The Company occupies office space in Simsbury, Connecticut, leased from a third party by Hartford Fire Insurance Company ("Hartford Fire"), an indirect subsidiary of The Hartford. Expenses associated with these offices are allocated on a direct and indirect basis to Hartford Life and its subsidiaries by Hartford Fire.
Certain statements contained in this discussion, other than statements of historical fact, are forward-looking statements. These statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and include estimates and assumptions related to economic, competitive, and legislative developments. These forward-looking statements are subject to change and uncertainty which are, in many instances, beyond the Company's control and have been made based upon management's expectations and beliefs concerning future developments and their potential effect on Hartford Life Insurance Company and subsidiaries (the "Company"). There can be no assurance that future developments will be in accordance with management's expectations or that the effect of future developments on the Company will be those anticipated by management. Actual results could differ materially from those expected by the Company, depending on the outcome of certain factors, including those described in the forward-looking statements.
Revenues increased $120, or 4%, to $3 billion in 1997 from $2.9 billion in 1996. Revenues were impacted by the Health Insurance Portability and Accountability Act of 1996 ("HIPA Act of 1996"), which phases out the deductibilty of interest expense on policy loans by the end of 1998, virtually eliminating all new sales of leveraged corporate owned life insurance ("COLI"), and by the Guaranteed Investment Contracts segment ("GIC"), which had a loss of $225 in 1996, primarily related to a closed block of guaranteed rate contract business ("Closed Book GRC"). Excluding COLI and GIC, revenues increased $293, or 20%, to $1.8 billion in 1997 as compared to $1.5 billion 1996. This growth was driven by increased Individual Annuity revenues of $256, or 42%, in 1997 as compared to 1996. This increase is primarily related to premiums and other considerations where individual variable annuity fee income grew $198, or 54%, in 1997 as compared to 1996, primarily resulting from increased average individual variable annuity account values of $13.1 billion, or 49%, to $39.7 billion in 1997. This solid growth in average account value was due to strong variable annuity sales of $9.7 billion and significant stock market appreciation. In addition, Individual Life Insurance premiums and other considerations grew $36, or 13%, reflecting the impact of applying cost of insurance charges and variable life fees to a larger block of business. Individual Life Insurance account values increased $555, or 17%, to $3.8 billion in 1997 as compared to 1996.
Net income totaled $302 in 1997 as compared to $38 in 1996. The 1996 results include a $225 net loss related to GIC, which when excluded, results in an increase in 1997 net income of $39, or 15%, over comparable 1996 results. The improvement in earnings, excluding GIC, for both comparative periods is primarily related to increased fee income earned on the Annuity segment's growing block of separate account assets due to strong sales and significant market appreciation and earnings growth in the Individual Life Insurance segment. Partially offsetting improved earnings in the principal segments was a decrease in earnings of $33 in the Corporate Operation due to the increased capital allocated to the other segments to fund their growth.
The Company operates in three principal segments: Annuity, Individual Life Insurance, and Employee Benefits as well as a Guaranteed Investments Contracts segment, which is primarily comprised of guaranteed rate contract business written prior to 1995. The Company also maintains a Corporate Operation through which it reports items that are not directly allocable to any of its business segments.
The Annuity segment focuses on the savings and retirement needs of the growing number of individuals who are preparing for retirement or have already retired. This segment consists of two areas of operation: Individual Annuity and Group Annuity. The variety of products sold within this segment reflects the diverse nature of the market. These products include, in the Individual Annuity operation, individual variable annuities, fixed MVA annuities, and mutual funds; and in the Group Annuity operation, deferred compensation and retirement plan services for municipal governments and corporations, structured settlement contracts and other special purpose annuity contracts, and investment management contracts. The Company was rated the number one writer of variable annuities for 1997 with an 11% market share according to the Variable Annuity Research and Data Service, and sold approximately $869 of mutual funds in its first full year offering the product, resulting in total mutual fund assets of $972 at December 31, 1997.
average separate account assets of this segment increased to $50.7 billion in 1997, from $37.2 billion in 1996 primarily due to sales of individual variable annuities of approximately $9.7 billion in 1997, as well as significant market appreciation. Also, Group Annuity sales were $820 in 1997, an increase of $186, or 29%, over 1996. In addition, net investment income grew $67, or 15%, to $500 in 1997 primarily due to growth in average general account assets which increased to $8.1 billion in 1997 from $7.2 billion in 1996 largely as a result of growth in the general account portion of the individual variable annuity products.
The growth in this segment in 1997 also resulted in an increase in expenses of $243, or 30%, to $1.1 billion in 1997 from $820 in 1996. Benefits, claims and claim adjustment expenses grew $33, or 8%, in 1997 primarily related to increased interest credited on Group Annuity general account liabilites. Amortization of DPAC related to the Individual Annuity operation grew $82, or 52%, in 1997 as prior and current year sales remained strong. Also, other business expenses increased $101, in 1997, as a result of the growth in this segment.
The growth in this segment's account values, particularly variable life, along with favorable mortality experience, contributed to an increase in net income of $11, or 25%, in 1997.
Net income increased $3, or 10%, in 1997 as compared to 1996 due to an increase in COLI of $1 and the sale of a block of reinsurance business which resulted in a gain of approximately $2, after tax.
During 1996, Closed Book GRC incurred a $51, after-tax, loss from operations as a result of negative interest spread. With the initiation of the hedge transactions discussed above, which eliminated the possibility that the fair value of Closed Book GRC investments would recover to their current amortized cost prior to sale, an other than temporary impairment loss of $82, after-tax, was determined to have occurred and was recorded in September 1996. An additional other than temporary impairment loss of $6, after-tax, occurred in the fourth quarter of 1996 bringing the total 1996 impairment to $88. Also, during the third quarter of 1996, Closed Book GRC had asset sales resulting in proceeds of approximately $500 and a realized loss of $55, after-tax. The asset sales were undertaken as a result of liquidity needs and favorable market conditions for certain securities. Other charges of $32, after-tax, were also incurred in the third quarter of 1996.
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 have any financial instruments entered into 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 interest, and interest rate risk, relating to the market price and/or cash flow variability associated with changes in market yield curves. See the Investment Risk Management section below for further discussion of the Company's approach to managing these investment risks.
As of December 31, 1997 and 1996, approximately 22.1% and 13.2%, respectively, of the Company's fixed maturity portfolio was invested in private placement securities (including Rule 144A offerings). Private placement securities are generally less liquid than public securities; however, covenants for private placements are designed to mitigate the impact of such increased liquidity risk. Most of the private placement securities in the Company's portfolio are rated by nationally recognized rating organizations.
(1) REPRESENTS NET INVESTMENT INCOME (EXCLUDING NET REALIZED CAPITAL LOSSES) DIVIDED BY AVERAGE INVESTED ASSETS AT COST (FIXED MATURITIES AT AMORTIZED COST).
ANTICIPATORY HEDGING -- For certain liabilities, the Company commits to the price of the product prior to receipt of the associated premium or deposit. Anticipatory hedges are routinely executed to offset the impact of changes in asset prices arising from interest rate changes pending the receipt of premium or deposit and the subsequent purchase of an asset. These hedges involve taking a long position in interest rate futures or entering into an interest rate swap with duration characteristics equivalent to the associated liabilities or anticipated investments. The Company did not have any anticipatory hedges as of December 31, 1997.
ASSET HEDGING -- To meet the various policyholder obligations and to provide cost effective prudent investment risk diversification, the Company may combine two or more financial instruments to achieve the investment characteristics of a fixed maturity security or that match an associated liability. The use of derivative instruments in this regard effectively transfers unwanted investment risks or attributes to others. The selection of the appropriate derivative instruments depends on the investment risk, the liquidity and efficiency of the market, and the asset and liability characteristics. The notional amount of asset hedges as of December 31, 1997 was $1.8 billion.
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, 1997 was $2.8 billion.
FIXED RATE ASSET ACCUMULATION VEHICLES -- Products in this category require the Company to pay a fixed rate for a certain period of time. The cash flows are not interest sensitive because the products are written with a market value adjustment feature and the liabilities have protection against the early withdrawal of funds through surrender charges. Product examples include fixed rate annuities with a market value adjustment and fixed rate guaranteed investment contracts. Contract duration is dependent on the policyholder's choice of guarantee period.
SHORT-TERM PAY OUT LIABILITIES -- These liabilities are short-term in nature with a duration of less than one year. The primary risks associated with these products are determined by the non-investment contingencies such as mortality or morbidity and the variability in the timing of the expected cash flows. Liquidity is of greater concern than for the long-term pay out liabilities. Products include individual and group term life insurance contracts and short-term disability contracts.
The National Association of Insurance Commissioners ("NAIC") has been developing several model laws and regulations, including a Model Investment Law and amendments to the Model Holding Company System Regulatory Act (the "Holding Act Amendments"). The Model Investment Law defines the investments which are permissible for life insurers to hold, and the Holding Act Amendments address the types of activities in which subsidiaries and affiliates may engage. The NAIC adopted these models in 1997 and 1996, but the laws have not been enacted for insurance companies domiciled in the State of Connecticut, such as Hartford Life Insurance Company. Even if enacted in Connecticut or other states in which the Company's subsidiaries are domiciled, it is expected that these laws will neither significantly change the Company's investment strategies nor have any material adverse effect on the Company's liquidity or financial position.
The NAIC is expected to adopt its codification of Statutory Accounting Principles ("SAP") in early 1998 with a proposed effective date of January 1, 1999. The American Institute of Certified Public Accountants has not yet determined whether SAP will qualify as an Other Comprehensive Basis of Accounting ("OCBOA"). If SAP is granted OCBOA status and is adopted by the Company's domiciliary states, the Company will make the necessary changes required for implementation. These changes are not anticipated to have a material impact on the statutory financial statements of the Company.
The Year 2000 issue relates to the ability or inability of computer systems to properly process information and data containing or related to dates beginning with the year 2000 and beyond. The Year 2000 issue exists because many computer systems that are in use today were developed years ago when a year was identified using a two-digit field rather than a four-digit field. As information and data containing or related to the century date are introduced to computer hardware, software and other systems, date sensitive systems may recognize the year 2000 as "1900", or not at all, which may result in computer systems processing information incorrectly. This, in turn, may significantly and adversely affect the integrity and reliability of information databases and may result in a wide variety of adverse consequences to a company. In addition, Year 2000 problems that occur with third parties with which a company does business, such as suppliers, computer vendors and others, may also adversely affect any given company.
As an insurance and financial services company, the Company has thousands of individual and business customers that have insurance policies, annuities, mutual funds and other financial products of the Company. Nearly all of these policies and products contain date sensitive data, such as policy expiration dates, birth dates, premium payment dates, and the like. In addition, the Company has business relationships with numerous third parties that affect virtually all aspects of the Company's business, including, without limitation, suppliers, computer hardware and software vendors, insurance agents and brokers, securities broker-dealers and other distributors of financial products.
Beginning in 1990, the Company began working on making its computer systems Year 2000 ready, either through installing new programs or replacing systems. In January 1998, the Company commenced a company-wide program to further identify, assess and remediate the impact of Year 2000 problems in all of the Company's business segments. The Company currently anticipates that this internal program will be substantially completed by the end of 1998, and testing of computer systems will continue through 1999. The costs of addressing the Year 2000 issue that have been incurred by the Company through the year ended December 31, 1997 have not been material to the Company's financial condition or results of operations. The Company will continue to incur costs related to its Year 2000 efforts and is in the process of attempting to determine the approximate total costs to be incurred in the future, which are not currently anticipated to be material to the Company's results of operations or financial condition.
In addition, as part of its Year 2000 program, the Company is identifying third parties with which it has significant business relations in order to attempt to assess the potential impact on the Company of their Year 2000 issues and remediation plans. Hartford Life currently anticipates that it will substantially complete this evaluation by the end of 1998, and will conduct systems testing with certain third parties through 1999. The Company does not have control over these third parties and, as a result, the Company cannot currently determine to what extent future operating results may be adversely affected by the failure of these third parties to successfully address their Year 2000 issues.
The following table summarizes Hartford Life's significant U.S. member companies' financial ratings from the major independent rating organizations as of February 10, 1998: