 Federal Budget Proposal currently contains certain recommendations for modifying tax rules related to the treatment of variable annuities and COLI by contractholders, which if enacted as described, could have a material adverse impact on the Company's sales of these products. It is too early to determine whether these tax proposals will ultimately be enacted by Congress and the potential impact, if any, to the Company's financial condition or results of operations.
Ratings are an important factor in establishing the competitive position of an insurance company such as Hartford Life Insurance Company. There can be no assurance that the Company's ratings will continue for any given period of time, or that they will not be changed. In the event that the Company's ratings are downgraded, the level of sales or the persistency of the Company's block of in-force business may be adversely impacted.
The NAIC adopted regulations establishing minimum capitalization requirements based on Risk-Based Capital ("RBC") formulas for life insurance companies (effective December 31, 1993). The requirements consist of formulas which identify companies that are undercapitalized and require specific regulatory actions. The RBC formula for life insurance companies establishes capital requirements relating to insurance, business, asset and interest rate risks. The RBC ratios for all insurance subsidiaries of Hartford Life are in excess of 200% as of December 31, 1997.
The rate of inflation as measured by the change in the average consumer price index has not had a material effect on the revenues or operating results of the Company during the three most recent fiscal years.