The Hartford owns the land and buildings comprising its Hartford location and other properties within the greater Hartford, Connecticut area which total approximately 1.6 million square feet. The Hartford's international subsidiaries own approximately 202 thousand square feet of office space in the United Kingdom, 218 thousand square feet of office space in the Netherlands and 94 thousand square feet of office space in Spain. In addition, The Hartford leases approximately 5.1 million square feet throughout the United States and 156 thousand square feet in other countries.
================================================================================ DISTRIBUTION ================================================================================ On December 19, 1995, ITT Corporation ("ITT") distributed all of the outstanding shares of common stock of The Hartford to the shareholders of ITT common stock (the "Distribution" or "Spin-off"). As a result of the Distribution, The Hartford became an independent publicly-traded company. "Regular Way" trading of The Hartford's common stock on the New York Stock Exchange (under the symbol "HIG") commenced on December 20, 1995. In connection with this transaction, ITT transferred First State Insurance Company, together with its subsidiaries, and Fencourt Reinsurance Company, Ltd., both of which were wholly owned companies of ITT, to The Hartford prior to the Distribution. Consistent with the Consolidated Financial Statements and related Notes, the financial information included herein reflects the results of The Hartford as if it were a separate entity for all periods presented. For additional information, see "Distribution Agreement" under Capital Resources and Liquidity.
Core earnings increased $59, or 12%, to $537 in 1996 due primarily to increased revenues earned on a growing annuity asset base, growth in net investment income, increased group insurance premiums and favorable mortality experience, partially offset by after-tax underwriting losses resulting from higher catastrophes in 1996.
Net income for 1996 includes other charges related to environmental and asbestos reserve increases, net of taxes, of $(429) in the North American Property & Casualty segment and $(81) at First State in the Runoff segment (as discussed in the Environmental and Asbestos Claims section), recognition of losses on Closed Book GRC of $(169) (as discussed in the Runoff section) and other, primarily foreign tax-related items, of $(2) in each of the North American Property & Casualty and Life segments and $(10) in the Runoff segment.
As part of the Distribution, The Hartford was allocated amounts originally recorded at the ITT corporate level. The allocations resulted in net income of $14 and $50 in 1995 and 1994, respectively. For more information on liability sharing arrangements related to the Distribution, see "Distribution Agreement" and "Tax Allocation Agreement" under Capital Resources and Liquidity.
1996 1995 1994 - ---------------------------------------------------------------- Underwriting results $ (986) $ (270) $ (182) Net investment income 661 646 606 Net realized capital gains 15 29 69 Other miscellaneous expenses 89 71 29 - ---------------------------------------------------------------- Operating income $ (399) $ 334 $ 464 - ----------------------------------------------------------------
1996 1995 1994 - ---------------------------------------------------------------- Written premiums $ 5,688 $ 5,670 $ 5,648 Underwriting results [1] $ (326) $ (270) $ (182) Combined ratio [1] [2] 105.2 104.5 102.5 - ---------------------------------------------------------------- [1] 1996 excludes the impact of $660, before-tax, environmental and asbestos charge. Including the impact of this charge, the combined ratio for 1996 was 116.9 for the North American Property & Casualty segment. [2] "Combined ratio" is a common industry measurement of the results of property and casualty insurance underwriting. This ratio is the sum of the ratio of incurred claims and claim expenses to premiums earned (the "loss ratio") and the ratio of underwriting expenses incurred to premiums written (the "expense ratio"). A combined ratio under 100.0 generally indicates an underwriting profit. Federal income taxes, net investment income, deferred policy acquisition costs and other non-underwriting expenses are not reflected in the combined ratio.
Written premiums for this segment were up slightly in 1996 and 1995 from the respective prior year's results. Continued growth in target markets such as reinsurance, small commercial accounts and business written under an exclusive licensing arrangement with The American Association of Retired Persons ("AARP") was offset by decreased premiums from mid-to-large commercial accounts, agency personal lines and residual markets. The conversion of certain workers' compensation business to large deductible programs also depressed the growth in written premiums.
1996 underwriting losses before-tax increased $56 over 1995 primarily due to severe weather-related catastrophe experience, most notably several first quarter winter storms and Hurricane Fran in September. These events drove total catastrophe losses in 1996 to exceed 1995 by approximately $130 causing a 2.3 point increase in the combined ratio.
Written premiums increased 3% in 1996 compared to a 4% increase in 1995. Both years include strong growth in AARP premium which is benefiting from the favorable expansion of this demographic group, partially offset by a selective disinvestment in unprofitable states and under-performing agents. AARP premiums represented 64% of the 1996 Personal operations premium, up from 62% in 1995 and 59% in 1994.
Reinsurance - ----------- 1996 1995 1994 - ---------------------------------------------------------------- Written premiums $ 613 $ 522 $ 481 Underwriting results $ (15) $ (22) $ (7) Combined ratio 102.8 104.3 101.8 - ----------------------------------------------------------------
The Hartford assumes reinsurance worldwide through its seven Hartford Reinsurance Company ("HartRe") offices located in Hartford, San Francisco, Toronto, London, Madrid, Munich and Hong Kong. HartRe primarily writes treaty reinsurance through professional reinsurance brokers covering various property, casualty, specialty and marine classes of business.
Other miscellaneous expenses for 1995 of $71 increased from $29 in 1994. This increase was largely attributable to a decrease in service fee income from third party administration and involuntary pool servicing contracts. The reduction in service fee income was due to lower servicing carrier allowances caused by the substantial depopulation of workers' compensation and involuntary pools. Increased debt costs also impacted other miscellaneous expenses in 1995.
Core earnings increased $72, or 48%, to $221 in 1995 from $149 in 1994 largely due to (i) a $30 increase in the Investment Products division principally driven by an increase in total account value, (ii) an $11 increase in the Individual Life Insurance division principally due to growth in the inforce block and favorable mortality experience and expense trends and (iii) a $21 increase in the Employee Benefits division principally due to an increase in group premiums and favorable morbidity experience, as well as growth in the COLI block of business.
The Life segment operates in three principal divisions: Investment Products, Individual Life Insurance and Employee Benefits as outlined in the table below. In addition, the Life segment maintains a Corporate Operation through which it reports net investment income on assets representing surplus not assigned to any of its business segments and certain other revenue and expenses not specifically allocable to any of its business segments.
Similar factors generated an increase in 1995, as compared with 1994, in revenues of $190, or 33%, average general account assets of $1.3 billion, or 26%, average separate account assets of $8.0 billion, or 44%, total benefits, claims and expenses of $149, or 34%, core earnings of $30, or 36%, and a reduction in individual annuity expenses as a percentage of total individual annuity account value to 31 basis points in 1995 from 35 basis points in 1994.
Revenues increased $64, or 16%, to $472 from $408 in 1995. This increase was primarily due to a $47 increase in premiums and other considerations, reflecting an increase in cost of insurance charges and variable life fees applied to a larger
Two other events, along with those mentioned above, influenced the results of 1995 compared with 1994. In 1994, the Life segment assumed $218 of individual life insurance reserves from the Pacific Standard Life Insurance Company. This affected both revenues and total benefits, claims and expenses for 1994. Expenses were also positively influenced by the consolidation of the professional functions previously performed in Minneapolis, Minnesota into the Life segment's Simsbury, Connecticut location. The combination of this acquisition, internal growth, expense management and favorable mortality experience caused core earnings in this division to increase $11, or 42%, to $37 in 1995 from $26 in 1994.
The International segment includes direct insurance business written by local companies in the United Kingdom, namely ITT London & Edinburgh, the Netherlands and Belgium, Zwolsche Algemeene, and Spain, ITT Ercos. These companies primarily offer property and casualty products in both personal and commercial lines. Zwolsche Algemeene and ITT Ercos also offer life products designed to meet the needs of local customers.
Core earnings in the International segment of $87 in 1996 decreased $4, or 4%, from 1995, following a $29, or 47%, increase in 1995 over 1994. The decrease in earnings from 1995 was primarily the result of deteriorating underwriting results due to heightened competition in the United Kingdom and unfavorable foreign exchange impacts, partially offset by growth in net investment income. 1996 revenues of $1.6 billion were $86, or 6%, higher than 1995 primarily due to growth at Zwolsche Algemeene and 1995 results at ITT Ercos only reflecting eight months of activity due to its acquisition by the Company in May 1995. Growth over 1995 was dampened by soft market conditions in the United Kingdom. Additionally, the U.S. dollar strengthened during 1996 compared to 1995, resulting in unfavorable foreign exchange translation movements during 1996 resulting in approximately $37 and $3 of the decrease in revenues and core earnings, respectively.
Zwolsche Algemeene's 1995 revenues of $416 and core earnings of $25 improved $88, or 27%, and $8, or 47%, respectively, compared with 1994. These increases were due to improved investment performance, moderate premium growth, stronger underwriting results and foreign exchange impacts. Property and casualty growth in 1995 was moderate as market pricing slowly improved. Strong growth in life savings and pension products was partially offset by lower than expected growth in mortgage savings product business.
The Hartford acquired ITT Ercos in May 1995. 1996 revenues at ITT Ercos of $78 exceeded the eight months reported for 1995 by $27. Core earnings of $3 were $1 higher than 1995. During 1996 the company has consolidated its branch offices into one centralized location and reorganized its national sales organization. These actions were taken to improve expense competitiveness and service which will position the company for future growth.
Relative to ITT Ercos, the outlook in the Spanish market is for moderate growth. ITT Ercos will build on the improved expense and operational foundation established in 1996 to expand its presence in both life and non-life business during 1997.
The International segment continues to explore acquisition opportunities in Western Europe, Latin America and Asia.
The Runoff segment consists of operations of The Hartford which have discontinued writing new and renewal business. The property and casualty operations of the Runoff segment primarily include First State Insurance Company and its subsidiaries ("First State") and Fencourt Reinsurance Company, Ltd. ("Fencourt"). The primary focus of these operations is the proper disposition of claims, resolving disputes and collecting reinsurance proceeds related largely to business underwritten and reinsured prior to 1985.
The Hartford's accounting policy for impairment of investments requires recognition of an other than temporary impairment charge on a security if it is determined that the Company is unable to recover all amounts due under the contractual obligations of the security. In addition, the Company has established specific criteria to be used in the impairment evaluation of an individual portfolio of assets. Specifically, if the asset portfolio is supporting a runoff operation, is forced to be liquidated prior to maturity to meet liability commitments, and has a fair value below amortized cost, which will not materially fluctuate as a result of future interest rate changes, then an other than temporary impairment has been determined to have occurred and is recognized. The Company then continues to review the impaired securities for appropriate valuation.
With the initiation of the hedge transactions, which eliminated the possibility that the fair value of the Closed Book GRC investments would recover to their current amortized cost, an other than temporary impairment loss of $(82) after-tax was determined to have occurred and was recorded in September 1996. Also, during the third quarter, 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.
================================================================================ RESERVES ================================================================================ The Hartford establishes property and casualty reserves to provide for the estimated costs of paying claims made by policyholders or against policyholders. These reserves include estimates for both claims that have been reported, and those that have been incurred, but not yet reported, and include estimates of all expenses associated with processing and settling these claims. Estimating the ultimate cost of future claims and claim adjustment expenses is an uncertain and complex process. This estimation process is based largely on the assumption that past developments are an appropriate predictor of future events, and involves a variety of actuarial techniques that analyze experience, trends and other relevant factors. The uncertainties involved with the reserving process have become increasingly unpredictable due to a number of complex factors including social and economic trends and changes in the concepts of legal liability and damage awards. Accordingly, final claim settlements may vary from the present estimates, particularly when those payments may not occur until well into the future.
In addition to estimating liabilities on reported environmental and asbestos claims, The Hartford estimated reserves for claims incurred but not reported ("IBNR"). The IBNR reserve was estimated using information on reporting patterns of known insureds, characteristics of insureds such as limits exposed, attachment points and number of coverage years involved, third party costs, and closed claims.
Upon completion of the study and assessment of the results in October 1996, The Hartford determined that its environmental and asbestos reserves should be increased, on an undiscounted basis, by $493 (net of reinsurance) and $292 (net of reinsurance), respectively.
Reserve activity for both reported and unreported environmental and asbestos claims, including reserves for legal defense costs, for the years ended December 31, 1996 and 1995, was as follows (net of reinsurance):
A supplemental benefit resulting from the purchase of municipal bonds continued to be the improvement in credit quality. While the bond portfolio has consistently remained "AA" average quality over many years, municipal bonds purchased in 1996 had an average rating of "AA+", an improvement on the "AA-" rating on the taxable bonds sold.
The North American Property & Casualty segment also continued its strategy of increasing equity exposure. In 1996, $275 of net purchases of common stock increased holdings to $1.3 billion, or 10%, of total invested assets at year end compared to $922, or 8%, of total invested assets at year end 1995.
Increased holdings of municipal bonds, high yield securities and common stock were partially accomplished through the sale of more interest rate sensitive collateralized mortgage obligations (CMO) and residential mortgage backed securities (MBS). At December 31, 1996, holdings in CMO and MBS were $868, or 7%, of total invested assets compared to $1.7 billion, or 14%, at December 31, 1995.
Total invested assets were $12.8 billion at December 31, 1996 and were comprised primarily of fixed maturities of $11.3 billion and other investments of $1.5 billion, primarily equity securities. Real estate investments consisted of $29 of land after the sale of substantially all real estate in 1995. The table below summarizes fixed maturity holdings by type.
This segment maintains a high quality fixed maturity portfolio. At December 31, 1996, approximately 93% of the fixed maturity portfolio was invested in investment-grade securities. The table below summarizes fixed maturity holdings by credit quality.
FIXED MATURITIES BY CREDIT QUALITY - ----------------------------------------------------------------- 1996 1995 - ----------------------------------------------------------------- FAIR FAIR CREDIT QUALITY VALUE PERCENT VALUE PERCENT - -----------------------------------------------------------------
The North American Property & Casualty segment uses a minimal amount of derivatives in managing its investments. The notional amount of derivatives was $1 and $14 as of December 31, 1996 and 1995, respectively.
Net investment income, before-tax $661 $646 $606 Net investment income, after-tax [1] 531 478 440 Yield on average invested assets, before-tax [2] 5.52% 5.77% 5.65% Yield on average invested assets, after-tax [1] [2] 4.44% 4.28% 4.09% Net realized capital gains, before-tax $ 15 $ 29 $ 69 --------------------------------------------------------------- [1] Due to the significant holdings in tax-exempt investments an after-tax net investment income and after-tax yield are also included. [2] Represents net investment income (excluding net realized capital gains) divided by average invested assets at cost (fixed maturities at amortized cost).
Net realized capital gains declined to $15 in 1996 from $29 in 1995. Included in 1996 activity was the generation of $77 of realized gains in the common stock portfolios which were partially offset by losses incurred in the sale of lower yielding taxable bonds and certain real estate writedowns.
The Life segment's investment operations are managed by its investment strategy group which reports directly to senior management of the Company and consists of a risk management unit and portfolio management unit. The risk management unit is responsible for monitoring and managing the segment's asset/liability profile and establishing investment objectives and guidelines; and, the portfolio management unit is responsible for determining, within specified risk tolerances and investment guidelines, the general asset allocation, duration and convexity and other characteristics of the segment's general account and guaranteed separate account investment portfolios. The investment staff of The Hartford executes the strategic investment decisions of the portfolio management unit, including the identification and purchase of securities that fulfill the objectives of the investment strategy group.
FIXED MATURITIES BY TYPE --------------------------------------------------------------- 1996 1995 - ------------------------ ------------------- ------------------- FAIR FAIR TYPE VALUE PERCENT VALUE PERCENT - ----------------------------------------------------------------
Corporate $6,536 53.7% $5,146 45.0% CMO 1,050 8.6% 2,071 18.1% Gov't/Gov't agencies-U.S. 145 1.1% 260 2.3% ABS 2,216 18.2% 1,782 15.6% Gov't/Gov't agencies-For. 287 2.4% 223 1.9% MBS-agency 401 3.3% 673 5.9% Commercial MBS 1,007 8.3% 348 3.0% Municipal-taxable 203 1.7% 130 1.1% Short-term 332 2.7% 817 7.1% - ---------------------------------------------------------------- TOTAL FIXED MATURITIES $12,177 100.0% $11,450 100.0% - ----------------------------------------------------------------
The Life segment continued to maintain a high quality fixed maturity portfolio. As of December 31, 1996, approximately 99.7% of the fixed maturity portfolio was invested in investment-grade securities. The table below summarizes fixed maturity holdings by credit quality.
FIXED MATURITIES BY CREDIT QUALITY - ------------------------------------------------------------------ 1996 1995 - ------------------------------------------------------------------ FAIR FAIR CREDIT QUALITY VALUE PERCENT VALUE PERCENT - ------------------------------------------------------------------ AAA $2,951 24.3% $3,688 32.2% AA 1,445 11.9% 1,502 13.1% A 4,737 38.9% 3,561 31.1% BBB 2,404 19.7% 1,276 11.1% Gov't 273 2.2% 523 4.6% BB & below 35 0.3% 29 0.3% Not rated -- -- 54 0.5% Short-term 332 2.7% 817 7.1% - ------------------------------------------------------------------ TOTAL FIXED MATURITIES $12,177 100.0% $11,450 100.0% - ------------------------------------------------------------------
The estimated maturities of the fixed and variable rate investments in the general account, along with the respective yields at December 31, 1996, are reflected below. Asset-backed securities including CMO and MBS are distributed to maturity year based on the Company's estimate of the rate of future prepayments of principal over the remaining lives of the securities. These estimates are developed using prepayment speeds reported in broker consensus data and can be expected to vary from actual experience. Expected maturities differ from contractual maturities due to call or prepayment provisions.
The table below summarizes the Life segment's results for the past three years.
Net investment income, before-tax $1,323 $1,114 $922 Yield on average invested assets, before-tax [1] 8.51% 8.30% 8.56% Net realized capital gains (losses), before-tax -- $(4) $1 --------------------------------------------------------------- [1] Represents net investment income (excluding net realized capital gains (losses)) divided by average invested assets at cost (fixed maturities at amortized cost).
For the year ended December 31, 1995, before-tax net investment income totaled $1.1 billion compared to $922 in 1994, an increase of 21%. Before-tax yields on average invested assets decreased to 8.30% in 1995 from 8.56% in 1994. The increase in before-tax net investment income was primarily due to an increase in policy loans and additional new business cash flow invested in fixed maturities.
The Life segment employs several risk management tools to quantify and manage interest rate risk arising from its investments and interest sensitive liabilities. Management monitors the changes in present value between assets and liabilities resulting from various interest rate scenarios using integrated asset/liability measurement systems and a proprietary system that simulates the impacts of parallel and non-parallel yield curve shifts. Based on this current and prospective information, management implements risk reducing techniques to improve the match between assets and liabilities.
Anticipatory Hedging -- For certain liabilities, the Life segment commits to the - -------------------- price of the product prior to receipt of the associated premium or deposit. The segment routinely executes anticipatory hedges to offset the impact of changes in asset prices arising from interest rate changes, pending the premium or deposit payment and the resulting 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 notional amount of anticipatory hedges as of December 31, 1996 and 1995 was $392 and $718, respectively.
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, 1996 and 1995 was $1.5 billion and $1.7 billion, respectively.
Fixed Rate Asset Accumulation Vehicles -- Products in this category require the - --------------------------------------- Life segment 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. The primary risk associated with these products is that the spread between investment return and credited rate may not be sufficient to earn the segment's targeted return. Product examples include fixed rate annuities with a market value adjustment and fixed rate guaranteed investment contracts. Contract duration is reflected above and is dependent on the policyholder's choice of guarantee period. The weighted average credited policyholder rate for these policyholder liabilities was 6.60% as of December 31, 1996.
Interest Credited Asset Accumulation Vehicles -- Products in this category - ------------------------------------------------- credit interest to policyholders, subject to market conditions and minimum guarantees. Policyholders may surrender at book value but are subject to surrender charges for an initial period. The primary risks vary depending on the degree of insurance element contained in the product. Product examples include universal life contracts and the general account portion of the segment's variable annuity products. Liability duration is short to intermediate-term and is reflected in the table above. The average credited rate for these liabilities was 5.52% as of December 31, 1996, excluding policy loans.
Long-term Pay Out Liabilities -- Products in this category are long-term in - ------------------------------- nature and may contain significant actuarial (including mortality and morbidity) pricing risks. The cash flows are not interest sensitive, but do vary based on the timing and amount of benefit payments. The primary risks associated with these products are that the benefits will exceed expected actuarial pricing and/or the investment return will be lower than assumed in pricing. Product examples include structured settlement contracts, on-benefit annuities (i.e., the annuitant is currently receiving benefits thereon) and long-term disability contracts. Contract duration is generally 6 to 10 years but, at times, exceeds 30 years. Policy liabilities under these contracts are not interest rate sensitive.
Investments are made in maturities and currencies which reflect the nature of the liabilities.
Invested assets, excluding separate accounts, were $3.0 billion at December 31, 1996 and were comprised of fixed maturities of $2.5 billion and other investments of $521, primarily equity securities. The table below summarizes fixed maturity holdings by type.
AAA $1,876 74.4% $1,428 59.1% AA 203 8.0% 89 3.7% A 4 0.2% 4 0.2% Short-term 440 17.4% 893 37.0% - ---------------------------------------------------------------- TOTAL FIXED MATURITIES $2,523 100.0% $2,414 100.0% - ----------------------------------------------------------------
For the year ended December 31, 1996, before-tax net investment income totaled $205 compared to $183 in 1995, an increase of 12%. Before tax yields on average invested assets decreased to 7.05% in 1996 from 7.10% in 1995. The change in income reflected the full year of investment results from ITT Ercos (acquired in May, 1995), a change in asset composition favoring longer maturities, and a modest increase in cash flow.
For the year ended December 31, 1995, before-tax net investment income totaled $183 compared to $135 in 1994, an increase of 36%. Before-tax yields on average invested assets increased to 7.10% in 1995 from 6.10% in 1994. The increase in before-tax net investment income was primarily due to increased operating cash flow and the acquisition of ITT Ercos in May 1995, while the increase in yield was the result of higher yields in the international bond and equity market.
Net realized capital gains increased to $79 in 1996 from $48 in 1995 due to increased sales in 1996 of both fixed maturity and equity securities. Net realized capital gains increased to $48 in 1995 from $23 in 1994, again, the result of greater sales of fixed maturity and equity securities.
The primary objective of the Runoff segment is to ensure the full and timely payment of all runoff liabilities. The ongoing strategy of this segment is to match closely the interest rate sensitivities of the assets with those of the liabilities.
Invested assets were $5.5 billion at December 31, 1996 and were mostly comprised of fixed maturities. The Runoff segment uses derivatives related to the Closed Book GRC. As of December 31, 1996 and 1995, the Runoff segment had derivatives with an aggregate notional amount of $7.5 billion and $5.6 billion, respectively, for asset/liability management purposes. The Company entered into various hedge transactions related to Closed Book GRC with a notional amount of $4.0 billion in September and October 1996 which substantially eliminated further fluctuation in fair value of the Closed Book GRC investments due to interest rate changes. (For additional information on Closed Book GRC, see the Runoff section.) The table below summarizes fixed maturity holdings by type.
FIXED MATURITIES BY TYPE - ---------------------------------------------------------------- 1996 1995 - ---------------------------------------------------------------- FAIR FAIR TYPE VALUE PERCENT VALUE PERCENT - ----------------------------------------------------------------
FIXED MATURITIES BY CREDIT QUALITY - ---------------------------------------------------------------- 1996 1995 - ---------------------------------------------------------------- FAIR FAIR CREDIT QUALITY VALUE PERCENT VALUE PERCENT - ----------------------------------------------------------------
The Investment division has a compliance function to affirm that derivatives transactions meet Company policy, are effectively hedging identified risks, and remain appropriately correlated. All derivatives strategies satisfy at least one of the following objectives: to hedge risk arising from interest rate, price or foreign exchange rate volatility; to manage liquidity; or to control transaction costs. The Company's derivatives counterparty exposure policy establishes market-based credit limits, favors long-term financial stability and creditworthiness, and typically requires credit enhancement/credit risk reducing agreements. To initiate contracts, counterparties must generally be rated A-/A3 or better by rating agencies. Credit risk is measured as the amount owed to The Hartford based on current market conditions. Payment obligations between The Hartford and its counterparties are netted and quantified monthly. Collateral is pledged/held to the extent the current value of derivatives exceed exposure thresholds. As of December 31, 1996, the Company's counterparty exposure, net of $17 collateral held, was $27.
The Hartford's total capitalization excluding unrealized gain (loss), net of tax, increased by $335 in 1996. This change was a result of additional net borrowings totaling $624, partially offset by a net loss of $99 and dividends declared of $188 on The Hartford common stock.
On February 28, 1996, Hartford Capital I, a subsidiary trust, issued 20,000,000 Series A, 7.7% Cumulative Quarterly Income Preferred Securities. The proceeds from the sale of these securities were used to acquire $500 of Junior Subordinated Deferrable Interest Debentures from The Hartford. The Hartford used the proceeds from the sale of such debentures for the partial repayment of outstanding commercial paper and short-term bank indebtedness. (For additional information, see Note 6 of Notes to Consolidated Financial Statements.)
On October 30, 1996, Hartford Capital II, a subsidiary trust, issued 20,000,000, Series B, 8.35% Cumulative Quarterly Income Preferred Securities. The proceeds from the sale of these securities were used to acquire $500 of Junior Subordinated Deferrable Interest Debentures from The Hartford. The Hartford used the proceeds from the sale of such debentures for general corporate purposes. (For additional information, see Note 6 of Notes to Consolidated Financial Statements.)
During 1995, Hartford Fire Insurance Company ("Hartford Fire"), a wholly-owned subsidiary of The Hartford, redeemed $86 of its Class A Preferred Stock - Series 2.
In 1996, The Hartford declared $188 and paid $140 in dividends to shareholders. In 1995, The Hartford paid dividends to ITT consisting of cash of $384 and non-cash of $395 prior to the Distribution.
On October 17, 1996, The Hartford declared a dividend on its common stock of $0.40 per share payable on January 2, 1997 to all shareholders of record as of November 29, 1996.
In 1997, The Hartford expects to continue paying quarterly dividends on its common stock of $0.40 per share. Dividend decisions will be based on, and affected by, a number of factors, including the operating results and financial requirements of The Hartford on a stand-alone basis and the impact of the regulatory restrictions discussed in the Liquidity Requirements section below.
A.M. DUFF STANDARD BEST & & POOR'S MOODY'S PHELPS - ---------------------------------------------------------------- INSURANCE RATINGS: Hartford Fire A+ AA AA Aa3 Hartford Life A+ AA+ AA Aa3 Hartford Life & Accident A+ AA+ AA -- ITT Hartford Life & Annuity A+ AA+ AA -- - ---------------------------------------------------------------- OTHER RATINGS: ITT Hartford Group, Inc.: Senior debt -- A+ A A2 Commercial paper -- D-1 A-1 P-1 Hartford Capital I and II quarterly income preferred securities -- A A- A2 - ----------------------------------------------------------------
On February 10, 1997, Standard & Poor's reaffirmed its claims-paying ability ratings and various other ratings of The Hartford group of companies. On September 24, 1996, Standard & Poor's announced that it had reduced the claims-paying ability ratings and various other ratings of The Hartford group of companies. In announcing the rating change, Standard & Poor's stated that the action was based primarily on increased concern with the overall strength of The Hartford's consolidated capital, partially offset by a superior business position within the markets that The Hartford operates.
On January 23, 1997, Moody's Investors Service announced that it downgraded various ratings of The Hartford and its subsidiaries, including the financial strength ratings of The Hartford's insurance subsidiaries, and the ratings assigned to the quarterly income preferred securities of Hartford Capital I and Hartford Capital II. Moody's indicated that the action reflected The Hartford's financial leverage, the remaining risks as to adequacy of loss reserves related to the Company's environmental and asbestos exposures, and the continuing intense competition in The Hartford's ongoing business segments.
The liquidity requirements of The Hartford have been and will continue to be met by funds from operations as well as the issuance of commercial paper, debt securities and bank borrowings. The principal sources of funds are premiums and investment income as well as maturities and sales of invested assets. The Hartford is a holding company which receives operating cash flow in the form of dividends from its subsidiaries, enabling it to service debt and pay business expenses.
company laws of Connecticut. Hartford Fire adheres to these laws which require notice to and approval by the state insurance commissioner for the declaration or payment of any dividend, which together with other dividends or distributions made within the preceding twelve months, exceeds the greater of (i) 10% of the insurer's policyholder surplus as of December 31 of the preceding year or (ii) net income (or net gain from operations, if such company is a life insurance company) for the twelve-month period ending on the thirty-first day of December last preceding, in each case determined under statutory insurance accounting policies. In addition, if any dividend of a Connecticut-domiciled insurer exceeds the insurer's earned surplus, it requires the prior approval of the Connecticut Insurance Commissioner. For this reason, any statutory dividend which may be paid to ITT Hartford Group, Inc. by its insurance subsidiaries in 1997 requires prior approval.
As part of the Distribution Agreement entered into by The Hartford, ITT Destinations, Inc., and ITT Industries, Inc. ("the former ITT subsidiaries"), provisions were outlined addressing the disposition of shared liabilities. A shared liability is defined as a liability arising out of, or related to, business conducted by ITT prior to the Distribution that was not otherwise specifically related to one of the former ITT subsidiaries. Under the Distribution Agreement, responsibility for shared liabilities shall be borne equally by each of the former ITT subsidiaries, including related attorney's fees and other out-of-pocket expenses. As of December 31, 1996, all known liabilities covered by this agreement have been accrued.
ITT and The Hartford have entered into a Tax Allocation Agreement whereby The Hartford will pay a share of ITT's consolidated tax liability for the tax years that The Hartford was included in ITT's consolidated federal income tax return. The Tax Allocation Agreement provides for the attribution to specific companies of any state, local and foreign taxes related to periods prior to December 20, 1995.
On February 14, 1997, HLI filed a shelf registration statement for the issuance and sale of up to $1.0 billion in the aggregate of senior debt securities, subordinated debt securities and preferred stock of HLI ("the HLI securities"). HLI intends to use the proceeds from any offering for the repayment of debt, including outstanding commercial paper and other third party indebtedness and the satisfaction of other obligations, for working capital, capital expenditures, investments in or loans to subsidiaries and for other general corporate purposes.
Although the Federal government does not directly regulate the insurance business, Federal initiatives often have an impact on the insurance industry in a variety of ways. Legislation has not been introduced in the current Congress but has in recent sessions which, if enacted, would result in substantially greater Federal regulation of the property and casualty and life insurance industries. Current and proposed Federal measures which may significantly affect the life insurance business include medical testing for insurability, tax law changes affecting the tax treatment of life insurance products and its impact on the relative desirability of various personal investment vehicles and proposed legislation to prohibit the use of gender in determining insurance and pension rates and benefits. Such measures which may significantly impact the property and casualty industry include possible modifications to the Superfund program, the tax laws governing property and casualty insurance companies, Federal catastrophe fund legislation and tort reform proposals.