The following table sets forth the Company's selected consolidated financial data at the dates and for the periods indicated below. The selected financial data should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") presented in
The Hartford currently conducts business principally in six reporting segments including Commercial Lines, Personal Lines, Property & Casualty Other Operations, Group Benefits, Mutual Funds and Talcott Resolution, as well as a Corporate category. The Hartford includes in its Corporate category the Company’s debt financing and related interest expense, as well as other capital raising activities; and purchase accounting adjustments related to goodwill and other expenses not allocated to the reporting segments.
For further discussion of these transactions, see Note 2 - Business Dispositions, Note 7 - Reinsurance and Note 19 - Discontinued Operations of Notes to Consolidated Financial Statements. These businesses are included in the Talcott Resolution reporting segment.
The Company derives its revenues principally from: (a) premiums earned for insurance coverages provided to insureds; (b) fee income, including asset management fees, on separate account and mutual fund assets and mortality and expense fees, as well as cost of insurance charges; (c) net investment income; (d) fees earned for services provided to third parties; and (e) net realized capital gains and losses. Premiums charged for insurance coverages are earned principally on a pro rata basis over the terms of the related policies in-force. Asset management fees and mortality and expense fees are primarily generated from separate account assets. Cost of insurance charges are assessed on the net amount at risk for investment-oriented life insurance products.
Book value per diluted common share (excluding AOCI) increased to $40.71 from $39.30 as of the prior year end due to the effect of net income less dividends and the effect of share repurchases for the year.
Higher short term interest rates and wider credit spreads increased the after-tax net unrealized gains in the investment portfolio by approximately $1.4 billion for the year.
Property & Casualty written premium increased 3% over the prior year, comprised of 3% growth in Commercial Lines and 4% in Personal Lines.
Catastrophe losses of $341, before tax, increased from catastrophe losses of $312, before tax, in the prior year.
Unfavorable prior year development totaled $228, before tax, primarily driven by strengthening of net asbestos and environmental reserves.
A $299 before tax improvement in current accident year underwriting results before catastrophes in Property & Casualty resulting in a 2.9 point decrease in the combined ratio before catastrophes and prior year development. Also contributing to the improvement in underwriting results was an increase in earned premiums of 2% or $232, before tax, in 2014, compared to 2013, reflecting earned premium growth of 1% in Commercial Lines and 4% in Personal Lines. For a discussion of the Company's operating results by segment, see the segment sections of MD&A.
Net investment income of $3,154, before tax, in 2014 decreased from $3,264, before tax, in 2013. The decrease in net investment income is primarily due to lower income from fixed maturities, as a result of a decline in asset levels, primarily in Talcott Resolution, lower income from repurchase agreements, and the impact of reinvesting at lower interest rates. For further discussion of investment results, see MD&A - Investment Results, Net Investment Income (Loss).
Current accident year catastrophe losses in Property & Casualty of $341, before tax, in 2014, compared to $312, before tax, in 2013. The increase in current accident year catastrophe losses was primarily due to increased frequency and severity from wind and hail 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.
A loss on extinguishment of debt of $213, before tax, in 2013, compared to $910, before tax in 2012. The loss in 2013 related to the repurchase of approximately $800 of senior notes and the loss in 2012 related to the repurchase of all outstanding 10% fixed-to-floating rate junior subordinated debentures due 2068 with a $1.75 billion aggregate principal amount all held by Allianz.
Net asbestos reserve strengthening of $130, before tax, in 2013 compared to $48, before tax, in 2012 resulting from the Company's annual review of its asbestos liabilities. For further information, see MD&A - Critical Accounting Estimates, Property & Casualty Other Operations Claims with the Property and Casualty Insurance Product Reserves, Net of Reinsurance.
Includes equity securities at fair value using the FVO of $348 and $0 as of December 31, 2014 and December 31, 2013, respectively.
Total investments decreased since December 31, 2013, primarily as a result of a decline in equity securities, trading and fixed maturities, AFS, partially offset by an increase in short-term investments. The decrease in equity securities, trading and fixed maturities, AFS is largely due to the sale of the Japan variable and fixed annuity business as well as the continued runoff of the remaining Talcott Resolution business. For further discussion on the Japan sale, see Note 2 - Business Dispositions of Notes to Consolidated Financial Statements. This decline was partially offset by an increase in the valuation of fixed maturities, AFS due to a decrease in interest rates. Short-term investments increased primarily due to the investment of proceeds from the sale of the Japan variable and fixed annuity business.
Yields calculated using annualized net investment income divided by the monthly average invested assets at cost, amortized cost, or adjusted carrying value, as applicable, excluding repurchase agreement collateral, if any, and derivatives book value. Yield calculations for each period exclude assets associated with the dispositions of the Japan variable and fixed annuity business, the Retirement Plans and Individual Life businesses, and the Hartford Life International Limited business, as applicable.
Total net investment income decreased primarily due to a decrease in income from fixed maturities as a result of a decline in asset levels, primarily in Talcott Resolution, lower income from repurchase agreements, and the impact of reinvesting at lower interest rates.
Based upon current reinvestment rates, we expect the annualized net investment income yield, excluding limited partnerships and other alternative investments, for 2015, to decline slightly compared to the 2014 net investment income yield. The estimated impact on net investment income is subject to change as the composition of the portfolio changes through normal portfolio management and trading activities and changes in market conditions.
Total net investment income decreased primarily due to a decrease in income due to lower asset levels as a result of the sale of the Retirement Plans and Individual Life businesses in 2013, and a decline in yield. The decline was partially offset by an increase in income from limited partnerships, due to real estate and private equity funds selling underlying investments and continued valuation improvements. The annualized net investment income yield, excluding limited partnerships and other alternative investments, declined to 4.2% in 2013 versus 4.5% in 2012. The decline was primarily attributable to the divestiture of Individual Life and Retirement Plans businesses.
Includes $1.5 billion of gains relating to the sales of the Retirement Plans and Individual Life businesses in the year ended December 31, 2013.
Includes $177 of intent-to-sell impairments for the year ended December 31, 2012, relating to the sales of the Retirement Plans and Individual Life businesses in 2013.
Primarily consists of changes in value of non-qualifying derivatives, including interest rate derivatives used to manage duration, and the Japan fixed payout annuity hedge.
For the year ended December 31, 2012 the gain on GMWB related derivatives, net, was primarily driven by gains due to liability model assumption updates of $274, largely related to a reduction in the reset assumptions to better align with actual experience, gains of $106 related to outperformance of the underlying actively managed funds compared to their respective indices, and gains of $83 driven by a decline in equity market volatility. The loss on the macro hedge program for the year ended December 31, 2013 was primarily driven by losses of $167 related to the passage of time, losses of $118 due to an improvement in domestic equity markets, and losses of $60 related to a decrease in equity market volatility.
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. The Company analyzes recent developments in commutation activity between reinsurers and cedants, recent trends in arbitration and litigation outcomes in disputes between reinsurers and cedants and the overall credit quality of the Company’s reinsurers. Where its contracts permit, the Company secures funding of future claim obligations with various forms of collateral, including irrevocable letters of credit, secured trusts, funds held accounts and group-wide offsets. The allowance for uncollectible reinsurance was $271 as of December 31, 2014, comprised of $46 related to Commercial Lines and $225 related to Property & Casualty Other Operations.
The Company’s reserving actuaries, who are independent of the business units, regularly review reserves for both current and prior accident years using the most current claim data. For most lines of business, these reserve reviews incorporate a variety of actuarial methods and judgments and involve rigorous analysis. These selections incorporate input, as judged by the reserving actuaries to be appropriate, from claims personnel, pricing actuaries and operating management on reported loss cost trends and other factors that could affect the reserve estimates. Most reserves are reviewed fully each quarter, including loss and loss adjustment expense reserves for property, auto physical damage, auto liability, package business, workers’ compensation, most general liability, professional liability and bond. Other reserves are reviewed semi-annually (twice per year) or annually. These include, but are not limited to, reserves for losses incurred in accident years older than twelve and twenty years, for Personal and Commercial Lines, respectively, assumed reinsurance, latent exposures, such as construction defects, and unallocated loss adjustment expense. For reserves that are reviewed semi-annually or annually, management monitors the emergence of paid and reported losses in the intervening quarters to either confirm that the estimate of ultimate losses should not change or, if necessary, perform a reserve review to determine whether the reserve estimate should change.
Most of the Company’s property and casualty insurance product reserves are not discounted. However, the Company has discounted liabilities funded through structured settlements and has discounted certain reserves for indemnity payments due to permanently disabled claimants under workers’ compensation policies. For further discussion of these discounted liabilities, see Note 11 - Reserves for Future Policy Benefits and Unpaid Losses and Loss Adjustment Expenses of Notes to Consolidated Financial Statements.
As of December 31, 2014 and 2013, net U.S. property and casualty insurance product reserves for losses and loss adjustment expenses reported under accounting principles generally accepted in the United States of America (“U.S. GAAP”) were approximately equal to net reserves reported on a statutory basis. Under U.S. GAAP, liabilities for unpaid losses for permanently disabled workers’ compensation claimants are discounted at rates that are no higher than risk-free interest rates in effect at the time the claims are incurred and which can vary from the statutory discount rates set by regulators. Largely offsetting/augmenting the effect of the difference in discounting is that a portion of the U.S. GAAP provision for uncollectible reinsurance is not recognized under statutory accounting.
In Personal Lines, 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 and class plans 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. To the extent that payment patterns are impacted by increases or decreases in the frequency of settlement payments, historical patterns would be less reliable, increasing the uncertainty around reserve estimates. 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.
Recorded reserves for workers’ compensation, net of reinsurance, are approximately $8.7 billion. Loss development patterns are a key indicator for this line of business, particularly for more mature accident years. Historically, loss development patterns have been impacted by, among other things, medical cost inflation and other changes in loss cost trends. The Company has reviewed the historical variation in paid loss development patterns. If the paid loss development patterns change by 2%, the estimated net reserve need would change by $400, in either direction. A 2% change in paid loss development patterns is within the Company’s historical variation, as measured by the variation around the average development factors as reported in statutory accident year reports.
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, 2014 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.
Strengthened reserves in commercial auto liability due to an increased frequency of severe claims spread across several accident years.
Released reserves in professional liability for accident years 2013, 2012 and 2010 due to lower frequency of reported claims.
Released reserves in general liability due to lower frequency in late emerging claims.
Bond reserves emerged favorably for accident years 2008 to 2013, offset by adverse emergence on reserves for accident years 2007 and prior.
Released reserves primarily for accident year 2013 catastrophes as fourth quarter 2013 catastrophes have developed favorably.
Released reserves in workers' compensation for recent accident years due to improved frequency and lower estimated claim handling costs.
Refer to the Property & Casualty Other Operations Claims section for discussion of the increase to net asbestos reserves, net environmental reserves and other reserve re-estimates, net.
Strengthened reserves in commercial auto liability, primarily related to specialty lines claims, arising from a higher frequency of large loss bodily injury claims in accident years 2010 through 2012.
Excludes amounts reported in Commercial Lines and Personal Lines reporting segments (collectively “Ongoing Operations”) for asbestos and environmental net liabilities of $16 and $6 respectively, as of December 31, 2014, $18 and $5, respectively, as of December 31, 2013, and $15 and $7, respectively, as of December 31, 2012; excludes total net losses and loss adjustment expenses incurred for the years ended December 31, 2014, 2013 and 2012 of $16, $15 and $13, respectively, related to asbestos and environmental claims; and excludes total net losses and loss adjustment expenses paid for the years ended December 31, 2014, 2013 and 2012 of $17, $14 and $15, respectively, related to asbestos and environmental claims.
Gross of reinsurance, asbestos and environmental reserves, including liabilities in Ongoing Operations, were $2,193 and $267, respectively, as of December 31, 2014; $2,182 and $311, respectively, as of December 31, 2013; and $2,294 and $334, respectively, as of December 31, 2012.
The one year and average three year net paid amounts for asbestos claims, including Ongoing Operations, were $229 and $201, respectively, resulting in a one year net survival ratio of 7.6 and a three year net survival ratio of 8.6 . 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.
For paid and incurred losses and loss adjustment expenses reporting, the Company classifies its asbestos and environmental reserves into three categories: Direct, Assumed Reinsurance and London Market. Direct insurance includes primary and excess coverage. Assumed Reinsurance includes both “treaty” reinsurance (covering broad categories of claims or blocks of business) and “facultative” reinsurance (covering specific risks or individual policies of primary or excess insurance companies). London Market business includes the business written by one or more of the Company’s subsidiaries in the United Kingdom, which are no longer active in the insurance or reinsurance business. Such business includes both direct insurance and assumed reinsurance.Of the three categories of claims (Direct, Assumed Reinsurance and London Market), direct policies tend to have the greatest factual development from which to estimate the Company’s exposures.
Assumed reinsurance exposures are less predictable than direct insurance exposures because the Company does not generally receive notice of a reinsurance claim until the underlying direct insurance claim is mature. This causes a delay in the receipt of information at the reinsurer level and adds to the uncertainty of estimating related reserves.
The following table sets forth, for the years ended December 31, 2014, 2013 and 2012, paid and incurred loss activity by the three categories of claims for asbestos and environmental.
The one year gross paid amount for total asbestos claims is $304, resulting in a one year gross survival ratio of 7.2. The three year average gross paid amount for total asbestos claims is $263, resulting in a three year gross survival ratio of 8.3.
Consistent with the Company’s long-standing reserving practices, the Company will continue to review and monitor its reserves in Property & Casualty Other Operations regularly, including its annual reviews of asbestos liabilities, reinsurance recoverables and allowance for uncollectible reinsurance, and environmental liabilities, and where future developments indicate, make appropriate adjustments to the reserves. The company will complete both its annual ground-up asbestos and environmental reserve studies during the second quarter of 2015.
The previous table shows the cumulative deficiency (redundancy) of the Company’s reserves, net of reinsurance, as now estimated with the benefit of additional information. Those amounts are comprised of changes in estimates of gross losses and changes in estimates of related reinsurance recoveries.
The following table is derived from the Loss Development table and summarizes the effect of reserve re-estimates, net of reinsurance, on calendar year operations for the ten-year period ended December 31, 2014. The total of each column details the amount of reserve re-estimates made in the indicated calendar year and shows the accident years to which the re-estimates are applicable. The amounts in the total accident year column on the far right represent the cumulative reserve re-estimates during the ten year period ended December 31, 2014 for the indicated accident year(s).
The reserve re-estimates in calendar years 2005 through 2006 were largely attributable to reductions in the reinsurance recoverable asset associated with older, long-term casualty liabilities, and unexpected development on mature claims in both general liability and workers’ compensation. In addition, catastrophe reserves related to the 2004 hurricanes developed favorably in 2006.
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 and 2011 are primarily related workers’ compensation and commercial auto liability. Workers’ compensation loss cost trends were higher than initially expected as an increase in frequency outpaced a moderation of severity trends. Commercial auto liability was driven by higher frequency of large loss bodily injury claims.
Reserves were released in calendar year 2014 for accident year 2010 due to lower frequency of professional liability reported claims, favorable bond claim emergence, and lower frequency of late emerging liability claims.
For additional information on DAC, see Note 8 - Deferred Policy Acquisition Costs and Present Value of Future Profits of Notes to Consolidated Financial Statements.
The benefit (charge) to income from continuing operations, net of tax by asset and liability as a result of the Unlocks is as follows:
The Unlock charge for the year ended December 31, 2014 was primarily due to lower future estimated gross profits on the fixed annuity block driven by the continued low interest rate environment as well as higher variable annuity units costs due to higher than expected surrenders, partially offset by actual separate account returns being above our aggregated estimated returns during the period.
The Unlock charge for the year ended December 31, 2012 was driven primarily by policyholder assumption changes which reduced expected future gross profits including additional costs associated with the U.S. variable annuity macro hedge program, partially offset by actual separate account returns above our aggregated estimated return.
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. 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%.
In the third quarter of 2014, the Company completed a comprehensive non-market related policyholder behavior assumption study and incorporates the results of those studies into its projection of future gross profits. Additionally, throughout the year, the Company evaluates various aspects of policyholder behavior and periodically revises its policyholder assumptions as credible emerging data indicates that changes are warranted. The Company will continue to evaluate its assumptions related to policyholder behavior as initiatives to reduce the size of the variable annuity business are implemented by management. Upon completion of an annual assumption study or evaluation of credible new information, the Company will revise its assumptions to reflect its current best estimate. These assumption revisions will change the projected account values and the related EGPs in the DAC, SIA and URR amortization models, as well as the death and other insurance benefit reserving model. Beginning in 2015, the annual comprehensive non-market related policyholder behavior assumption study will be completed in the fourth quarter of the year.
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 36% as of December 31, 2014. 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.
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 legal entity capital held or 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.
The annual goodwill assessment for the Group Benefits, Personal Lines and Mutual Funds reporting units was completed during the fourth quarter of 2014, which resulted in no write-downs of goodwill for the year ended December 31, 2014. The reporting units passed the first step of the annual impairment test with a significant margin with the exception of the Group Benefits reporting unit. Group Benefits passed the first step of its annual impairment test with less than a 10% margin. The fair value of the Group Benefits reporting unit is based on discounted cash flows using earnings projections on in force business and future business growth. There could be a positive or negative impact on the results of step one in future periods if assumptions change about the level of economic capital, future business growth, earnings projections or the weighted average cost of capital. Please see Note 9 - Goodwill for information regarding the 2013 and 2012 impairment tests.
The fair value of AFS securities, fixed maturities, FVO, equity securities, trading, and short-term investments in an active and orderly market (i.e., not distressed or forced liquidation) are determined by management after considering one of three primary sources of information: third-party pricing services, independent broker quotations or pricing matrices. Security pricing is applied using a “waterfall” approach whereby publicly available prices are first sought from third-party pricing services, any remaining unpriced securities are submitted to independent brokers for prices, or lastly, securities are priced using a pricing matrix. Typical inputs used by these pricing methods include, but are not limited to, reported trades, benchmark yields, issuer spreads, bids, offers, and/or estimated cash flows, prepayment speeds and default rates. Based on the typical trading volumes and the lack of quoted market prices for fixed maturities, third-party pricing services will normally derive the security prices through recent reported trades for identical or similar securities making adjustments through the reporting date based upon available market observable information as outlined above. If there are no recent reported trades, the third party pricing services and brokers may use matrix or model processes to develop a security price where future cash flow expectations are developed based upon collateral performance and discounted at an estimated market rate. Included in the pricing of asset-backed-securities ("ABS") and residential mortgage-backed securities ("RMBS") are estimates of the rate of future prepayments of principal over the remaining life of the securities. Such estimates are derived based upon the characteristics of the underlying structure and prepayment speeds previously experienced at the interest rate levels projected for the underlying collateral. Actual prepayment experience may vary from these estimates. For further discussion, see the AFS Securities, Equity Securities, FVO Fixed Maturities, FVO, Equity Securities, Trading, and Short-Term Investments section in Note 5 of Notes to Consolidated Financial Statements.
Assets under management (“AUM”) include account values and mutual fund assets. AUM is a measure used by the Company because a significant portion of the Company’s revenues are based upon asset values. These revenues increase or decrease with a rise or fall in the amount of account value whether caused by changes in the market or through net flows.
The expense ratio for the underwriting segments of Commercial Lines and Personal Lines is the ratio of underwriting expenses to earned premiums. Underwriting expenses include the amortization of deferred policy acquisition costs and insurance operating costs and expenses, including certain centralized services and bad debt expense. Deferred policy acquisition costs include commissions, taxes, licenses and fees and other underwriting expenses and are amortized over the policy term.
The loss ratio is utilized for the Group Benefits segment and is expressed as a ratio of benefits, losses and loss adjustment expenses to premiums and other considerations, excluding buyout premiums. Since Group Benefits occasionally buys a block of claims for a stated premium amount, the Company excludes this buyout from the loss ratio used for evaluating the underwriting results of the business as buyouts may distort the loss ratio. Buyout premiums represent takeover of open claim liabilities and other non-recurring premium amounts.
Policies in force represent the number of policies with coverage in effect as of the end of the period. The number of policies in force is a growth measure used for Personal Lines and standard commercial lines within Commercial Lines and is affected by both new business growth and policy count retention.
Renewal written price increase (decrease) represents the combined effect of rate changes, amount of insurance and individual risk pricing decisions per unit of exposure since the prior year. The rate component represents the change in rate filings during the period and the amount of insurance represents the change in the value of the rating base, such as model year/vehicle symbol for auto, building replacement costs for property and wage inflation for workers’ compensation. A number of factors affect renewal written price increases (decreases) including expected loss costs as projected by the Company’s pricing actuaries, rate filings approved by state regulators, risk selection decisions made by the Company’s underwriters and marketplace competition. Renewal written price changes reflect the property and casualty insurance market cycle. Prices tend to increase for a particular line of business when insurance carriers have incurred significant losses in that line of business in the recent past or the industry as a whole commits less of its capital to writing exposures in that line of business. Prices tend to decrease when recent loss experience has been favorable or when competition among insurance carriers increases. Renewal written price statistics are subject to change from period to period, based on a number of factors, including changes in actuarial estimates and the effect of subsequent cancellations and non-renewals on rate achieved, and modifications made to better reflect ultimate pricing achieved.
The Company's management evaluates profitability of the P&C businesses primarily on the basis of underwriting gain (loss). Underwriting gain (loss) is a before-tax measure that represents earned premiums less incurred losses, loss adjustment expenses and underwriting expenses. Underwriting gain (loss) is influenced significantly by earned premium growth and the adequacy of the Company's pricing. Underwriting profitability over time is also greatly influenced by the Company's pricing and underwriting discipline, which seeks to manage exposure to loss through favorable risk selection and diversification, its management of claims, its use of reinsurance 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. Net income (loss) is the most directly comparable GAAP measure. The Company believes that underwriting gain (loss) provides investors with a valuable measure of before-tax profitability derived from underwriting activities, which are managed separately from the Company's investing activities. A reconciliation of underwriting gain (loss) to net income (loss) for Commercial Lines, Personal Lines and Property & Casualty Other Operations is set forth in their respective discussions herein.
Represents the residual income (loss) from operations and sale in 2011 of Specialty Risk Services (“SRS”).
Standard commercial premium measures exclude Middle Market specialty programs and livestock lines of business.
Net income, as compared to the prior year period, increased in 2014 primarily due to an improvement in underwriting results, driven by lower current accident year losses and loss adjustment expenses before catastrophes and lower prior accident years development, partially offset by a shift to net realized capital losses in the current year from net realized capital gains in the prior year period. Underwriting expenses, compared to the prior year period, reflect a reduction of $49, before tax, in the Company's estimated liability for NY State Workers' Compensation Board assessments.
Written premium increased in all small commercial lines of business, driven by favorable renewal premium due to higher policy count retention and higher written pricing, as well as an increase in new business and higher audit premium on workers' compensation policies. Written premium increases in middle market were driven primarily by higher renewal written premium in property, general liability and auto, partially offset by the impact of underwriting actions that reduced written premium in the programs business. Written premium decreases in specialty lines were primarily the result of underwriting actions to improve profitability of the captives business, partially offset by growth in national accounts and bond.
Losses and loss adjustment expenses reflect favorable current accident year losses before catastrophes in all lines of business and lower unfavorable prior accident years development.
Prior accident years reserve strengthening of $13, before tax, in 2014, compared to $83, before tax, in 2013. Development in 2014 was primarily due to discount accretion on workers' compensation and strengthening related to commercial auto liability, partially offset by a release of professional and general liability reserves. Development in 2013 was primarily due to strengthening related to commercial auto liability and the closing of the New York Section 25A Fund for Reopened Cases, partially offset by a release of professional and general liability reserves. For additional information, see MD&A - Critical Accounting Estimates, Reserve Roll-forwards and Development.
Prior accident years reserve releases of $46, before tax, in 2014 compared to $39, before tax, in 2013. Reserve releases in 2014 were primarily related to prior accident year catastrophes, as well as prior accident year homeowners and extra contractual liability reserves. Reserve releases in 2013 were primarily related to Storm Sandy. For additional information, see MD&A - Critical Accounting Estimates, Property and Casualty Insurance Product Reserves, Net of Reinsurance.
Investment income decreased in 2014, as compared to the prior year period. For discussion of consolidated investment results, see MD&A - Investment Results, Net Investment Income (Loss) and Net Realized Capital Gains (Losses).
Current accident year losses and loss adjustment expenses before catastrophes increased in 2013 compared to 2012 in line with the growth in earned premium and as reflected by the current accident year loss and loss adjustment expense ratio before catastrophes of 65.9 in 2013 as compared with 65.7 in 2012.
Prior accident years reserve releases of $39, before tax, in 2013 compared to $141, before tax, in 2012. Reserve releases in 2013 were primarily related to Storm Sandy. Reserve releases in 2012 were due to favorable emergence of losses in auto liability, homeowners and catastrophes. For additional information, see MD&A - Critical Accounting Estimates, Property and Casualty Insurance Product Reserves, Net of Reinsurance.
Group Benefits has a block of Association - Financial Institution business that is subject to a profit sharing arrangement with third parties. The Association - Financial Institutions business represented $72, $277 and $321 of premiums and other considerations, and $1, $1 and $2 of net income in 2014, 2013 and 2012, respectively.
Premiums and other considerations decreased in 2014, as compared to the prior year period, due primarily to management actions related to the Association - Financial Institutions block of business. Insurance operating costs and other expenses decreased in 2014, compared to the prior year period, due primarily to lower profit sharing expense related to the Association - Financial Institutions block of business.
Fully insured ongoing sales, excluding buyouts declined 17% in 2014, as compared to prior year period. Excluding Association - Financial Institutions block of business, fully insured ongoing sales, excluding buyouts decreased 12% in 2014 primarily due to lower large case sales.
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. For further discussion of income taxes, see Note 13 - Income Taxes of Notes to Consolidated Financial Statements.
The primary objective of Mutual Funds is to grow total AUM and core earnings. Strong fund performance, market appreciation, developing and maintaining client relationships and positive net flows are all factors that can increase AUM. Assuming normal market conditions, Mutual Funds expects moderate 2015 earnings growth driven by improved earnings from Mutual Fund assets offset by the runoff of the Talcott assets supporting the Hartford's legacy variable insurance products. The relationship with Wellington Management, sole sub-advisor for Mutual Funds, provides clients with a diversified lineup of domestic and international equity, fixed income, alternative, and asset allocation funds. These products combined with our strong long-term fund performance and expanded key client relationships are critical to drive improved net flows and future earnings.
Includes earned premiums, fee income and other related to the Retirement Plans business of $38 and $368 and the Individual Life business of $2 and $866, for the years ended December 31, 2013 and 2012, respectively.
Represents the loss from operations and sale of HLIKK in 2014, 2013 and 2012, and HLIL in 2013 and 2012. For additional information, see Note 19 Discontinued Operations of Notes to Consolidated Financial Statements.
Other account value includes $53.0 billion, $14.9 billion, and $39.8 billion as of December 31, 2014, and $54.7 billion, $14.7 billion, and $38.7 billion as of December 31, 2013, for the Retirement Plans, Individual Life, and Private Placement Life Insurance businesses; respectively. Account values associated with the Retirement Plans, and Individual Life businesses no longer generate asset-based fee income due to the sales of these businesses through reinsurance.
Includes net losses for the year ended December 31, 2012, related to the Retirement Plans and Individual Life businesses sold in 2013 of $39 and $172, respectively. For further discussion of the disposed businesses, see Note 2 - Business Dispositions of Notes to Consolidated Financial Statements.
[6] Excludes account value related to the Japan business sold on June 30, 2014.
The principal goal for Talcott Resolution is to reduce the size and risk associated with the Company's 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 effective tax rates in 2014 and 2013 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 13 - Income Taxes of Notes to Consolidated Financial Statements.
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). 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.
The pension settlement charge in 2014 is related to voluntary lump-sum settlements with vested participants in the Company's defined benefit pension plan who had separated from service, but who had not yet commenced annuity benefits. For additional information regarding the pension settlement, see Note 17 - Employee Benefit Plans of Notes to Consolidated Financial Statements.
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 of the property and casualty insurance subsidiaries prior to reinsurance and to less than 15% of statutory surplus of the property and casualty insurance subsidiaries 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 6.0 to 8.2 on the Moment Magnitude scale. For the peril of hurricane, the 21 events averaged to determine the modeled loss estimate include category 2, 3, 4 and 5 events in Florida, as well as other Gulf, Mid Atlantic and Northeastern region landfalls.
The Company defines terrorism risk as the risk of losses from terrorist attacks, including losses caused by single-site and multi-site conventional attacks, as well as the potential for attacks using nuclear, biological, chemical or radiological weapons (“NBCR”). The Company monitors aggregations of terrorism risk exposure around key landmarks primarily in major metropolitan areas that span the Company's insurance portfolio. ERM limits for terrorism apply to aggregations of risk across property-casualty, group benefits and specific asset portfolios and are defined based on a deterministic, single-site conventional terrorism attack scenario. The Company manages its potential estimated loss from a conventional terrorism loss scenario to less than $1.3 billion. In addition, the Company monitors exposures monthly and employs both internally developed and vendor-licensed loss modeling tools as part of its risk management discipline. While our modeled exposures to conventional terrorist attacks around landmark locations may fluctuate above and below $1.3 billion, currently, all such terrorism exposures are within ERM limits. For a discussion on risks related to terrorist attacks, see the risk factor, "The occurrence of one or more terrorist attacks in the geographic areas we serve or the threat of terrorism in general may have a material adverse effect on our business, financial condition, results of operations and liquidity."
The per occurrence limit on the FHCF treaty is $109 for the 6/1/2014 to 6/1/2015 treaty year based on the Company's election to purchase the required coverage from FHCF. Coverage is based on the best available information from FHCF, which was updated in January 2015.
In addition to the property catastrophe reinsurance coverage described in the above table, the Company has other catastrophe and working layer treaties and facultative reinsurance agreements that cover property catastrophe losses on an aggregate excess of loss and on a per risk basis. The principal property catastrophe reinsurance program and certain other reinsurance programs include a provision to reinstate limits in the event that a catastrophe loss exhausts limits on one or more layers under the treaties. In addition, covering the period from January 1, 2014 to December 31, 2016, the Company has an aggregate loss treaty in place which provides one limit of $200 over the three-year period of aggregate qualifying property catastrophe losses in excess of a net retention of $860.
In addition to the reinsurance protection provided by The Hartford's traditional property catastrophe reinsurance program described above, until February 18, 2015, the Hartford had a fully collateralized reinsurance coverage from Foundation Re III for losses sustained from qualifying hurricane loss events. Under the terms of the treaty, the Company had coverage 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 December 31, 2014:
For the risk of terrorism, private sector catastrophe reinsurance capacity is generally limited and largely unavailable for terrorism losses caused by nuclear, biological, chemical or radiological weapons attacks. As such, the Company's principal reinsurance protection against large-scale terrorist attacks is the coverage currently provided through the TRIPRA 2015. On January 12, 2015, the President signed TRIPRA 2015, extending TRIPRA 2007, through the end of 2020. TRIPRA 2015 provides a backstop for insurance-related losses resulting from any “act of terrorism”, which is certified by the Secretary of Homeland Security and Attorney General and requires consultation by the Secretary of Treasury, for losses that that exceed a threshold of industry losses of $100 in 2015, and continue to increase to $200 by 2020. Under the program, in any one calendar year, the federal government would pay losses of 85% in 2015, which then continue to decrease 1% annually, starting on January 1st, 2016, down to 80% by the year 2020, from a certified act of terrorism after an insurer's losses exceed 20% of the Company's eligible direct commercial earned premiums of the prior calendar year up to a combined annual aggregate limit for the federal government and all insurers of $100 billion. The Company's estimated deductible under the program is $1.19 billion for 2015. If an act of terrorism or acts of terrorism result in covered losses exceeding the $100 billion annual industry aggregate limit, a future Congress would be responsible for determining how additional losses in excess of $100 billion will be paid.
Based on A.M. Best ratings as of December 31, 2014 and 2013, respectively.
Where its contracts permit, the Company secures future claim obligations with various forms of collateral, including irrevocable letters of credit, secured trusts, funds held accounts and group wide offsets. As part of its reinsurance recoverable review, the Company analyzes recent developments in commutation activity between reinsurers and cedants, recent trends in arbitration and litigation outcomes in disputes between cedants and reinsurers and the overall credit quality of the Company’s reinsurers. As indicated in the above table, 64.1% of the gross reinsurance recoverables due from reinsurers rated by A.M. Best were rated A- (excellent) or better as of December 31, 2014. Due to the inherent uncertainties as to collection and the length of time before such amounts will be due, it is possible that future adjustments to the Company’s reinsurance recoverables, net of the allowance, could be required, which could have a material adverse effect on the Company’s consolidated results of operations or cash flows in a particular quarterly or annual period.
Annually, the Company completes evaluations of the reinsurance recoverable asset associated with older, long-term casualty liabilities reported in the Property & Casualty Other Operations reporting segment, and the allowance for uncollectible reinsurance reported in the Commercial Lines reporting segment. For a discussion regarding the results of these evaluations, see MD&A - Critical Accounting Estimates, Property and Casualty Insurance Product Reserves, Net of Reinsurance.
ORM works closely with the Operational Risk Committee (“ORC”), an enterprise wide governance group comprised of senior leaders from functional areas such as ORM, Operations and Technology, Claims, Legal, Compliance, Finance and Internal Audit. The ORC meets regularly and provides a forum for ensuring the effective identification, assessment, control, ownership, management and reporting of operational risks across the enterprise. Individual committees, such as the Enterprise Privacy and Security Committee, Enterprise Health, Environment and Safety Committee, and the Model Oversight Committees focus on specific operational risk issues.
ORM has various tools and processes for identifying, monitoring, measuring, prioritizing, and reporting operational risks. ORM facilitates the business risk assessment process which is used to identify the top risks in the business and functional areas, evaluate controls to mitigate those risks, and monitor control improvements. ORM also facilitates loss event collection and analysis, scenario analysis, and aggregated reporting of risks. ORM uses a centralized Governance, Risk, and Compliance (GRC) system to help manage operational risk primarily within the Company's finance, legal, compliance, data security, and information technology functions.
The Company has defined ongoing monitoring and reporting requirements to assess liquidity across the enterprise. The Company measures and manages liquidity risk exposures and funding needs within prescribed limits and across legal entities, business lines and currencies, taking into account legal, regulatory and operational limitations to the transferability of liquidity. The Company also monitors internal and external conditions, identifies material risk changes and emerging risks that may impact liquidity. The Company's CFO has primary responsibility for liquidity risk.
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. Key metrics that 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 17 - 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.
As of December 31, 2014 and 2013 notional amounts pertaining to derivatives utilized to manage interest rate risk, including offsetting positions, totaled $19.3 billion and $15.3 billion, respectively ($19.2 billion and $15.1 billion, respectively, related to investments and $0.1 billion and $0.2 billion, respectively, related to Talcott Resolution liabilities). The fair value of these derivatives was $(468) and $(603) as of December 31, 2014 and 2013, respectively. These amounts do not include derivatives associated with the Variable Annuity Hedging Program.
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, 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 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.
The carrying value of fixed maturities, commercial mortgage loans and short-term investments related to the businesses included in the table above was $27.2 billion and $28.6 billion, as of December 31, 2014 and 2013, respectively. The hypothetical change in net economic value increased as compared to December 31, 2013, primarily as a result of the impact of higher asset fair values driven by lower interest rates. The assets supporting the fixed liabilities are monitored and managed within set duration guidelines, and are evaluated on a daily basis, as well as annually using scenario simulation techniques in compliance with regulatory requirements.
Equity risk is defined as the risk of financial loss due to changes in the value of global equities or equity indices. The Company has exposure to equity risk from assets under management, embedded derivatives within the Company’s variable annuities and assets that support the Company’s pension plans. Equity Risk on the Company’s Variable Annuity products is mitigated through various hedging programs. (See the Variable Annuity Hedge Program Section)
The Company’s macro hedging program uses derivative instruments such as options and futures on equities and interest rates to provide protection against the statutory tail scenario risk arising from GMWB and GMDB liabilities, on the Company’s statutory surplus. These macro hedges cover some of the residual risks not otherwise covered by specific dynamic hedging programs. Management assesses this residual risk under various scenarios in designing and executing the macro hedge program. The macro hedge program will result in additional U.S. GAAP earnings volatility as changes in the value of the macro hedge derivatives, which are designed to reduce statutory reserve and capital volatility, may not be closely aligned to changes in GAAP liabilities.
The following table presents our estimates of the potential instantaneous impacts from sudden market stresses related to equity market prices, interest rates, implied market volatilities, and foreign currency exchange rates. The sensitivities below represent: (1) the net estimated difference between the change in the fair value of GMWB liabilities and the underlying hedge instruments and (2) the estimated change in fair value of the hedge instruments for the macro program, before the impacts of amortization of DAC, and taxes. As noted above, certain hedge assets are used to hedge liabilities that are not carried at fair value and will not have a liability offset in the GAAP sensitivity analysis. All sensitivities are measured as of year end and are related to the fair value of liabilities and hedge instruments in place as of year end for the Company’s variable annuity hedge programs. The impacts presented in the table below are estimated individually and measured without consideration of any correlation among market risk factors.
The sensitivity analysis is only valid as of the measurement date and assumes instantaneous changes in the capital market factors and no ability to rebalance hedge positions prior to the market changes;
Based on the fair values of the Company’s non-U.S. dollar denominated securities and derivative instruments as of December 31, 2014 and 2013, management estimates that a 10% unfavorable change in exchange rates would decrease the fair values by a before-tax total of approximately $38 and $165, respectively. The estimated impact was based upon a 10% change in December 31 spot rates. The selection of the 10% unfavorable change was made only for illustration of the potential hypothetical impact of such an event and should not be construed as a prediction of future market events. Actual results could differ materially from those illustrated above due to the nature of the estimates and assumptions used in the above analysis.
The Company has foreign currency exchange risk associated with the yen denominated Japan fixed payout annuities reinsured from HLIKK. The Company has entered into pay U.S. dollar, receive yen swap contracts to hedge the currency exposure between the U.S. dollar denominated assets and the yen denominated fixed liability reinsurance payments.
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, 2014 and 2013, the derivatives used to hedge foreign currency exchange risk related to foreign denominated liability contracts had a total notional amount of $94 and a total fair value of $(20) and $(1), respectively.
Our statutory surplus is also impacted by widening credit spreads as a result of the accounting for the assets and liabilities in our fixed market value adjusted ("MVA") annuities. Statutory separate account assets supporting the fixed MVA annuities are recorded at fair value. In determining the statutory reserve for the fixed MVA annuities, we are required to use current crediting rates in the U.S. In many capital market scenarios, current crediting rates in the U.S. are highly correlated with market rates implicit in the fair value of statutory separate account assets. As a result, the change in statutory reserve from period to period will likely substantially offset the change in the fair value of the statutory separate account assets. However, in periods of volatile credit markets, such as we experienced in 2008 and 2009, actual credit spreads on investment assets may increase sharply for certain sub-sectors of the overall credit market, resulting in statutory separate account asset market value losses. As actual credit spreads are not fully reflected in the current crediting rates in the U.S. the calculation of statutory reserves will not substantially offset the change in fair value of the statutory separate account assets resulting in reductions in statutory surplus. This has resulted and may continue to result in the need to devote significant additional capital to support the product.
Credit risk policies at the enterprise and operation level ensure comprehensive and consistent approaches to quantifying, evaluating, and managing credit risk under expected and stressed conditions. These policies define the scope of the risk, authorities, accountabilities, terms, and limits, and are regularly reviewed and approved by senior management and ERM. Aggregate counterparty credit quality and exposure is monitored on a daily basis utilizing an enterprise-wide credit exposure information system that contains data on issuers, ratings, exposures, and credit limits. Exposures are tracked on a current and potential basis. Credit exposures are reported regularly to the ERCC and to the Finance, Investment and Risk Management Committee. Exposures are aggregated by ultimate parent across investments, reinsurance receivables, insurance products with credit risk, and derivative counterparties. The credit database and reporting system are available to all key credit practitioners in the enterprise.
The Company exercises various and differing methods to mitigate its credit risk exposure within its investment and reinsurance portfolios. Some of the reasons for mitigating credit risk include financial instability or poor credit, avoidance of arbitration or litigation, future uncertainty, and exposure in excess of risk tolerances. Credit risk within the investment portfolio is most commonly mitigated through asset sales or the use of derivative instruments. Counterparty credit risk is mitigated through the practice of entering into contracts only with highly creditworthy institutions and through the practice of holding and posting of collateral. In addition, transactions cleared through a central clearing house reduce risk due to their ability to require daily variation margin, monitor the Company's ability to request additional collateral in the event of a counterparty downgrade, and be an independent valuation source. Systemic credit risk is mitigated through the construction of high-quality, diverse portfolios that are subject to regular underwriting of credit risks. For further discussion of the Company’s investment and derivative instruments, see MD&A - Enterprise Risk Management, Portfolio Risks and Risk Management and Note 6 - Investments and Derivative Instruments of Notes to Consolidated Financial Statements. For further discussion on managing and mitigating credit risk from the use of reinsurance via an enterprise security review process, see MD&A - Enterprise Risk Management, Insurance Risk Management, Reinsurance as a Risk Management Strategy.
For the company’s derivative programs, the maximum uncollateralized threshold for a derivative counterparty for a single legal entity is $10. The Company currently transacts OTC derivatives in five legal entities that have a threshold greater than zero; and therefore the maximum combined threshold for a single counterparty across all legal entities that use derivatives is $50. In addition, the Company may have exposure to multiple counterparties in a single corporate family due to a common credit support provider. As of December 31, 2014 the maximum combined threshold for all counterparties under a single credit support provider across all legal entities that use derivatives is $100. Based on the contractual terms of the collateral agreements, these thresholds may be immediately reduced due to a downgrade in either party’s credit rating. For further discussion, see the Derivative Commitments section of Note 15 of Notes to Consolidated Financial Statements.
For the year ended December 31, 2014, the Company has incurred no losses on derivative instruments due to counterparty default.
As of December 31, 2014 and 2013, the notional amount related to credit derivatives that purchase credit protection was $0.6 billion and $1.3 billion, respectively, while the fair value was $(6) and $(10), respectively. As of December 31, 2014 and 2013, the notional amount related to credit derivatives that assume credit risk was $1.5 billion and $1.9 billion, respectively, while the fair value was $3 and $33, respectively. For further information on credit derivatives, see Note 6 of Notes to Consolidated Financial Statements.
The value of securities in the AA category declined as compared to December 31, 2013, primarily due to the sale of Japan Government bonds concurrent with the disposition of the Japan variable and fixed annuity business. The value of securities in the A category increased as a percentage of total as a result of the reduction in the AA rated securities discussed above. In addition, the value of securities in the BBB and BB & below categories has declined, as a result of sales of certain emerging market securities, primarily within the foreign government and corporate sectors. Fixed maturities, FVO, are not included in the above table. For further discussion on fair value option securities, see Note 5 - Fair Value Measurements of Notes to Consolidated Financial Statements.
The Company has limited direct exposure within its investment portfolio to the energy sector, totaling only 5% of total invested assets as of December 31, 2014, and is primarily comprised of corporate and sovereign debt. The Company's exposure is primarily comprised of investment grade securities and the exposure is diversified by issuer and in different sub sectors of the energy market. The Company selectively reduced its exposure to the energy sector by approximately $300 in the fourth quarter of 2014. The table below summarizes the Company's exposure to the energy sector by sector and credit quality.
The Company manages the credit risk associated with the energy sector within the investment portfolio on an on-going basis using macroeconomic analysis and issuer credit analysis. The Company considers alternate scenarios including oil prices remaining at low levels for an extended period and/or declining significantly below current levels. For additional details regarding the Company’s management of credit risks, see the Credit Risk Section of this MD&A. The Company has evaluated all available-for-sale securities for potential other-than-temporary impairments as of December 31, 2014 and 2013 and concluded that for the securities in an unrealized loss position, it is more likely than not that we will recover our entire amortized cost basis in the securities. In addition, the Company does not currently have the intent-to-sell, nor will we be required to sell, the securities discussed above. For additional details regarding the Company’s impairment process, see the Other-Than-Temporary Impairments Section of this MD&A.
The Company has limited direct exposure within its investment portfolio to emerging market issuers, totaling only 2% of total invested assets as of December 31, 2014, and is primarily comprised of sovereign and corporate debt issued in US dollars. The Company identifies exposures with the issuers’ ultimate parent country of domicile, which may not be the country of the security issuer. The following table presents the Company’s exposure to securities within certain emerging markets currently under the greatest stress, defined as countries that have a sovereign S&P credit rating of B- or below; or countries that have had a current account deficit and has an average inflation level greater than 5% over the past six months.
Includes an amortized cost and fair value of $137 and $131, respectively, as of December 31, 2014 and an amortized cost and fair value of $254 and $237, respectively, as of December 31, 2013 included in the exposure to the energy sector table above.
As of December 31, 2014 and 2013, the Company had credit default swap protection with a notional amount of $3 related and $23 related to Corporate and Equity, AFS, respectively.
Includes an amortized cost and fair value of $389 and $407, respectively, as of December 31, 2014 and an amortized cost and fair value of $574 and $590, respectively, as of December 31 2013 included in the exposure to the energy sector table above.
The Company's exposure to the financial services sector remained relatively consistent, as the impact of sales was largely offset by higher valuations due to a decline in interest rates.
The Company also has AFS exposure to CRE CDOs with an amortized cost and fair value of $114 and $193, respectively, as of December 31, 2014 and $176 and $248, respectively, as of December 31, 2013. These securities are comprised of diversified pools of commercial mortgage loans or equity positions of other CMBS securitizations. We continue to monitor these investments as economic and market uncertainties regarding future performance impact market liquidity and security premiums.
The following table summarizes the amortized cost, fair value, and weighted average credit quality of the Company's available-for-sale investments in securities backed by states, municipalities and political subdivisions (“municipal bonds”).
Pre-refunded bonds are bonds for which an irrevocable trust containing sufficient U.S. treasury, agency, or other securities has been established to fund the remaining payment of principal and interest.
The following table presents the Company’s investments in limited partnerships and other alternative investments which include hedge funds, mortgage and real estate funds, mezzanine debt funds, and private equity and other funds. Hedge funds are comprised of approximately half credit and equity related funds and approximately half global macro related funds with a market neutral focus. Mortgage and real estate funds consist of investments in funds whose assets consist of mortgage loans, mortgage loan participations, mezzanine loans or other notes which may be below investment grade, as well as equity real estate and real estate joint ventures. Mezzanine debt funds include investments in funds whose assets consist of subordinated debt that often incorporates equity-based options such as warrants and a limited amount of direct equity investments. Private equity and other funds primarily consist of investments in funds whose assets typically consist of a diversified pool of investments in small to mid-sized non-public businesses with high growth potential.
The total gross unrealized losses were $385 as of December 31, 2014, and have decreased $692, or 64%, from December 31, 2013, primarily due to a decrease in interest rates as well as sales. As of December 31, 2014, $324 of the gross unrealized losses were associated with securities depressed less than 20% of cost or amortized cost.
The remaining $61 of gross unrealized losses were associated with securities depressed greater than 20%. The securities depressed more than 20% are primarily corporate and equity securities within the energy sector, and securities with exposure to commercial real estate that have market spreads that are wider than the spreads at the securities' respective purchase dates. Unrealized losses on corporate and equity securities in the energy sector is primarily the result of the recent decline in oil prices previously discussed; see Exposure to the Energy Sector in the Investment Portfolio Risks and Risk Management section of this MD&A. 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 with exposure to commercial real estate have sufficient credit protection levels to receive contractually obligated principal and interest payments.
As part of the Company’s ongoing security monitoring process, the Company has reviewed its AFS securities in an unrealized loss position and concluded that these securities are temporarily depressed and are expected to recover in value as the securities approach maturity or as real estate related market spreads continue to improve. For these securities in an unrealized loss position where a credit impairment has not been recorded, the Company’s best estimate of expected future cash flows are sufficient to recover the amortized cost basis of the security. Furthermore, the Company neither has an intention to sell nor does it expect to be required to sell these securities. For further information regarding the Company’s impairment analysis, see Other-Than-Temporary Impairments in the Investment Portfolio Risks and Risk Management section of this MD&A.
Impairments for the year ended December 31, 2014 were primarily credit impairments concentrated in corporate securities. The corporate securities were impaired due to certain issuers that have experienced financial difficulty and either defaulted or are expected to default on contractually obligated principal and interest payments. Also included in credit impairments for the year ended December 31, 2014, were private placements that were impaired due to declines in expected cash flows related to the underlying referenced securities. The Company’s determination of expected future cash flows used to calculate the credit loss amount is a quantitative and qualitative process. The Company incorporates its best estimate of future cash flows using internal assumptions and judgments that are informed by economic and industry specific trends, as well as our expectation with respect to security specific developments. Credit impairments for the year ended December 31, 2014 were primarily identified through security specific reviews and resulted from changes in the financial condition and near term prospects of certain issuers. Other impairments for the year ended December 31, 2014 primarily related to certain equity, AFS securities with debt-like characteristics that the Company intends to sell.
In addition to the credit impairments recognized in earnings, the Company recognized non-credit impairments in other comprehensive income of $5 for the year ended December 31, 2014, predominantly concentrated in corporate securities and CMBS. These non-credit impairments represent the difference between fair value and the Company’s best estimate of expected future cash flows discounted at the security’s effective yield prior to impairment, rather than at current market implied credit spreads. These non-credit impairments primarily represent increases in market liquidity premiums and credit spread widening that occurred after the securities were purchased, as well as a discount for variable-rate coupons which are paying less than at purchase date. In general, larger liquidity premiums and wider credit spreads are the result of deterioration of the underlying collateral performance of the securities, as well as the risk premium required to reflect future uncertainty in the real estate market.
For the year ended December 31, 2013, impairments recognized in earnings were comprised of credit impairments of $32, primarily concentrated in corporate and fixed rate CMBS bonds. Also, included were impairments on debt securities for which the Company had the intent-to-sell of $26, primarily related to structured securities with exposure to commercial and residential real estate and corporate securities. In addition, impairments recognized in earnings included impairments on equity securities of $15 that were in an unrealized loss position and the Company no longer believed the securities would recover in the foreseeable future.
For the year ended December 31, 2012, impairments recognized in earnings were comprised of intent-to-sell impairments of $238, which included $177 related to the sale of the Retirement Plans and Individual Life businesses. Also included were impairments on equity securities of $63 largely comprised of downgraded preferred equity securities of financial institutions. The Company's credit impairments totaled $48, primarily concentrated in structured securities associated with residential and commercial real estate, as well as ABS small business.
The Hartford has an intercompany liquidity agreement that allows for short-term advances of funds among the HFSG Holding Company and certain affiliates of up to $2.0 billion for liquidity and other general corporate purposes. The Connecticut Insurance Department granted approval for certain affiliated insurance companies that are parties to the agreement to treat receivables from a parent, including the HFSG Holding Company, as admitted assets for statutory accounting purposes. As of December 31, 2014, there were no amounts outstanding from the HFSG holding company.
In 2014, the Board of Directors approved increases aggregating $1.525 billion in the Company's authorized equity repurchase program, bringing the total authorization for equity repurchases to $2.775 billion for the period January 1, 2014 through December 31, 2015, with $979 remaining as of December 31, 2014.
In 2014, the Board also authorized the Company to allocate up to $500, including any premium or associated costs, to reduce debt outstanding. Initially expected to be completed prior to year end 2014, any repurchase of debt under the debt reduction allocation is now intended to occur in 2015 dependent on market conditions. In addition, the Company intends to repay at maturity the 4% senior notes due March 2015 and the 7.3% senior notes due November 2015 totaling $456.
On April 18, 2013, the Company issued $300 aggregate principal amount of 4.3% Senior Notes (the "4.3% Notes") due April 15, 2043. On March 26, 2013, the Company repurchased principal amounts of approximately $800, plus a payment for unpaid interest on senior notes due through the settlement date. The Company recognized a loss on extinguishment in 2013 of approximately $213, before tax, representing the excess of the repurchase price over the principal repaid and the write-off of the unamortized discount and debt issuance costs. For further information regarding debt, see Note 12 - Debt of Notes to Consolidated Financial Statements.
Until April 1, 2014, Hartford Life and Annuity Insurance Company ("HLAI"), a wholly-owned subsidiary of the Company, ceded certain variable annuity contracts and their associated riders as well as certain payout annuities issued by HLAI or assumed by it to White River Life Reinsurance Company ("WRR"), an affiliate captive reinsurer which was dissolved on April 30, 2014. Upon dissolution, WRR repaid an intercompany note payable to the Company in the amount of $655 and returned $367 in capital to the Company, all of which was contributed as capital to HLAI to support the recaptured business. Effective April 1, 2014, the Company recaptured all reinsured risks from WRR to HLAI. This transaction received required regulatory approvals.
On February 26, 2015, The Hartford’s Board of Directors declared a quarterly dividend of $0.18 per common share payable on April 1, 2015 to common shareholders of record as of March 9, 2015. 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 Part I, Item 1A, - Risk Factors for the risk factor "Our ability to declare and pay dividends is subject to limitations" .
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 State of Connecticut Insurance Department ("CTDOI"). 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.
In 2014, HFSG Holding Company received approximately $2.5 billion in dividends from its property-casualty insurance subsidiaries through a series of transactions affecting the property and casualty and life insurance subsidiaries, including $1.4 billion of extraordinary dividends. As a result of the extraordinary dividend received in July 2014, Hartford Fire has no remaining ordinary dividend capacity for the twelve months following. As such, the Company does not anticipate taking any dividends from Hartford Fire until the third quarter of 2015. The dividends received from its property-casualty subsidiaries included $97 related to funding interest payments on an intercompany note between Hartford Holdings, Inc. (“HHI”) and Hartford Fire Insurance Company.
In 2015, 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 without prior approval from the applicable insurance commissioner. In 2015, HFSG Holding Company anticipates receiving approximately $600 in dividends from its property-casualty insurance subsidiaries, net of any dividends paid by its property-casualty subsidiaries to fund interest payments on an intercompany note between HHI and Hartford Fire Insurance Company.
On January 30, 2015, HLA paid an extraordinary dividend of $100, based on approval received from the CTDOI. As a result of dividends and distributions taken in the preceding twelve months, effective March 3, 2015, HLA will have approximately $155 of ordinary dividend capacity available for the remainder of 2015. HFSG Holding Company anticipates receiving an additional $100 of dividends from HLA during 2015.
On January 30, 2015, HLIC paid an extraordinary dividend of $500, based on approval received from the CTDOI. As a result of this dividend, HLIC has no ordinary dividend capacity for the remainder of 2015. HFSG Holding Company anticipates receiving an additional $500 of extraordinary dividends from HLIC during 2015.
The Hartford endeavors to maintain a capital structure that provides financial and operational flexibility to its insurance subsidiaries, ratings that support its competitive position in the financial services marketplace (see the “Ratings” section below for further discussion), and shareholder returns. As a result, the Company may from time to time raise capital from the issuance of equity, equity-related debt or other capital securities and is continuously evaluating strategic opportunities. The issuance of debt, common equity, equity-related debt or other capital securities could result in the dilution of shareholder interests or reduced net income due to additional interest expense.
HLIKK previously had four revolving credit facilities in support of operations. These credit facilities were transfered with the sale of HLIKK on June 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, 2014 was $1.0 billion. Of this $1.0 billion the legal entities have posted collateral of $1.3 billion in the normal course of business. In addition, the Company has posted collateral of $41 associated with a customized GMWB derivative. Based on derivative market values as of December 31, 2014, a downgrade of one level below the current financial strength ratings by either Moody’s or S&P could require approximately an additional $4 to be posted as collateral. Based on derivative market values as of December 31, 2014, 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 $18 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, 2014, the aggregate notional amount and fair value of derivative relationships that could be subject to immediate termination in the event of rating agency downgrades to either BBB+ or Baa1 was $388 and $3, respectively.
The Company’s insurance operations consist of property and casualty insurance products (collectively referred to as “Property & Casualty Operations”) and life insurance and legacy annuity products (collectively referred to as “Life Operations”).
As of December 31, 2014, Property & Casualty 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.
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 2013.
HLIC, an indirect wholly owned subsidiary, became a member of the Federal Home Loan Bank of Boston (“FHLBB”) in May 2011. Membership allows HLIC access to collateralized advances, which may be used to support various spread-based businesses and enhance liquidity management. The Connecticut Department of Insurance (“CTDOI”) will permit HLIC to pledge up to $1.39 billion in qualifying assets to secure FHLBB advances for 2015. The amount of advances that can be taken are dependent on the asset types pledged to secure the advances. The pledge limit is recalculated annually based on statutory admitted assets and capital and surplus. HLIC would need to seek the prior approval of the CTDOI if there were a desire to exceed these limits. As of December 31, 2014, HLIC had no advances outstanding under the FHLBB facility.
In the event customers elect to surrender separate account assets or international statutory separate accounts, Life Operations will use the proceeds from the sale of the assets to fund the surrender, and Life Operations’ liquidity position will not be impacted. In many instances Life Operations will receive a percentage of the surrender amount as compensation for early surrender (surrender charge), increasing Life Operations’ liquidity position. In addition, a surrender of variable annuity separate account or general account assets (see below) will decrease Life Operations’ obligation for payments on guaranteed living and death benefits.
Surrenders of, or policy loans taken from, as applicable, these general account liabilities, which include the general account option for Life Operations' individual variable annuities and the variable life contracts of the former Individual Life business, the general account option for annuities of the former Retirement Plans business and universal life contracts sold by the former Individual Life business, may be funded through operating cash flows of Life Operations, available short-term investments, or Life Operations may be required to sell fixed maturity investments to fund the surrender payment. Sales of fixed maturity investments could result in the recognition of realized losses and insufficient proceeds to fully fund the surrender amount. In this circumstance, Life Operations may need to take other actions, including enforcing certain contract provisions which could restrict surrenders and/or slow or defer payouts. The Company has ceded reinsurance in connection with the sales of its Retirement Plans and Individual Life businesses in 2013 to MassMutual and Prudential, respectively.
The Company does not have any off-balance sheet arrangements that are reasonably likely to have a material effect on the financial condition, results of operations, liquidity, or capital resources of the Company, except for the contingent capital facility described above, as well as unfunded commitments to purchase investments in limited partnerships and other alternative investments, private placements, and mortgage loans of $865 as disclosed in Note 14 - Commitments and Contingencies of Notes to Consolidated Financial Statements.
Under U.S. GAAP, the Company is only permitted to discount reserves for losses and loss adjustment expenses in cases where the payment pattern and ultimate loss costs are fixed and determinable on an individual claim basis. For the Company, these include claim settlements with permanently disabled claimants. As of December 31, 2014, the total property and casualty reserves in the above table are gross of a reserve discount of $556.
Includes future minimum lease payments on operating lease agreements. See Note 14 of Notes to Consolidated Financial Statements for additional discussion on lease commitments.
Includes $865 in commitments to purchase investments including approximately $604 of limited partnership and other alternative investments, $15 of private placements, and $246 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 Sheets. Also included in purchase obligations is $980 relating to contractual commitments to purchase various goods and services such as maintenance, human resources, and information technology 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.
The capital structure of The Hartford as of December 31, 2014 and 2013 consisted of debt and stockholders’ equity, summarized as follows:
For additional information AOCI, net of tax, see Note 2 - Business Dispositions and Note 16 - Changes In and Reclassifications From Accumulated Other Comprehensive Income of Notes to Consolidated Financial Statements, respectively.
Year ended December 31, 2013 compared to the year ended December 31, 2012
Cash provided by operating activities decreased primarily due to realized capital losses of $1.5 billion in 2013, compared to an increase in income taxes received of $486 in 2012.
Cash used for investing activities in 2013 primarily relates to net proceeds of available-for-sale securities of $4.9 billion and proceeds from business sold of $815 offset by net payments on derivatives of $2.2 billion. Cash used for investing activities in 2012 primarily relates to net payments on derivatives of $2.7 billion, purchases of mortgage loans of $968 and net payments for the purchases of partnerships of $695, partially offset by net proceeds of available-for-sale securities of $1.7 billion and net receipts of fixed maturities, fair value option of $101.
On March 6, 2014, Moody’s Investors Service (“Moody’s”) affirmed the debt ratings of The Hartford Financial Services Group, Inc. and the insurance financial strength ratings of its property and casualty subsidiaries and Hartford Life and Accident Insurance Company. The outlook on these entities was changed to positive from stable. Moody’s downgraded the insurance financial strength rating of Hartford Life Insurance Company to Baa2 from A3. Moody’s affirmed the insurance financial strength rating of Hartford Life and Annuity Insurance Company. Moody's outlook for Hartford Life Insurance Company and Hartford Life and Annuity Insurance Company is stable.
On August 29, 2014 Fitch Ratings affirmed and withdrew the ratings on the HFSG holding company, as well as the insurer financial strength rating of its insurance subsidiaries for commercial reasons.
The table below sets forth statutory surplus for the Company’s insurance companies as of December 31, 2014 and 2013:
Statutory capital and surplus for the U.S. life insurance subsidiaries, including domestic captive insurance subsidiaries in 2013, increased by $518, primarily due to variable annuity surplus impacts of $788, net income from non-variable annuity business of $187, increases in unrealized gains from other invested assets carrying values of $138, partially offset by returns of capital of $500, and changes in reserves on account of change in valuation basis of $100. Effective April 30, 2014 the last domestic captive ceased operations.
The Company also held regulatory capital and surplus for its former operations in Japan until the sale of those operations on June 30, 2014. Under the accounting practices and procedures governed by Japanese regulatory authorities, the Company’s statutory capital and surplus was $1.2 billion as of December 31, 2013.
U.S. STAT for life insurance companies establishes a formula reserve for realized and unrealized losses due to default and equity risks associated with certain invested assets (the Asset Valuation Reserve), while U.S. GAAP does not. Also, for those realized gains and losses caused by changes in interest rates, U.S. STAT for life insurance companies defers and amortizes the gains and losses, caused by changes in interest rates, into income over the original life to maturity of the asset sold (the Interest Maintenance Reserve) while U.S. GAAP does not.
The Company's U.S. insurance companies' states of domicile impose risk-based capital (“RBC”) requirements. The requirements provide a means of measuring the minimum amount of statutory capital and surplus (referred to collectively as "capital") appropriate for an insurance company to support its overall business operations, based on its size and risk profile. Regulatory compliance is determined by a ratio of a company's total adjusted capital (“TAC”) to its authorized control level RBC (“ACL RBC”). Companies below specific trigger points or ratios are classified within certain levels, each of which requires specified corrective action. The minimum level of TAC before corrective action commences (“Company Action Level”) is two times the ACL RBC. The adequacy of a company's capital is determined by the ratio of a company's TAC to its Company Action Level, known as the "RBC ratio". All of the Company's operating insurance subsidiaries had RBC ratios in excess of the minimum levels required by the applicable insurance regulations. On an aggregate basis, The Company's U.S. property and casualty insurance companies' RBC ratio was in excess of 200% of its Company Action Level as of December 31, 2014 and 2013. The RBC ratios for the Company's principal life insurance operating subsidiaries were all in excess of 425% of their respective Company Action Levels as of December 31, 2014 and 2013. The reporting of RBC ratios is not intended for the purpose of ranking any insurance company, or for use in connection with any marketing, advertising or promotional activities.
Legal Proceedings - For a discussion regarding contingencies related to The Hartford’s legal proceedings, please see the information contained under “Litigation” and “Asbestos and Environmental Claims,” in Note 14 - Commitments and Contingencies of Notes to Consolidated Financial Statements, which is incorporated herein by reference.
For a discussion of terrorism reinsurance legislation and how it affects The Hartford, see MD&A - Enterprise Risk Management, Insurance Risk Management, Terrorism Risk.
On February 2, 2015, the Obama Administration released its “Fiscal Year 2016, Budget of the U.S. Government” (the “Budget”). Although the Administration has not released proposed statutory language, the Budget includes proposals that if enacted, would affect the taxation of life insurance companies and certain life insurance products. In particular, the proposals would change the method used to determine the amount of dividend income received by a life insurance company on assets held in separate accounts used to support products, including variable life insurance and variable annuity contracts, which are eligible for the dividends received deduction (“DRD”). The DRD reduces the amount of dividend income subject to tax and is a significant component of the difference between the Company's actual tax expense and expected amount determined using the federal statutory tax rate of 35%. If this proposal were enacted, the Company's actual tax expense could increase, reducing earnings.