The transition impact related to the adoption of fair value accounting guidance was a reduction in revenues of $788, for year ended December 31, 2008.
The transition impact related to the adoption of fair value accounting guidance was a reduction in net income of $311 for the year ended December 31, 2008.
Year ended December 31, 2009 compared to the year ended December 31, 2008
Net loss improved as a result of lower net realized losses. The following factors detail changes in operating results between these two periods:
Lower realized losses were primarily due to lower net losses from impairments on investment securities, as well as decreased credit related losses and gains on GMWB/GMIB/GMAB reinsurance compared to 2008 and the impact of the adoption of fair value accounting guidance in 2008. For further discussion on refer to Note 16 Transactions with Affiliates.
In the fourth quarter of 2009, Retail recorded a DAC Unlock of $1.9 billion, pre-tax at the inception of a reinsurance transaction with an affiliated captive reinsurer. For further discussions refer to Note 16.
Earned premiums declined in Other as a result of ceded premiums upon inception of an October 1st reinsurance transaction with an affiliated captive reinsurer. For further discussions on transaction with affiliates, refer to Note 16. Additionally, declines resulted from ratings downgrades in the later half of 2008 restricting sales of payout annuities within Institutional and a corresponding decrease in losses and loss adjustment expenses.
Fee income and other decreased as a result of the decline in average account values of the variable annuity and mutual fund assets in Retail.
The effective tax rate for 2009, 2008 and 2007 was 39%, 38%, and 22%, respectively. The principal cause of the difference between the effective rate and the U.S. statutory rate of 35% for 2009, 2008 and 2007 was the separate account dividends received deduction (“DRD”). This caused an increase in the tax benefit on the 2009 and 2008 pretax losses and a decrease in the tax expense on the 2007 pretax income. Income taxes refunded in 2009 and 2008 were $(282) and $(183), respectively, in 2007 income taxes paid were $329.
The Company receives a foreign tax credit against its U.S. tax liability for foreign taxes paid by the Company including payments from its separate account assets. The separate account foreign tax credit is estimated for the current year using information from the most recent filed return, adjusted for the change in the allocation of separate account investments to the international equity markets during the current year. The actual current year foreign tax credit can vary from the estimates due to actual foreign tax credits passed through by the mutual funds. The Company recorded benefits of $16, $16 and $11 related to separate account foreign tax credit in the years ended December 31, 2009, 2008 and, 2007 respectively. These amounts included benefits related to true-ups of prior years’ tax returns of $3, $4 and $0 in 2009, 2008 and 2007, respectively.
In the long-term, management continues to believe the market for retirement products will 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.
For the retail mutual fund business, net sales can vary significantly depending on market conditions, as was experienced throughout 2009. The continued declines in equity markets in the first quarter of 2009 helped drive declines in the Company’s mutual fund deposits and assets under management. During the last nine months of 2009, the equity markets improved from the first quarter and as a result the Company’s mutual fund assets under management and deposits have increased correspondingly. As this business continues to evolve, success will be driven by diversifying net sales across the mutual fund platform, delivering superior investment performance and creating new investment solutions for current and future mutual fund shareholders.
The decline in assets under management as compared to 2008 is the result of continued depressed values of the equity markets in 2009 as compared to 2008, which has decreased the extent of the scale efficiencies that Retail has
Future sales for all products will be influenced by active management of current distribution relationships, responding to the negative impact of recent merger and consolidation activity on existing distribution relationships and the development of new sources of distribution, and the Company’s ratings as published by the various ratings agencies, while offering competitive and innovative products and product features. The current economic environment poses challenges for future sales; while life insurance products respond well to consumer demand for financial security and wealth accumulation solutions, individuals may be reluctant to transfer funds when market volatility has recently resulted in significant declines in investment values. In addition, the availability and terms of capital solutions in the marketplace, as discussed below, to support universal life products with secondary guarantees, may reduce future growth in these products.
Effective November 1, 2007, Individual Life reinsured the policy liability related to statutory reserves in universal life with secondary guarantees to a captive reinsurance affiliate. An unaffiliated standby third party letter of credit supports a portion of the statutory reserves that have been ceded to this subsidiary. The use of the letter of credit enhanced statutory capital but resulted in a decline in net investment income and increased expenses in future periods for Individual Life. As of December 31, 2009, the transaction provided approximately $585 of statutory capital relief associated with the Company’s universal life products with secondary guarantees. The Company has received notice from the issuer of the letter of credit that they will be terminating the letter of credit as it applies to the new business written after January 31, 2010. In addition, the issuer has notified the Company that it will not extend the letter of credit covering the inforce beyond its current expiration date of December 31, 2028. The letter of credit is expected to provide sufficient coverage for the reinsured business through 2028. Management is reviewing product design alternatives with the objective of developing a competitively priced product that meets the Company’s capital efficiency objectives.
The future financial results of the Retirement Plans segment will depend on Life’s ability to increase assets under management across all businesses, achieve scale in areas with a high degree of fixed costs and maintain its investment spread earnings on the general account products sold largely in the 403(b)/457 business.
The Company has completed the strategic review of the Institutional businesses and has decided to exit several businesses that have been determined to be outside of the Company’s core business model. Several lines - institutional mutual funds, private placement life insurance, income annuities and certain institutional annuities will continue to be managed for growth. The private placement life insurance industry (including the corporate-owned and bank-owned life insurance markets) has experienced a slowdown in sales due to, among other things, limited availability of stable value wrap providers. We believe that the Company’s current PPLI assets will experience high persistency, but our ability to grow this business in the future will be affected by near term market and industry challenges. The remaining businesses, Structured Settlements, Guaranteed Investment Products, and most Institutional Annuities will be managed in conjunction with other businesses that the Company has previously decided will not be actively marketed. Certain guaranteed investment products may be offered on a selective basis.
The net income of this segment depends on Institutional’s ability to retain assets under management, the relative mix of business, and net investment spread. Net investment spread, as discussed in Institutional’s Operating section of this MD&A, has declined year over year and management expects net investment spread will remain pressured in the intermediate future due to the low level of short-term interest rates, increased allocation to lower yielding U.S. Treasuries and short-term investments, and anticipated performance of limited partnerships and other alternative investments.
The Company has identified the following estimates as critical in that they involve a higher degree of judgment and are subject to a significant degree of variability: estimated gross profits used in the valuation and amortization of assets and liabilities associated with variable annuity and other universal life-type contracts; living benefits required to be fair valued; valuation of investments and derivative instruments; evaluation of other-than-temporary impairments on available-for-sale securities and contingencies relating to corporate litigation and regulatory matters; DTA and goodwill impairment. In developing these estimates management makes subjective and complex judgments that are inherently uncertain and subject to material change as facts and circumstances develop. Although variability is inherent in these estimates, management believes the amounts provided are appropriate based upon the facts available upon compilation of the financial statements.
Beginning with the second quarter of 2009, the Company now 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 a 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 or floors. This DAC Unlock, for future separate account returns, is determined each quarter. Under RTM, the expected long term rate of return is 7.1%, on a weighted average basis, including 9.5% for equities and 6.0% for fixed income.
Estimated gross profits are also used to determine the expected excess benefits and assessments included in the measurement of death and other insurance benefit reserves. These excess benefits and assessments are derived from a range of stochastic scenarios that have been calibrated to the Company’s RTM separate account returns. The determination of death and other insurance benefit reserves is also impacted by discount rates, lapses, volatilities and mortality assumptions.
Effective October 1, 2009, a subsidiary of HLIC, Hartford Life and Annuity Insurance Company (“HLAI”) entered into a reinsurance agreement with an affiliated captive reinsurer, White River Life Reinsurance Company (“the affiliated captive reinsurer” or “WRR”). This agreement provides that HLAI will cede, and WRR will reinsure 100% of the in-force and prospective U.S. variable annuities and the associated GMDB and GMWB riders. This transaction resulted in a DAC Unlock of $2.0 billion, pre-tax and $1.3 billion, after-tax as the related EGP’s were ceded to the affiliate. See Note 16 Transactions with Affiliates for further information on the transaction.
The after-tax impact on the Company’s assets and liabilities as a result of the Unlocks for the years ended 2009, 2008 and 2007 were:
The most significant contributor to the Unlock was a result of actual separate account returns being significantly below our aggregated estimated return.
Includes $(49) related to DAC recoverability impairment associated with the decision to suspend sales in the U.K. variable annuity business.
As a result of the Unlock, Retail reserves increased $389, pre-tax, offset by an increase in reinsurance recoverables of $273, pre-tax.
Fair values for direct, assumed and ceded GMWB, GMIB and GMAB contracts are calculated based upon internally developed models because active, observable markets do not exist for those items. The fair value of the Company’s guaranteed benefit liabilities, classified as embedded derivatives, and the related reinsurance and customized freestanding derivatives is calculated as an aggregation of the following components: Best Estimate Claims Costs; Credit Standing Adjustment; and Margins. The resulting aggregation is reconciled or calibrated, if necessary, to market information that is, or may be, available to the Company, but may not be observable by other market participants, including reinsurance discussions and transactions. The Company believes the aggregation of each of these components, as necessary and as reconciled or calibrated to the market information available to the Company, results in an amount that the Company would be required to transfer, or receive, to or from market participants in an active liquid market, if one existed, for those market participants to assume the risks associated with the guaranteed minimum benefits and the related reinsurance and customized derivatives. The fair value is likely to materially diverge from the ultimate settlement of the liability as the Company believes settlement will be based on our best estimate assumptions rather than those best estimate assumptions plus risk margins. In the absence of any transfer of the guaranteed benefit liability to a third party, the release of risk margins is likely to be reflected as realized gains in future periods’ net income. Each of the components described below are unobservable in the marketplace and require subjectivity by the Company in determining their value.
On a daily basis, the Company updates capital market assumptions used in the GMWB liability model such as interest rates and equity indices. On a weekly basis, the blend of implied equity index volatilities is updated. The Company continually monitors various aspects of policyholder behavior and may modify certain of its assumptions, including living benefit lapses and withdrawal rates, if credible emerging data indicates that changes are warranted. At a minimum, all policyholder behavior assumptions are reviewed and updated, as appropriate, in conjunction with the completion of the Company’s comprehensive study to refine its estimate of future gross profits during the third quarter of each year.
liabilities net of third party reinsurance. For the year ended December 31, 2007, these updates affected best estimates resulting in a pre-tax loss of $(158).
In addition to the non-market based updates described above, the Company recognized non-market based updates to the reinsured Japan GMWB, GMIB, and GMAB fair values primarily driven by:
Updates to assumptions, including policyholder behavior resulting in a pre-tax loss of approximately $ (264) for the year ended December 31, 2009; and
The Company has analyzed the third-party pricing services valuation methodologies and related inputs, and has also evaluated the various types of securities in its investment portfolio to determine an appropriate fair value hierarchy level based upon trading activity and the observability of market inputs. For further discussion of fair value measurement, see Note 3 of the Notes to the Consolidated Financial Statements.
The following table presents the fair value of AFS securities and short-term investments by pricing source and hierarchy level as of December 31, 2009.
As of December 31, 2009 and 2008, the Company had goodwill allocated to the following reporting units:
In 2009, the Company added $8 of goodwill related to a contingent earnout provisions.
However, as noted above, goodwill is reassessed at an interim date if certain circumstances occur which would cause the entity to conclude that it was more likely than not that the carrying value of one or more of its reporting units would be in excess of the respective reporting unit’s fair value. As a result of the continued decline in the equity markets from January 1, 2009, rating agency downgrades, and a decline in The Hartford’s share price, the Company concluded, during the first quarter of 2009, that the conditions had been met to warrant an interim goodwill impairment test.
Deferred tax assets represent the tax benefit of future deductible temporary differences and operating loss and tax credit carryforwards. Deferred tax assets are measured using the enacted tax rates expected to be in effect when such benefits are realized if there is no change in tax law. Under U.S. GAAP, we test the value of deferred tax assets for impairment on a quarterly basis at the entity level within each tax jurisdiction, consistent with our filed tax returns. Deferred tax assets are reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion, or all, of the deferred tax assets will not be realized. The determination of the valuation allowance for our deferred tax assets requires management to make certain judgments and assumptions. In evaluating the ability to recover deferred tax assets, we have considered all available evidence including past operating results, the existence of cumulative losses in the most recent years, forecasted earnings, future taxable income, and prudent and feasible tax planning strategies. In the event we determine that we most likely would not be able to realize all or part of our deferred tax assets in the future, an increase to the valuation allowance would be charged to earnings in the period such determination is made. Likewise, if it is later determined that it is more likely than not that those deferred tax assets would be realized, the previously provided valuation allowance would be reversed. Our judgments and assumptions are subject to change given the inherent uncertainty in predicting future performance, which is impacted by such things as policyholder behavior, competitor pricing, new product introductions, and specific industry and investment market conditions.
The Company is organized into four reporting segments: Retail Products Group (“Retail”), Individual Life (“Individual Life”), Retirement Plans (“Retirement Plans”), and Institutional Solutions Group (“Institutional”). The Company provides retail and institutional investment products such as variable and fixed annuities, mutual funds, private placement life insurance (“PPLI”) and retirement plan services, individual life insurance products including variable universal life, universal life, interest sensitive whole life and term life.
The Company’s expenses essentially consist of interest credited to policyholders on general account liabilities, insurance benefits provided, amortization of deferred policy acquisition costs, expenses related to selling and servicing the various products offered by the Company, dividends to policyholders, and other general business expenses.
The profitability of the Company’s fixed annuities and other “spread-based” products depends largely on its ability to earn target spreads between earned investment rates on its general account assets and interest credited to
policyholders. In addition, the size and persistency of gross profits from these businesses is an important driver of earnings as it affects the rate of amortization of deferred policy acquisition costs.
DAC amortization ratio, return on assets (“ROA”)” or after-tax margin, excluding realized gains (losses) or DAC Unlock are non-GAAP financial measures that the Company uses to evaluate, and believes are important measures of, segment operating performance. DAC amortization ratio, ROA or after-tax margin is the most directly comparable GAAP measure. The Hartford believes that the measures of DAC amortization ratio, ROA or after-tax margin, excluding realized gains (losses) and DAC Unlock provide investors with a valuable measure of the performance of the Company’s on-going businesses because it reveals trends in our businesses that may be obscured by the effect of realized gains (losses) or periodic DAC Unlocks. Some realized capital gains and losses are primarily driven by investment decisions and external economic developments, the nature and timing of which are unrelated to insurance aspects of our businesses. Accordingly, these non-GAAP measures exclude the effect of all realized gains and losses that tend to be highly variable from period to period based on capital market conditions. The Company believes, however, that some realized capital gains and losses are integrally related to our insurance operations, so DAC amortization ratio, ROA and after-tax margin, excluding the realized gains (losses) and DAC Unlock should include net realized gains and losses on net periodic settlements on the Japan fixed annuity cross-currency swap. These net realized gains and losses are directly related to an offsetting item included in the statement of operations such as net investment income. DAC Unlocks occur when the Company determines based on actual experience or other evidence, that estimates of future gross profits should be revised. As the DAC Unlock is a reflection of the Company’s new best estimates of future gross profits, the result and its impact on DAC amortization ratio, ROA and after-tax margin is meaningful; however, it does distort the trend of DAC amortization ratio, ROA and after-tax margin. DAC amortization ratio, ROA or after-tax margin, excluding realized gains (losses) and DAC Unlock should not be considered as a substitute for DAC amortization ratio, ROA or after-tax margin and does not reflect the overall profitability of our businesses. Therefore, the Company believes it is important for investors to evaluate both DAC amortization ratio, ROA and after-tax margin, excluding realized gains (losses) and DAC Unlock and DAC amortization ratio, ROA and after-tax margin when reviewing the Company’s performance.
Management evaluates performance of certain products based on net investment spread. These products include those that have insignificant mortality risk, such as fixed annuities, certain general account universal life contracts and certain institutional contracts. Net investment spread is determined by taking the difference between the earned rate, (excluding the effects of capital gains and losses, including those related to the Company’s GMWB product and related reinsurance and hedging programs), and the related crediting rates on average general account assets under management. The net investment spreads are for the total portfolio of relevant contracts in each segment and reflect business written at different times. When pricing products, the Company considers current investment yields
and not the portfolio average. The determination of credited rates is based upon consideration of current market rates for similar products, portfolio yields and contractually guaranteed minimum credited rates. Net investment spread can be volatile period over period, which can have a significant positive or negative effect on the operating results of each segment. Investment earnings can also be influenced by factors such as the actions of the Federal Reserve and a decision to hold higher levels of short-term investments. The volatile nature of net investment spread is driven primarily by prepayment premiums on securities and earnings on limited partnership and other alternative investments.
There are three major categories for expenses. The first major category of expenses is benefits and losses. These include the costs of mortality in the individual life business, as well as other contractholder benefits to policyholders. The second major category is insurance operating costs and expenses, which is commonly expressed in a ratio of a revenue measure depending on the type of business. The third major category is the amortization of deferred policy acquisition costs and the present value of future profits (“DAC amortization ratio”), which is typically expressed as a percentage of pre-tax income before the cost of this amortization (an approximation of actual gross profits) and excludes the effects of unrealized gains (losses).
reinsurance transaction with an affiliated captive reinsurer. Refer to Note 16 Transactions with Affiliates.
The decrease in Individual Annuity’s ROA, excluding realized gains (losses) and the effect of the DAC Unlock, reflects significant losses on limited partnership and other alternative investments, a higher DAC amortization rate and lower investment spread in 2009. Return on assets in Retail is expected to be lower in the future due to cession of a large block of variable annuity contracts to an affiliate in the fourth quarter of 2009.
The decrease in Retirement Plans ROA, excluding realized losses and DAC Unlock was primarily driven by lower returns on fixed maturities and a full year of activity from the business acquired in 2008, which produce a lower ROA as they are primarily mutual fund businesses.
For the year ended December 31, 2008, the transition impact related to the fair value guidance was a reduction in net income of $209. For further discussion of the fair value guidance transition impact, refer to Note 3 in the Notes to the Consolidated Financial Statements.
Fee income and other decreased $564 primarily as a result of lower variable annuity and mutual fund fee income due to a decline in average account values. Average variable annuity account values declined from $99.8 billion in 2008 to $77 billion in 2009 driven by net outflows of $7.1 billion during 2009 as well as the effect of the equity market declines. Net outflows were driven by surrender activity resulting from the aging of the variable annuity in-force block of business; lower deposits driven by increased competition, particularly competition related to guaranteed living benefits, and volatility in the equity markets. Average retail mutual fund assets under management declined from $42.4 billion to $35.5 billion driven primarily by the effect of the equity market declines, partially offset by net flows of $2.0 billion during 2009.
Net realized capital losses decreased as a result of the recognition of $1.5 billion of gains on GMWB derivatives in 2009 compared with losses of $631 in 2008; the transition impact related to the adoption of fair value accounting guidance, which resulted in losses of $616 in 2008; and impairment losses of $263 in 2009 compared with $474 in 2008. Partially offsetting these items were losses of $733 in 2009 related to the Company’s macro hedge program compared with gains of $40 in 2008; losses of $183 related to the affiliated captive reinsurance transaction and net losses on sales of $329 in 2009 compared with net losses of $31 in 2008.
The general insurance expense ratio has remained flat as a result of management’s efforts to reduce expenses, offset by a decline in the average asset base.
Amortization of DAC increased primarily due to the write-off of DAC related to the variable annuity business reinsured to an affiliated captive reinsurer as well as a higher individual annuity DAC amortization rate in 2009 as compared to 2008 due primarily to Unlock assumption changes made in 2008 and 2009 and lower gross profits in 2009. Additionally, the adoption of fair value
accounting guidance at the beginning of the first quarter of 2008 resulted in a DAC benefit.
The income tax benefit is primarily due to the pre-tax losses driven by the factors discussed previously. 2009 included a higher DRD benefit than 2008. The difference from a 35% tax rate is primarily due to the recognition of tax benefits associated with the DRD and foreign tax credits.
Net income decreased primarily as a result of increased realized capital losses, the impact of the 2008 Unlock charge, the impairment of goodwill attributed to the individual annuity line of business and the effect of equity market declines on variable annuity and mutual fund fee income. The following other factors also contributed to the changes in net income:
Fee income and other decreased primarily as a result of lower variable annuity fee income of $342 due to a decline in average account values. The decrease in average variable annuity account values can be attributed to market depreciation of $38.3 billion and net outflows of $6.2 billion during the year. Net outflows were driven by surrender activity due to the aging of the variable annuity in-force block of business, volatility in the equity markets and increased sales competition, particularly competition related to guaranteed living benefits. Also contributing to the decrease in fee income was lower mutual fund fees due to declining assets under management primarily driven by market depreciation of $20.1 billion, partially offset by $2.8 billion of net flows.
Net investment spread decreased primarily due to negative earnings on limited partnership and other alternative investment income in 2008 compared to strong earnings in these classes in 2007 and lower yields on fixed maturities, partially offset by reduced average credited rates.
Net realized capital losses increased primarily as a result of losses on GMWB derivatives of $631 in 2008 compared with losses of $286 million in 2007; the transition impact related to the adoption of fair value accounting guidance, which resulted in losses of $616 in 2008; and impairments of $474 in 2008 compared with $87 in 2007.
Insurance operating costs and other expenses decreased primarily as a result of lower non deferrable asset based trail commissions due to equity market declines.
General insurance expense ratio increased from 2007 to 2008 due to the impact of a declining asset base on relatively consistent expenses
DAC amortization ratio (individual annuity), excluding the effects of the DAC Unlock and realized losses, increased in 2008 as compared to 2007 due to the write-off of goodwill and changes in assumptions made as part of the 2007 Unlock.
As a result of testing performed during the fourth quarter of 2008, all goodwill attributed to the individual annuity business in Retail was deemed to be impaired and was written off. For further discussion of this impairment, see the Critical Accounting Estimates section of the MD&A.
The effective tax rate increased from 21% in 2007 to 42% in 2008 primarily due to losses before income taxes in 2008 compared to pre-tax earnings in 2007. The impact of DRD and other permanent differences caused an increase in the tax benefit to above 35% on the 2008 pre-tax loss and a decrease in the tax expense on the 2007 pre-tax income.
Net income improvements are primarily attributed to lower net realized capital losses. The following other factors contributed to the changes in net income:
Fee income and other increased primarily due to the impact of the 2009 Unlock amortization of unearned revenue reserves of $83 and increased cost of insurance charges of $40 as a result of growth in guaranteed universal life insurance in-force, partially offset by lower variable life fees as a result of equity market declines. For further discussion on the Unlock, see Unlock in the Critical Accounting Estimates section of the MD&A.
Net investment spread was lower due to a $4 decline in investment income and a $3 increase in interest credited. Interest credited increased due primarily to increased average account values, partially offset by a reduction in the average credited rate of 19 bps.
Net realized capital losses improved primarily related to lower losses from impairments. For further discussion on impairments, see Other-Than-Temporary Impairments within the Investment Credit Risk Section of the MD&A.
Benefits, losses and loss adjusted expenses increased primarily related to reserve increases on secondary guaranteed universal life products due to aging and growth in life insurance in-force, partially offset by favorable mortality experience
Death benefits decreased due to favorable mortality volatility partially offset by an increase in net amount at risk for variable universal life policies caused by equity market declines.
Insurance operating costs and other expenses decreased primarily as a result of continued active expense management efforts.
Net income decreased for the year ended December 31, 2008, driven primarily by significantly higher net realized capital losses and the impacts of the Unlock in the third quarter of 2008 as compared to the third quarter of 2007. For further discussion on the Unlock, see Unlock in the Critical Accounting Estimates section of the MD&A. The following other factors contributed to the changes in net income:
Fee income and other increased primarily due to an increase in cost of insurance charges of $47 as a result of growth in guaranteed universal life insurance in-force and fees on higher surrenders of $12 due to internal exchanges from non-guaranteed universal life insurance to variable universal life insurance. Partially offsetting these increases are the impacts of the 2008 and 2007 Unlocks as well as lower variable life fees as a result of equity market declines.
Earned premiums, which include premiums for ceded reinsurance, decreased primarily due to increased ceded reinsurance premiums due to life insurance in-force growth.
Net realized capital losses increased primarily related to losses from impairments. For further discussion on impairments, see Other-Than-Temporary Impairments within the Investment Credit Risk Section of the MD&A.
Death benefits increased, primarily due to growth of life insurance in-force and unfavorable mortality.
Insurance operating costs and other increased less than the growth of in- force business as a result of active expense management efforts.
Income tax benefits were a result of lower income before income taxes primarily due to an increase in realized capital losses and DAC amortization.
Net loss in Retirement Plans increased due to an increase in net realized capital losses, lower net investment income and lower fee income. For further discussion of the DAC Unlock, see Unlocks within the Critical Accounting Estimates section of the MD&A. The following other factors contributed to the changes in net loss:
Fee income and other decreased primarily due to lower average account values. Despite equity market improvements during the last nine months of 2009, account values have not returned to early 2008 levels. Net flows in group annuities and net sales in mutual funds have declined due primarily to a few large case surrenders.
Net investment income decreased primarily as a result of lower yields on fixed maturity investments partially offset by an increase in derivative income.
The decline in net investment spread is attributable to lower fixed income returns of 34 bps and lower partnership returns of 3 bps, partially offset by a reduction in credited rates of 10 bps.
Insurance operating costs and other expenses increased primarily due to a full year of operating expenses associated with the businesses acquired in the latter part of the first quarter of 2008 and lower deferrable acquisition expenses unable to be deferred due to low sales levels, partially offset by expense management initiatives.
Fee income and other increased primarily due to $109 of fees earned on assets relating to the acquisitions in the first quarter of 2008. Offsetting this increase was lower annuity fees driven by lower average account values as a result of market depreciation of $7.3 billion, partially offset by positive net flows of $2.4 billion over the past four quarters. Group annuities had positive net flows
Insurance operating costs and other expenses increased primarily attributable to operating expenses associated with the acquired businesses. Also contributing to higher insurance operating costs were higher trail commissions resulting from an aging portfolio and higher service and technology costs.
The income tax benefit for 2008 as compared to the prior year periods income tax expense was due to lower income before income taxes primarily due to increased realized capital losses and increased tax benefits associated with the DRD.
Institutional investment product account values include transfers from Retirement Plans of $413 and $350 from the Retail segment during 2007.
Includes policyholder balances for investment contracts and reserves for future policy benefits for insurance contracts.
Earned premiums decreased as ratings downgrades reduced payout annuity sales. The decrease in earned premiums was offset by a corresponding decrease in benefits, losses, and loss adjustment expenses.
Net investment income declined due to lower income on fixed maturities resulting from a decline in average rates and fixed maturity investments, as well as an increased average asset base of securities with greater market liquidity. This lower yield on income was partially offset by a corresponding decrease in interest credited on liabilities reported in benefits, losses, and loss adjustment expenses.
Stable Value, net investment spreads were negatively impacted by 166 bps due to lower yields on variable rate securities and maintaining additional liquidity in the Institutional portfolios in the form of short term and Treasury securities. In both periods, the drop in variable rate yields was partially offset by lower credited rates on floating rate liabilities.
Net realized capital losses were slightly lower due to smaller impairments
Insurance operating costs and other expenses decreased due to active expense management efforts and reduced information technology expenses.
Institutional general expense ratio decreased from 2009 as compared to 2008 due to active expense management efforts and reduced information technology expenses.
Net investment spread decreased primarily due to negative earnings on limited partnership and other alternative investment income in 2008 compared to strong earnings in these classes in 2007 and lower yields on fixed maturities, partially offset by reduced credited rates.
Benefits, losses and loss adjustment expenses decreased primarily due to lower changes in reserve as the result of lower sales in life contingent business, as well as lower interest credited on liabilities indexed to LIBOR. The decrease was partially offset by $8 greater mortality loss.
Institutional general insurance expense ratio increased from 2008 as compared to 2007 due to additional product development expenses.
The income tax benefit increased compared to the prior year primarily due to a decline in income before taxes primarily due to increased realized capital losses.
The transition impact related to the fair value adoption was a reduction in revenues of $172 for Other for the year ended December 31, 2008. For further discussion of the fair value transition impact, refer to Note 3 in the Notes to the Consolidated Financial Statements.
Net investment income includes investment income and mark-to-market effects of equity securities, held for trading, supporting the international variable annuity business, which are classified in net investment income with corresponding amounts credited to policyholders.
The Company includes in an Other category its leveraged PPLI product line of business; corporate items not directly allocated to any of its reporting segments; intersegment eliminations, guaranteed minimum income benefit (“GMIB”), guaranteed minimum death benefit. (“GMDB”), guaranteed minimum accumulation benefit (“GMAB”) and guaranteed minimum withdrawal benefit (“GMWB”) and reinsurance assumed from an affiliate and subsequently ceded to another related party, certain group benefit products, including group life and group disability insurance that is directly written by the Company and for which nearly half is ceded to its parent, HLA, as well as other International operations.
transaction with an affiliated captive reinsurer. Refer to Note 16 Transaction with Affiliates.
Insurance operating costs and other expenses increased due to restructuring costs that are severance benefits and other costs associated with the suspension of sales in the Company’s European operations and severance and other benefits associated with the restructuring of the Company’s domestic insurance operations as well as interest expense for the structured financing transaction with HLIKK that was initiated in the fourth quarter of 2008. See Note 17 for further details on the Company’s restructuring, severance and other costs and restructurings within other Life segments and Note 16 for further details on the structured financing transaction with HLIKK.
The decrease in benefits, losses and loss adjustment expenses relates to reinsurance transaction with an affiliated captive reinsurer. Refer to Note 16 Transaction with Affiliate for further discussion.
Insurance operating costs and other expenses decreased, primarily due to a charge of $21 for regulatory matters in the second quarter of 2007, a decline in 2008 expenses now allocated to other segments partially offset by increased tax expenses due to a state tax credit that was recorded in the third quarter of 2007.
Yields calculated using annualized net investment income before investment expenses divided by the monthly average invested assets at cost, amortized cost, or adjusted carrying value, as applicable, excluding collateral received associated with the securities lending program and consolidated variable interest entity noncontrolling
Includes income from derivatives that qualify for hedge accounting and hedge fixed maturities. Also, includes fees associated with securities lending activities of $4, $60 and $84, respectively, for the years ended December 31, 2009, 2008 and 2007. The income from securities lending activities is included within fixed maturities.
Total net investment income decreased primarily due to a negative yield on limited partnerships and other alternative investments and a lower yield on variable rate securities due to declines in short-term interest rates, increased allocation to lower yielding U.S. Treasuries and short-term investments. The decline in limited partnerships and other alternative investments yield was largely due to negative returns on hedge funds and real estate partnerships as a result of the lack of liquidity in the financial markets and a wider credit spread environment. Also contributing to the decline in net investment income was lower income on equity securities, trading due to a decline in the value of the underlying investment funds supporting the U.K. unit-linked and pension product as a result of negative market performance year over year.
Gross gains and losses on sales for the year ended December 31, 2009 were predominantly within structured, government and corporate securities resulting primarily from efforts to reduce portfolio risk through sales of subordinated financials and real
estate related securities and from sales of U.S. Treasuries to manage liquidity.
For further information, see Other- Than-Temporary Impairments within the Investment Credit Risk section of the MD&A.
See Note 4 of the Notes to the Consolidated Financial Statements for a discussion of the gains related to the variable annuity hedge program.
Under the reinsurance agreement with an affiliate, the gains experienced from the GMAB, GMWB, and GMIB reinsurance along with the net gains from liability model assumption updates, lower volatility, increases in long-term interest rates, and rising equity markets on the US GMWB are ceded to the affiliated reinsurer and result in a realized loss.
Other, net losses for the year ended December 31, 2009 primarily resulted from net losses of $329 on credit derivatives where the company purchased credit protection due to credit spread tightening and $289 related to net additions to valuation allowances on impaired mortgage loans. These losses were partially offset by gains of $128 on credit derivatives that assume credit risk due to credit spread tightening, as well as $191 from a change in spot rates related to transactional foreign currency predominately on the internal reinsurance of the Japan variable annuity business, which is offset in accumulated other comprehensive income (“AOCI”).
Other, net losses for the year ended December 31, 2008 were primarily related to net losses of $295 related to transactional foreign currency predominately on the internal reinsurance of the Japan variable annuity business, which is offset in AOCI, resulting from appreciation of the yen, as well as credit derivatives losses of $191 due to significant credit spread widening. Also included were derivative related losses of $39 due to counterparty default related to the bankruptcy of Lehman Brothers Holdings Inc.
The Company invests primarily in securities which are rated investment grade and has established exposure limits, diversification standards and review procedures for all credit risks including borrower, issuer and counterparty. Creditworthiness of specific obligors is determined by consideration of external determinants of creditworthiness,
typically ratings assigned by nationally recognized ratings agencies and is supplemented by an internal credit evaluation. Obligor, asset sector and industry concentrations are subject to established Company limits and are monitored on a regular basis.
The maximum uncollateralized threshold for a derivative counterparty for a single legal entity is $10. The Company currently transacts over-the-counter derivatives in two legal entities and therefore the maximum combined threshold for a single counterparty over all legal entities that use derivatives is $20. 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, 2009, the maximum combined threshold for all counterparties under a single credit support provider over all legal entities that use derivatives is $40. Based on the contractual terms of the collateral agreements, these thresholds may be immediately reduced due to a downgrade in a counterparty’s credit rating. For further discussion, see the Derivative Commitments Section of Note 9 of the Consolidated Financial Statements.
For the year ended December 31, 2009, the Company has incurred no losses on derivative instruments due to counterparty default.
In addition to counterparty credit risk, the Company enters into credit default swaps to manage credit exposure. Credit default swaps involve a transfer of credit risk of one or many referenced entities from one party to another in exchange for periodic payments. The party that purchases credit protection will make periodic payments based on an agreed upon rate and notional amount, and for certain transactions there will also be an upfront premium payment. The second party, who sells credit protection, will typically only make a payment if there is a credit event and such payment will be equal to the notional value of the swap contract less the value of the referenced security
issuer’s debt obligation. A credit event is generally defined as default on contractually obligated interest or principal payments or bankruptcy of the referenced entity.
The Company uses credit derivatives to purchase credit protection and, to a lesser extent, assume credit risk with respect to a single entity, referenced index, or asset pool. The Company purchases credit protection through credit default swaps to economically hedge and manage credit risk of certain fixed maturity investments across multiple sectors of the investment portfolio. The Company has also entered into credit default swaps that assume credit risk as part of replication transactions. Replication transactions are used as an economical means to synthetically replicate the characteristics and performance of assets that would otherwise be permissible investments under the Company’s investment policies. These swaps reference investment grade single corporate issuers and baskets, which include trades ranging from baskets of up to five corporate issuers to standard and customized diversified portfolios of corporate issuers. The baskets of diversified portfolios are established within sector concentration limits and are typically divided into tranches which possess different credit ratings ranging from AAA through the CCC rated first loss position.
The movement within the Company’s investment ratings was primarily attributable to rating agency downgrades across multiple sectors and sales of U.S. Treasuries that were re-deployed to securities with more favorable risk profiles, in particular investment grade corporate securities. The ratings associated with the Company’s commercial mortgage backed-securities (“CMBS”), commercial real estate (“CRE”) collateralized debt obligations (“CDOs”) and residential mortgage-backed securities (“RMBS”) may be negatively impacted as rating agencies continue to make changes to their methodologies and monitor security performance.
As of December 31, 2009, 80% of these senior secured bank loan collateralized loan obligations (“CLOs”) were rated AA and above with an average subordination of 29%.
The Company reallocated its AFS investment portfolio to securities with more favorable risk profiles, in particular investment grade corporate securities, while reducing its exposure to real estate related securities. Additionally, the Company reduced its allocation to U.S. Treasuries in order to manage liquidity. The Company’s AFS net unrealized loss position decreased as a result of improved security valuations due to credit spread tightening, partially offset by rising interest rates and a $738 before-tax cumulative effect of accounting change related to impairments. For further discussion on the accounting change, see Note 1 of the Notes to the Consolidated Financial Statements. The following sections highlight the Company’s significant investment sectors.
The Company has exposure to the financial services sector predominantly through banking and insurance firms. The following table presents the Company’s exposure to the financial services sector included in the AFS Securities by Type table above. A comparison of fair value to amortized cost is not indicative of the pricing of individual securities as impairments have occurred.
The following table presents the Company’s exposure to RMBS supported by sub-prime mortgage loans by current credit quality and vintage year included in the AFS Securities by Type table above. These securities have been affected by deterioration in collateral performance caused by declining home prices and continued macroeconomic pressures including higher unemployment levels. A comparison of fair value to amortized cost is not indicative of the pricing of individual securities as impairments have occurred. Credit protection represents the current weighted average percentage, excluding wrapped securities, of the outstanding capital structure subordinated to the Company’s investment holding that is available to absorb losses before the security incurs the first dollar loss
Includes second lien residential mortgages with an amortized cost and fair value of $33 and $28, respectively, as of December 31, 2009 and $120 and $60, respectively, as of December 31, 2008, which are composed primarily of loans to prime and Alt-A borrowers.
As of December 31, 2009, the weighted average life of the sub-prime residential mortgage portfolio was 4.5 years.
Approximately 94% of the portfolio is backed by adjustable rate mortgages.
outstanding debt. The ratings associated with the Company’s CMBS and CRE CDOs may be negatively impacted as rating agencies continue to make changes to their methodologies and monitor security performance.
For certain CRE CDOs, the collateral manager has the ability to reinvest proceeds that become available, primarily from collateral maturities. The increase in the 2008 and 2009 vintage years represents reinvestment under these CRE CDOs.
and should these trends continue, additional increases in the Company’s valuation allowance for mortgage loans may result.
At origination, the weighted average loan-to-value (“LTV”) rate of the Company’s commercial mortgage loan portfolio was approximately 63%. As of December 31, 2009, the current weighted average LTV was approximately 81%. LTV rates compare the loan amount to the value of the underlying property collateralizing the loan. The loan values are updated periodically through property level reviews of the portfolio. Factors considered in the property valuation include, but are not limited to, actual and expected property cash flows, geographic market data and capitalization rates.
As of December 31, 2009, approximately 9% of the auto consumer loan-backed securities were issued by lenders whose primary business is to sub-prime borrowers.
For further discussion on the Company’s ongoing impairment evaluation process and the factors considered in determining whether a credit impairment exists, see the Recognition and Presentation of Other-Than-Temporary Impairments Section in Note 4 of the Notes to the Consolidated Financial Statements.
Average cumulative CMBS collateral loss rates that varied by vintage year but reached approximately 12% for the 2007 vintage year.
Impairments on securities for which the Company had the intent to sell were primarily on corporate financial services securities where the Company had an active plan to dispose of the securities. Impairments on equity securities were primarily on below investment grade hybrid securities that had been depressed 20% for six continuous months.
Impairments were primarily concentrated in subordinated fixed maturities within the financial services sector, as well as in sub-prime RMBS and CRE CDOs. The remaining impairments were primarily recorded on securities in various sectors that experienced significant credit spread widening and for which the Company was uncertain of its intent to retain the investments for a period of time sufficient to allow for recovery.
The Company has a disciplined approach to managing risks associated with its capital markets and asset/liability management activities. Investment portfolio management is organized to focus investment management expertise on the specific classes of investments, while asset/liability management is the responsibility of a dedicated risk management unit supporting the Company. Derivative instruments are utilized in compliance with established Company policy and regulatory requirements and are monitored internally and reviewed by senior management.
The fixed liabilities included above represented approximately 61% and 59% of the Company’s general account liabilities as of December 31, 2009 and 2008, respectively. The assets supporting the fixed liabilities are monitored and managed within rigorous duration guidelines, and are evaluated on a monthly basis, as well as annually using scenario simulation techniques in compliance with regulatory requirements.
short-term and long-term interest rates will remain constant over time. As a result, these calculations may not fully capture the impact of portfolio re-allocations, significant product sales or non-parallel changes in interest rates.
In addition to counterparty credit risk, the Company enters into credit derivative instruments to manage credit exposure. The Company purchases credit protection through credit default swaps to economically hedge and manage credit risk of certain fixed maturity investments across multiple sectors of the investment portfolio. The Company has also entered into credit default swaps that assume credit risk to synthetically replicate the characteristics and performance of assets that would otherwise be permissible investments under the Company’s investment policies. Credit spread widening will generally result in an increase in fair value of derivatives that purchase credit protection and a decrease in fair value of derivatives that assume credit risk. These derivatives do not receive hedge accounting treatment and, as such, changes in fair value are reported through earnings. As of December 31, 2009 and 2008, the notional amount related to credit derivatives that purchase credit protection was $1.9 billion and $2.6 billion, respectively, while the fair value was ($34) and $246, respectively. As of December 31, 2009 and 2008, the notional amount related to credit derivatives that assume credit risk was $902 and $940, respectively, while the fair value was ($176) and ($309), respectively. For further information on credit derivatives, see the Investment Credit Risk section of the MD&A and Note 4 of Notes to Consolidated Financial Statements.
The Company does not have significant equity risk exposure from invested assets. The Company’s primary exposure to equity risk relates to the potential for lower earnings associated with certain of its businesses such as variable annuities where fee income is earned based upon the fair value of the assets under management. During 2009, the Company’s fee income declined $404 or 10%. In addition, the Company offers certain guaranteed benefits, primarily associated with variable annuity products, which increases the Company’s potential benefit exposure as the equity markets decline.
The risk associated with the non-U.S. dollar denominated fixed maturities relates to potential decreases in value and income resulting from unfavorable changes in foreign exchange rates. The fair value of the non-U.S. dollar denominated fixed maturities, which are primarily denominated in euro, sterling, yen and Canadian dollars, at December 31, 2009 and 2008, were approximately $549 and $2.9 billion, respectively.
In order to manage its currency exposures, the Company enters into foreign currency swaps and forwards to hedge the variability in cash flows associated with certain foreign denominated fixed maturities. These foreign currency swap and forward agreements are structured to match the foreign currency cash flows of the hedged foreign denominated securities. At December 31, 2009 and 2008, the derivatives used to hedge currency exchange risk related to non-U.S. dollar denominated fixed maturities had a total notional amount of $316 and $1.2 billion, respectively, and total fair value of ($22) and $8 respectively.
The yen based fixed annuity product is written by HLIKK and ceded to the Company. The underlying investment involves investing in U.S. securities markets, which offer favorable credit spreads. The yen denominated fixed annuity product (“yen fixed annuities”) assumed is recorded in the consolidated balance sheets with invested assets denominated in U.S. dollars while policyholder liabilities are denominated in yen and converted to U.S. dollars based upon the December 31, 2009 yen to U.S. dollar spot rate. The difference between U.S. dollar denominated investments and yen denominated liabilities exposes the Company to currency risk. The Company manages this currency risk associated with the yen fixed annuities primarily with pay variable U.S. dollar and receive fixed yen currency swaps. As of December 31, 2009 and 2008, the notional value of the currency swaps was $2.3 billion and the fair value was $316 and $383, respectively. Although economically an effective hedge, a divergence between the yen denominated fixed annuity product liability and the currency swaps exists primarily due to the difference in the basis of accounting between the liability and the derivative instruments (i.e. historical cost versus fair value). The yen denominated fixed annuity product liabilities are recorded on a historical cost basis and are only adjusted for changes in foreign spot rates and accrued income. The currency swaps are recorded at fair value incorporating
increase the amount of required statutory capital necessary to maintain targeted risk based capital ratios;
turn customer sentiment toward equity-linked products negative, causing a decline in sales; and
GRB. As the account value fluctuates with equity market returns on a daily basis and the “life-time” GMWB payments can exceed the GRB, the ultimate amount to be paid by the Company, if any, is uncertain and could be significantly more or less than $775. For additional information on the Company’s GMWB liability, see Note 3 of Notes to Consolidated Financial Statements.
The Company’s derivative hedging programs are structured at a parent company level, as the Company is a member of a controlled group of subsidiaries which are consolidated and reported by their parent company HFSG. Certain portions of the derivative hedging program are held in the Company for the purpose of hedging U.S. equity product risk within the controlled group.
events, providing resources to pay product guarantee claims, and minimizing U.S GAAP earnings volatility, statutory surplus volatility and other economic metrics.
The Company holds customized derivative contracts to provide protection from certain capital market risk for the remaining term of specific blocks of non-reinsured GMWB riders. These customized derivative contracts provide protection from capital markets risks based on policyholder behavior assumptions specified at the inception of the derivative transactions. The Company retains the risk for actual policyholder behavior that is different from assumptions within the customized derivatives.
See Note 4 of Notes to Consolidated Financial Statements for additional information on hedging derivatives.
The notional amount and fair value include both the scenario where only one rating agency takes action to this level as well as where both rating agencies take action to this level.
As of December 31, 2009, the Company’s total assets under management were $286.4 billion. Of the total assets under management, approximately $217.8 billion is held in separate accounts, within mutual funds or were held in international statutory separate accounts. Mutual funds are not recorded on the Company’s balance sheet. The remaining $68.5 billion was held in the Company’s general account supported by the Company’s general account invested assets of $53.5 billion including a significant short-term investment position to meet liquidity needs. As of December 31, 2009 and December 31, 2008, the Company held total fixed maturity investments of $45.5 billion and $45.3 billion, respectively. As of December 31, 2009, the Company’s cash and short-term investments of $5.9 billion, included $833 of collateral received from, and held on behalf of, derivative counterparties and $212 of collateral pledged to derivative counterparties. The Company also held $2.3 billion of treasury securities, of which $454 had been pledged to derivative counterparties.
Surrenders of, or policy loans taken from, as applicable, the remaining $18.4 billion of general account liabilities, which include the general account option for Retail’s individual variable annuities and Individual Life’s variable life contracts, the general account option for Retirement Plan annuities and universal life contracts sold by Individual Life may be funded through operating cash flows of the Company, available short-term investments, or the Company may be required to sell fixed maturity investments to fund the surrender payment. Sales of fixed maturity investments could result in the recognition of significant realized losses and insufficient proceeds to fully fund the surrender amount. In this circumstance, the Company may need to acquire additional liquidity from the HFSG Holding Company or take other actions, including enforcing certain contract provisions which could restrict surrenders and/or slow or defer payouts.
Institutional began issuing consumer notes through its Retail Investor Notes Program in September 2006. A consumer note is an investment product distributed through broker-dealers directly to retail investors as medium-term, publicly traded fixed or floating rate, or a combination of fixed and floating rate, notes. Consumer notes are
The following table identifies the Company’s contractual obligations as of December 31, 2009:
The Company declared dividends of $38, $313 and $461 to HLA for 2009, 2008 and 2007, respectively. Future dividend decisions will be based on, and affected by, a number of factors, including the operating results and financial requirements of the Company on a stand-alone basis and the impact of regulatory restrictions.
Year ended December 31, 2008 compared to Year-ended December 31, 2007 - The decrease in cash provided by operating activities was primarily the result of a decrease in net investment income as a result of lower yields and reduced fee income as a result of declines in equity markets. Net purchases of available-for-sale securities continue to account for the majority of cash used for Investing activities. The increase in net cash provided by financing activities was primarily due to increased transfers from the separate account to the general account for investment and universal life-type contracts and issuance of structured financing and consumer notes. Operating cash flows in both periods have been more than adequate to meet liquidity requirements.
capital of the insurance company reported in accordance with accounting practices prescribed by the applicable state insurance department.
The Company’s stockholder’s equity, as prepared using U.S. generally accepted accounting principles (“US GAAP”) was $6.2 billion as of December 31, 2009. The Company’s estimated aggregate statutory capital and surplus, as prepared in accordance with the National Association of Insurance Commissioners’ Accounting Practices and Procedures Manual (“US STAT”) was $5.4 billion as of December 31, 2009.
In December, 2009 the NAIC issued SSAP 10R which modified the accounting for deferred income taxes prescribed by the NAIC by increasing the realization period for deferred tax assets from one year to three years and increasing the asset recognition limit from 10% to 15% of adjusted statutory capital and surplus. SSAP 10R will expire for periods after December 31, 2010.
Certain assumptions used in the determination of Life benefit reserves are prescribed under US STAT and are intended to be conservative, while the assumptions used under US GAAP are generally the Company’s best estimates. In addition, the methodologies used for determining life reserve amounts are different between U.S. STAT and U.S. GAAP. Annuity reserving and cash-flow testing for death and living benefit reserves under US STAT are generally addressed by the Commissioners’ Annuity Reserving Valuation Methodology and the related Actuarial Guidelines. Under these Actuarial Guidelines, in general, future cash flows associated with the variable annuity business are included in these methodologies with estimates of future fee revenues, claim payments, expenses, reinsurance impacts and hedging impacts. At December 31, 2008, in determining the cash-flow impacts related to future hedging, assumptions were made in the scenarios that generate reserve requirements, about the potential future decreases in the hedge benefits and increases in hedge costs which resulted in increased reserve requirements. Reserves for death and living benefits under U.S. GAAP are either considered embedded derivatives and recorded at fair value, or they may be considered death and other insurance benefit reserves.
The difference between the amortized cost and fair value of fixed maturity and other investments, net of tax, is recorded as an increase or decrease to the carrying value of the related asset and to equity under US GAAP, while US STAT only records certain securities at fair value, such as equity securities and certain lower rated bonds required by the NAIC to be recorded at the lower of amortized cost or fair value. In the case of the Company’s market value adjusted (MVA) fixed annuity products, invested assets are marked to fair value (including the impact of credit spreads) and liabilities are marked to fair value (but generally excluding the impacts of credited spreads) for statutory purposes only. In the case of the Company’s market value adjusted (MVA) fixed annuity products, invested assets are marked to fair value (but generally actual credit spreads are not fully reflected) for statutory purposes only.
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 many capital market scenarios, current crediting rates 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 are now experiencing, 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, 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.
Most of these factors are outside of the Company’s control. The Company’s financial strength and credit ratings are significantly influenced by the statutory surplus amounts and RBC ratios of our insurance company subsidiaries. Due to all of these factors, projecting statutory capital and the related projected RBC ratios is complex. In addition, rating agencies may implement changes to their internal models that have the effect of increasing or decreasing the amount of statutory capital we must hold in order to maintain our current ratings.
The Company has reinsured approximately 11% of its risk associated with GMWB with a third party and 72% of its risk associated with GMWB with an affiliated captive reinsurer. The Company has also reinsured 86% of its risk associated with the aggregate GMDB exposure. These reinsurance agreements serve to reduce the Company’s exposure to changes in the statutory reserves and the related capital and RBC ratios associated with changes in the equity markets. The Company also continues to explore other solutions for mitigating the capital market risk effect on surplus, such as internal and external reinsurance solutions, migrating towards a more statutory based hedging program, changes in product design, increasing pricing and expense management.
Regulatory Developments - For a discussion regarding contingencies related to regulatory developments that affect the Company, please see Note 10 of the Notes to the Consolidated Financial Statements.
For further information on other contingencies, see Note 10 of Notes to Consolidated Financial Statements
Liabilities for guaranty fund and other insurance-related assessments are accrued when an assessment is probable, when it can be reasonably estimated, and when the event obligating the Company to pay an imposed or probable assessment has occurred. Liabilities for guaranty funds and other insurance-related assessments are not discounted and are included as part of other liabilities in the Consolidated Balance Sheets. As of December 31, 2009 and 2008, the liability balance was $7 and $4, respectively. As of December 31, 2009 and 2008, $10 and $11, respectively, related to premium tax offsets were included in other assets.