Hartford Life's principal executive offices are located in Simsbury, Connecticut. The Company's home office complex consists of approximately 615 thousand square feet, and is leased from a third party by Hartford Fire Insurance Company (Hartford Fire), an indirect subsidiary of The Hartford. This lease expires in the year 2009. Expenses associated with these offices are allocated on a direct and indirect basis to Hartford Life by Hartford Fire.
(3) For financial reporting purposes, the Company has treated certain amounts previously allocated by The Hartford Financial Services Group, Inc. (The Hartford) to the Company's life insurance subsidiaries as allocated advances from parent. Cash received in respect of allocated advances from parent was used to support the growth of the life insurance subsidiaries. For additional information, see Note 7 of Notes to Consolidated Financial Statements.
(4) On June 29, 1998, Hartford Life Capital I, a special purpose Delaware trust formed by Hartford Life, issued 10,000,000, 7.2% Trust Preferred Securities, Series A (Series A Preferred Securities). The proceeds from the sale of the Series A Preferred Securities were used to acquire $250 of 7.2% Series A Junior Subordinated Deferrable Interest Debentures (Junior Subordinated Debentures) issued by Hartford Life. For additional information, see Note 8 of Notes to Consolidated Financial Statements.
(5) 1996 includes realized losses of $225 primarily resulting from actions taken in the third quarter of 1996 related to the Company's guaranteed investment contract business. For additional information, see the Investment Products section of the MD&A.
(7) Dividends per common share represent amounts declared subsequent to the Company's IPO on May 22, 1997. (For information regarding the IPO, see Note 3 of Notes to Consolidated Financial Statements.) The table does not include dividends paid to the parent in periods prior to the IPO.
(Dollar amounts in millions, except for share data, unless otherwise stated)
The Company derives its revenues principally from: (a) asset management fees on separate accounts and mutual fund assets and mortality and expense fees; (b) fully insured premiums; (c) net investment income on general account assets; and, (d) certain other fees earned by the Company. Asset management fees and mortality and expense fees are primarily generated from separate account assets which are deposited with the Company through the sale of variable annuity and variable life products and from mutual fund sales. Premium revenues are derived primarily from the sale of group life and group disability insurance products. Hartford Life's operating expenses primarily consist of interest credited to policyholders on general account liabilities, insurance benefits provided, dividends to policyholders, costs of selling and servicing the various products offered by the Company, and other general business expenses. Hartford Life's profitability depends largely on the amount of assets under management, the level of fully insured premiums, the adequacy of product pricing and underwriting discipline, and its ability to earn target spreads between earned investment rates on general account assets and credited rates to customers.
Revenues increased $1.1 billion, or 23%, to $5.8 billion in 1998 from $4.7 billion in 1997. The increase was due in part to the continued growth in revenues in Investment Products of $274 and Individual Life of $57 as a result of higher aggregate fees earned on growth in account values due to strong sales and equity market appreciation. Additionally, Employee Benefits revenues increased $109 primarily due to strong sales and good persistency. Also contributing to the increase were COLI revenues which grew $587 primarily due to the recapture of an in force block of COLI business (referred to as "MBL Recapture") previously ceded to MBL Life Assurance Co. of New Jersey (MBL Life) transacted in the fourth quarter 1998.
Total benefits, claims and expenses increased $984, or 23%, to $5.2 billion in 1998 from $4.2 billion in 1997. Benefits, claims and claim adjustment expenses increased $556 and dividends to policyholders increased $89 which were primarily attributable to the COLI segment where benefits, claims and claim adjustment expenses increased $485 and dividends to policyholders increased $89 primarily related to the MBL Recapture. In addition, increased benefits, claims and claim adjustment expenses in Employee Benefits of $34 and Individual Life of $18 were associated with the growth in these segments. Higher amortization of deferred policy acquisition costs (DPAC) of $96 in 1998 was a result of the large volume of sales in Investment Products and Individual Life in the past several years. Also, other expenses increased $243 in 1998 as a result of higher commissions and operating expenses in Investment Products and Employee Benefits primarily related to the growth in these segments.
Revenues increased $315, or 7%, to $4.7 billion in 1997 from $4.4 billion in 1996. This increase was primarily due to Investment Products, where revenues increased $503 in 1997 from 1996 as a result of fee income earned on growth in separate account assets due to strong annuity sales and equity market appreciation. Investment Products revenues were also impacted by the guaranteed investment contract (GIC) business, where revenues increased $205, primarily as a result of net realized capital losses in the third quarter of 1996. Additionally, revenues in Employee Benefits increased $237 due to sales growth. Higher revenues in Individual Life of $38, reflecting the impact of applying cost of insurance charges and variable life fees to a larger block of business, also contributed to the increase. Partially offsetting these increases was a decrease in COLI revenues of $380 due to the Health Insurance Portability and Accountability Act of 1996 (HIPA Act of 1996), which phased out the deductibility of interest expense on policy loans by the end of 1998, virtually eliminating all new sales of leveraged COLI.
The Investment Products segment focuses on the savings and retirement needs of the growing number of individuals who are preparing for retirement or have already retired through the sale of individual annuities and other investment products. The individual annuity products offered include individual variable annuities, fixed market value adjusted annuites (MVA) annuities and fixed and variable immediate annuities. The other investment products offered include retail mutual funds, deferred compensation and retirement plan services for municipal governments, teachers, hospitals and corporations; structured settlement contracts and other special purpose annuity contracts; and, investment management services. The Company sells both variable and fixed individual annuity products through a wide distribution network of national and regional broker-dealer organizations, banks and other financial institutions, and independent financial advisors. The Company was ranked the number one writer of individual variable annuities in the United States for 1998 according to Variable Annuity and Research Data Service (VARDS) and the number one seller of individual variable annuities through banks, according to Kenneth Kehrer and Associates.
Revenues increased $274, or 18%, to $1.8 billion in 1998 from $1.5 billion in 1997. Driven primarily by the individual annuity operation, this improvement was a result of higher aggregate fees earned on growth in account values due to strong net cash flow resulting from a high volume of sales and favorable persistency as well as significant equity market appreciation in the Company's separate accounts. Fee income related to individual variable annuity products increased $236 as related average account values grew $14.9 billion, or 38%, to $54.6 billion in 1998 from $39.7 billion in 1997. This growth was a result of strong individual variable annuity sales of $9.9 billion in 1998 as well as equity market appreciation. In addition, fee income from other investment products increased $60 primarily as a result of growth in the Company's mutual fund operations, where assets under management increased $1.5 billion in 1998 to $2.5 billion as compared to $972 in 1997.
Total benefits, claims and expenses increased $177, or 15%, to $1.4 billion in 1998 from $1.2 billion in 1997 as a result of the continued growth in this segment. Other expenses increased $107 in 1998 as compared to 1997 primarily due to growth in the mutual funds and individual annuity operations. Amortization of DPAC grew $76 primarily due to individual annuity products as sales remained strong. A 38% growth in average variable annuity account value in 1998, coupled with a reduction in individual annuity operating expenses as a percentage of total individual annuity account value to 23 basis points in 1998 from 25 basis points in 1997, contributed to the increase in net income of $64, or 32%, to $266 in 1998 from $202 in 1997.
The market for retirement products continues to expand as individuals increasingly save and plan for retirement. Demographic trends suggest that as the baby boom generation matures, a significant portion of the United States population will allocate a greater percentage of their disposable incomes to saving for their retirement years due to uncertainty surrounding the Social Security system and increases in average life expectancy. As this market grows, particularly for variable annuities and mutual funds, new companies are continually entering the market and aggressively seeking distribution capabilities and pursuing market share. This trend is not expected to subside, particularly in light of pending legislation to deregulate the financial services industry.
The Individual Life segment, which focuses on the high end estate and business planning markets, sells a variety of life insurance products, including variable life, universal life, interest-sensitive whole life and term life insurance.
Revenues in 1997 increased $38, or 8%, to $510 from $472 in 1996. In the first quarter of 1996, a block of business was assumed from Investors Equity Life Insurance Company (IEL) which increased 1996 revenues by $9. Excluding this transaction, 1997 revenues increased $47, or 10%, as compared to 1996, reflecting the impact of applying cost of insurance charges and variable life fees to a larger block of business. Total account values increased $555, or 17%, to $3.8 billion in 1997 from $3.2 billion in 1996. Sales were $140 in 1997, an increase of 8% over 1996. Variable life sales constituted 70%, or $98, of total 1997 sales and grew $23, or 31%, over 1996 levels. Total benefits, claims and expenses increased $19, or 5%, to $423 in 1997 from $404 in 1996. Total benefits, claims and expenses, excluding IEL, increased $28, or 7%, in 1997. This increase was primarily driven by an increase in amortization of DPAC of $24 in 1997 related to the growth in new variable life business. The growth in this segment's account values, particularly variable life, along with favorable mortality experience, contributed to an increase in net income of $12, or 27%, in 1997 from 1996.
The Employee Benefits segment primarily sells group life and group disability insurance as well as other products including, stop loss and supplementary medical coverage to employers and employer sponsored plans, accidental death and dismemberment, travel accident, long-term care insurance and other special risk coverages to employers and associations. The Company also offers disability underwriting, administration, claims processing services and reinsurance to other insurers and self-funded employer plans. According to the latest results published by Life Insurance Marketing and Research Association (LIMRA), the Company was the second largest provider of group disability insurance and the third largest writer of group life insurance in the United States for the nine months ended September 30, 1998.
Total benefits, claims and expenses increased $101, or 6%, to $1.7 billion in 1998 from $1.6 billion in 1997. The increase was the result of higher benefits, claims and claim adjustment expenses, which, excluding buyouts, increased $121 due to the growth in this segment; however, the ratio of benefits, claims and claim adjustment expenses as a percentage of premiums and other considerations (excluding buyouts) improved to 81.5% in 1998 from 83.2% in 1997. This improvement was partially offset by an increase in other expenses of $66, whereby other expenses as a percentage of premiums and other considerations, excluding buyouts, increased to 23.3% in 1998 from 21.5% in 1997. This trend is due to the Company's continued investment in claims management initiatives which result in higher operating expenses, but improve benefits, claims and claim adjustment expenses.
Revenues in this operation increased $587, or 60%, to $1.6 billion in 1998 from $980 in 1997. This increase was primarily related to the recapture of an in force block of COLI business, previously ceded to MBL Life, which was transacted in the fourth quarter 1998. (For additional information regarding the MBL Recapture, see "Purchases of Affiliates and Other" under the Capital Resources and Liquidity section.) The MBL Recapture, which was retroactive to January 1, 1998, resulted in an increase in COLI revenues of $624 and is comprised of $245 of premiums and other considerations and $379 of net investment income. Higher fee income on the segment's growing block of variable COLI account values also contributed to the increase in revenues. Partially offsetting these increases was a decline in premiums and other considerations on leveraged COLI as that block of business continues to decline due to the implications of the HIPA Act of 1996 (discussed above).
Net income declined $3, or 11%, to $24 in 1998 from $27 in 1997 as the growth in the Company's variable COLI business was offset by the declining block of leveraged COLI the Company had prior to passage of the HIPA Act of 1996. The MBL Recapture had no impact on earnings in 1998.
The focus of this segment is variable COLI, which continues to be a product generally used by employers to fund non-qualified benefits or other post-employment benefit liabilities. The leveraged COLI product has been an important contributor to Hartford Life's profitability in recent years and will continue to contribute to the profitability of Hartford Life in the future, although the level of profit is expected to decline. COLI is subject to a changing legislative and regulatory environment that could have a material adverse affect on its business.
The primary investment objective of the Company's general account and guaranteed separate accounts is to maximize after-tax returns consistent with acceptable risk parameters (including the management of the interest rate sensitivity of invested assets relative to that of policyholder obligations). The Company does not hold any financial instruments purchased for trading purposes. The Company is exposed to two primary sources of investment risk: credit risk, relating to the uncertainty associated with an obligor's continued ability to make timely payment of principal and/or interest, and interest rate risk, relating to the market price and/or cash flow variability associated with changes in market yield curves. See the Capital Markets Risk Management section for further discussion of the Company's approach to managing these investment risks.
The following table sets forth by type the fixed maturity securities held in the Company's general account as of December 31, 1998 and 1997.
Changes in interest rates can potentially impact the Company's profitability. Under certain circumstances of interest rate volatility, the Company could be exposed to disintermediation risk and reduction in net interest rate spread or profit margins. For non-guaranteed separate accounts, the Company's exposure is not significant since the policyholder assumes substantially all of the investment risk.
The Company's general account and guaranteed separate account investment portfolios primarily consist of investment grade, fixed maturity securities, including corporate bonds, asset backed securities, collateralized mortgage obligations and mortgage backed securities. The fair value of these and the Company's other invested assets fluctuates depending on the interest rate environment and other general economic conditions. During periods of declining interest rates, paydowns on mortgage backed securities and collateralized mortgage obligations increase as the underlying mortgages are prepaid. In addition, during such periods, the Company generally will not be able to reinvest the proceeds of any such prepayments at comparable yields. Conversely, during periods of rising interest rates, the rate of prepayments generally declines exposing the Company to the possibility of asset/liability cash flow and yield mismatch. For a discussion of the Company's risk management techniques to manage this market risk, see "Asset/Liability Management Strategies Used to Manage Market Risk" below.
The table below provides information as of December 31, 1998 and 1997 on debt obligations and reflects principal cash flows and related weighted average interest rate by maturity year.
Derivatives play an important role in facilitating the management of interest rate risk, creating opportunities to efficiently fund obligations, hedge against risks that affect the value of certain liabilities and adjust broad investment risk characteristics as a result of any significant changes in market risks. The Company uses a variety of derivatives, including swaps, caps, floors, forwards and exchange-traded financial futures and options, in order to hedge exposure primarily to interest rate risk on anticipated investment purchases or existing assets and liabilities. The Company does not make a market or trade derivatives for the express purpose of earning trading profits. The Company's derivative program is monitored by an internal compliance unit and is reviewed frequently by senior management and reported to Hartford Life's Finance Committee. The notional amounts of derivative contracts, which represent the basis upon which pay or receive amounts are calculated and are not reflective of credit risk, totaled $11.2 billion as of December 31, 1998 ($6.0 billion related to insurance investments and $5.2 billion related to life insurance liabilities). As of December 31, 1997, the notional amounts pertaining to derivatives totaled $10.9 billion ($6.6 billion related to insurance investments and $4.3 billion related to life insurance liabilities).
The strategies described below are used to manage the aforementioned risks.
Liability Hedging -- Several products obligate the Company to credit a return to the contract holder which is indexed to a market rate. To hedge risks associated with these products, the Company typically enters into interest rate swaps to convert the contract rate into a rate that trades in a more liquid and efficient market. This hedging strategy enables the Company to customize contract terms and conditions to customer objectives and satisfies the operation's asset/liability matching policy. Additionally, interest rate swaps are used to convert certain fixed contract rates into floating rates, thereby allowing them to be appropriately matched against floating rate assets. The notional amount of derivatives used for liability hedges as of December 31, 1998 and 1997 was $5.2 billion and $4.3 billion, respectively.
Portfolio Hedging -- The Company periodically compares the duration and convexity of its portfolios of assets to their corresponding liabilities and enters into portfolio hedges to reduce any difference to desired levels. Portfolio hedges reduce the mismatch between assets and liabilities and offset the potential impact to cash flows caused by changes in interest rates. The notional amount of portfolio hedges as of December 31, 1998 and 1997 was $1.5 billion and $3.1 billion, respectively.
Hartford Life's insurance liabilities, other than non-guaranteed separate accounts, are primarily related to accumulation vehicles such as fixed or variable annuities and investment contracts and other insurance products such as long-term disability and term life insurance.
Hartford Life's international holdings as of December 31, 1998 totaled approximately $100, which are primarily located in Latin America and are inherently affected by currency fluctuations. The Company's primary currency exposure relates to the Brazilian real and the Argentine peso and is not expected to have a material impact on the Company's liquidity or financial condition.
For liabilities whose cash flows are not substantially affected by changes in interest rates (fixed liabilities) and where investment experience is substantially absorbed by the Company, the sensitivity of the net economic value (discounted present value of asset cash flows less the discounted present value of liability cash flows) of those portfolios to 100 basis point shifts in interest rates is shown in the table below. These fixed liabilities represent approximately 60% of the Company's general and guaranteed separate account liabilities at both December 31, 1998 and 1997. The remaining liabilities generally allow the Company significant flexibility to adjust credited rates to reflect actual investment experience and thereby pass through a substantial portion of actual investment experience to the policyholder. The fixed liability portfolios are managed and monitored relative to defined objectives and are analyzed regularly by management for internal risk management purposes using scenario simulation techniques, and evaluated annually consistent with regulatory requirements.
Capital resources and liquidity represent the overall financial strength of Hartford Life and its ability to generate strong cash flows from each of the business segments and borrow funds at competitive rates to meet operating and growth needs. The Company maintained cash and short-term investments totaling $2.2 billion, $1.5 billion and $837 as of December 31, 1998, 1997 and 1996, respectively. The capital structure of Hartford Life consists of debt and equity, and is summarized as follows:
As a holding company, Hartford Life, Inc. has no significant business operations of its own and, therefore, primarily relies on the dividends from its insurance company subsidiaries, which are primarily domiciled in Connecticut, as the principal source of cash to meet its obligations (primarily debt obligations) and pay stockholder dividends. Hartford Life, Inc. received dividends from its regulated life insurance subsidiaries of $76 in 1998. Statutory net income and statutory capital and surplus, key determinants in the amount of dividend capacity available in the insurance company subsidiaries, has grown significantly over the past several years.
During 1998, to make shares available to employees pursuant to stock-based benefit plans, the Company repurchased 285,000 shares of its Class A Common Stock in the open market at a total cost of $15. Shares repurchased in the open market are carried at cost and reflected as a reduction to stockholders' equity. Treasury shares subsequently reissued are reduced from treasury stock on a weighted average cost basis. The Company currently intends to purchase additional shares of its Class A Common Stock to make shares available for its various employee stock-based benefit plans.
The following table summarizes Hartford Life's significant U.S. member companies' financial ratings from the major independent rating organizations as of February 17, 1999:
The insurance holding company laws of the other jurisdictions in which Hartford Life's insurance subsidiaries are incorporated or deemed commercially domiciled generally contain similar (although in certain instances somewhat more restrictive) limitations on the payment of dividends.
In 1998, the change in cash provided by operating activities was primarily the result of timing in the settlement of receivables and payables as well as an increase in income taxes paid. The change in cash provided by or used for investing activities primarily reflects a decrease in policy loans resulting from the reduction of COLI account values in conjunction with the decline of the block of leveraged COLI offset by the investment of cash from operating and financing activities. The change in cash used for financing activities was primarily due to declines in GIC and COLI account values as well as proceeds from the IPO in May 1997, partially offset by changes in debt, dividends paid and proceeds from the TruPS offering.
Planco -- On August 26, 1998, the Company completed the purchase of all outstanding shares of PLANCO Financial Services, Inc. and its affiliate, PLANCO, Incorporated (collectively, "PLANCO"). PLANCO, a primary distributor of the Company's annuities and mutual funds, is the nation's largest wholesaler of individual annuities and has played a significant role in Hartford Life's growth over the past decade. As a wholesaler, PLANCO distributes Hartford Life's fixed and variable annuities, mutual funds and single premium variable life insurance, as well as providing sales support to registered representatives, financial planners and broker-dealers at brokerage firms and banks across the United States. The acquisition has been accounted for as a purchase and accordingly, the results of PLANCO's operations have been included in the Company's consolidated financial statements from the closing date of the transaction.
If significant Year 2000 problems arise, including problems arising with third parties, failures of IT and non-IT systems could occur, which in turn could result in substantial interruptions in Hartford Life's business. In addition, Hartford Life's investing activities are an important aspect of its business and Hartford Life may be exposed to the risk that issuers of investments held by it will be adversely impacted by Year 2000 issues. Given the uncertain nature of Year 2000 problems that may arise, especially those related to the readiness of third parties discussed above, management cannot determine at this time whether the consequences of Year 2000 related problems that could arise will have a material impact on Hartford Life's financial condition or results of operations.