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. In addition, The Hartford leases approximately 5.4 million square feet throughout the United States and 56 thousand square feet in other countries. All of the properties owned or leased are used by one or more of all eight operating segments, depending on the location. (For more information on operating segments see Part 1, Item 1, Business of The Hartford - Reporting Segments.) The Company believes its properties and facilities are suitable and adequate for current operations.
Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") addresses the financial condition of The Hartford Financial Services Group, Inc. and its subsidiaries (collectively, "The Hartford" or the "Company") as of December 31, 2000, compared with December 31, 1999, and its results of operations for the three years ended December 31, 2000, 1999 and 1998. This discussion should be read in conjunction with the Consolidated Financial Statements and related Notes beginning on page.
Consolidated Results of Operations: Operating Summary 15 Worldwide Life 18 Investment Products 19 Individual Life 20 Group Benefits 21 Corporate Owned Life Insurance (COLI) 22 Worldwide Property & Casualty 23 Commercial 24 Personal 25 Reinsurance 26 International and Other Operations 26 Reserves 27 Environmental and Asbestos Claims 28 Investments 30 Capital Markets Risk Management 32 Capital Resources and Liquidity 42 Regulatory Matters and Contingencies 45 Effect of Inflation 46 Accounting Standards 46
used by the Company in the management of its operations. Management believes that this performance measure delineates the results of operations of the Company's ongoing businesses in a manner that allows for a better understanding of the underlying trends in the Company's current business. However, core earnings should only be analyzed in conjunction with, and not in lieu of, net income and may not be comparable to other performance measures used by the Company's competitors.
2000 COMPARED TO 1999 -- Revenues increased $1.2 billion, or 9%, primarily as a result of continued strong growth in fee income in the Investment Products and Individual Life segments, along with premium growth in the Group Benefits segment and in all North American Property & Casualty underwriting segments.
1999 COMPARED TO 1998 -- Revenues decreased $1.5 billion, or 10%, primarily as a result of the November 1998 sale of United Kingdom-based London & Edinburgh Insurance Group, Ltd. ("London & Edinburgh"), which was The Hartford's largest international subsidiary, the declining block of leveraged corporate owned life insurance ("COLI") business and lower net realized capital gains. The decrease was partially offset by earned premium growth in the Personal segment of Worldwide Property & Casualty and higher fee income in the Investment Products segment of Worldwide Life as a result of increasing account values. (For an analysis of net investment income and net realized capital gains, see the Investments section.)
Prior to the June 27, 2000 acquisition of all of the outstanding shares of Hartford Life, Inc. ("HLI") that The Hartford did not already own ("The HLI Repurchase"), the minority interest in consolidated subsidiary represented an approximate 19% minority interest in HLI's operating results. (For additional information, see the Capital Resources and Liquidity section under "Acquisitions" and Note 2 of Notes to Consolidated Financial Statements.)
While the measure of profit or loss used by The Hartford's management in evaluating performance is core earnings for its non-underwriting segments, the Commercial, Personal and Reinsurance segments are evaluated by The Hartford's management primarily based upon underwriting results. While
Certain transactions between segments occur during the year that primarily relate to tax settlements, insurance coverage, expense reimbursements, services provided and capital contributions. Certain reinsurance stop loss agreements exist between the segments which specify that one segment will reimburse another for losses incurred in excess of a predetermined limit. Also, one segment may purchase group annuity contracts from another to fund pension costs and claim annuities to settle casualty claims. In addition, certain intersegment transactions occur in Worldwide Life. These transactions include interest income on allocated surplus and the allocation of net realized capital gains and losses through net invested income utilizing the duration of the segment's investment portfolios.
The following is a summary of North American underwriting results by underwriting segment within Worldwide Property & Casualty. Underwriting results represent premiums earned less incurred claims, claim adjustment expenses and underwriting expenses.
Worldwide Life's expenses essentially consist of interest credited to policyholders on general account liabilities, insurance benefits provided, dividends to policyholders, costs of selling and servicing the various products offered by the Company, and other general business expenses.
As discussed above, Worldwide Life consists of the following reportable operating segments: Investment Products, Individual Life, Group Benefits (formerly Employee Benefits) and COLI. In addition, Worldwide Life includes in an Other category its international operations, which are primarily located in Latin America and the Far East, and corporate items not directly allocable to any of its reportable operating segments.
On June 27, 2000, The Hartford acquired all of the outstanding shares of HLI that it did not already own. (For additional information, see the Capital Resources and Liquidity section under "Acquisitions".)
The Investment Products segment focuses on the savings and retirement needs of the growing number of individuals who are preparing for retirement or have already retired through the sale of individual variable and fixed annuities, mutual funds, retirement plan services and other investment products. The Company was ranked the number one writer of individual variable annuities in the United States for 2000 according to Variable Annuity and Research Data Service ("VARDS") and the number one seller of individual variable annuities through banks, according to Kenneth Kehrer Associates (a leading consultant to banks). In addition, The Hartford Mutual Funds, Inc. reached $10 billion in assets faster than any other retail-oriented mutual fund family in history, according to Strategic Insight. Also, eight of the fourteen retail mutual funds have Morningstar ratings and, as of December 31, 2000, all eight have three-, four- or five-star ratings.
1999 COMPARED TO 1998 -- Revenues increased $257, or 14%, primarily driven by higher fee income in the individual annuity and retail mutual fund operations. Fee income generated by individual annuities increased $248, or 29%, as related account values grew $18.2 billion, or 26%. The growth in individual annuity account values was mostly due to strong individual annuity sales of $10.9 billion in 1999 and favorable persistency, as well as equity market appreciation. In addition, fee income from other investment products increased $68, or 59%, primarily due to the Company's continued growth in its retail mutual fund operation, where related assets under management grew $3.9 billion, or 154%. This significant growth in the retail mutual fund operation was driven by strong sales of $3.3 billion in 1999, favorable persistency and equity market appreciation.
Core earnings increased $64, or 24%, for the most part due to the growth in revenues discussed above. Also contributing to the higher core earnings were operating efficiencies that the segment continues to achieve, particularly in its individual variable annuity operation, where individual annuity operating expenses as a percentage of average individual annuity account values decreased from 23 basis points in 1998 to 21 basis points in 1999.
and variable life insurance in force increased $9.6 billion, or 40%.
Benefits, claims and expenses increased $47, or 10%, primarily due to a $16, or 6%, increase in benefits, claims and claim adjustment expenses and a $16, or 12%, increase in amortization of deferred policy acquisition costs mostly associated with the growth in this segment's variable business. Additionally, insurance operating costs and other expenses increased $15, or 17%, directly associated with the growth in this segment as previously described. Core earnings increased $8, or 11%, primarily due to higher fee income as mortality experience (death claims as a percentage of net amount at risk) was consistent with prior year.
1999 COMPARED TO 1998 -- Revenues increased $17, or 3%, resulting primarily from higher fee income associated with the growing block of variable life insurance. Fee income increased $59, or 18%, as variable life account values increased $868, or 50%, and variable life insurance in force increased $7.5 billion, or 46%. The higher fee income was partially offset by a decrease in earned premiums resulting from the sale of HLI's Canadian life insurance operation in 1999. Benefits, claims and expenses increased slightly, principally due to a $21, or 19%, increase in amortization of deferred policy acquisition costs associated with the growth in this segment's revenues. The increase was partially offset by a decrease of $11, or 4%, in benefits, claims and claim adjustment expenses due to the sale of the Canadian life insurance operation and lower mortality costs. Core earnings increased $6, or 9%, essentially due to higher fee income and favorable mortality experience.
Management believes that the Company's strong market position will provide opportunities for growth in this segment as individuals increasingly focus on estate planning. The Hartford's agreement to acquire the U.S. individual life insurance business of Fortis is expected to increase its scale while broadening its distribution capabilities through the addition of a retail broker-dealer. It is expected that the consummation of this transaction will enhance the Company's goal of broadening its reach in the emerging affluent market.
Total benefits, claims and expenses increased $171, or 9%, primarily due to higher benefits, claims and claim adjustment expenses which, excluding buyouts, increased $168, or 12%, directly related to revenue growth in this segment. The segment's combined ratio (ratio of total benefits, claims and expenses as a percentage of earned premiums and other) was consistent with the prior year. As such, core earnings increased $11, or 14%, primarily driven by the increased revenues described above.
Consistent with the decrease in revenues, benefits, claims and expenses decreased $747, or 49%. Core earnings increased $6, or 25%, primarily due to growth in the variable COLI business, where related account values increased $1.2 billion, or 10%. Additionally, leveraged COLI core earnings increased due to earnings associated with a block of leveraged COLI business recaptured in 1998, which was partially offset by decreases associated with the downsizing of the overall leveraged COLI business.
The following is a summary of Worldwide Property & Casualty core earnings, after-tax. Core earnings exclude net realized capital gains.
2000 COMPARED TO 1999 -- Core earnings decreased $27, or 6%, primarily due to an increase in Personal automobile loss costs, adverse loss development in Reinsurance and expenses related to the Commercial field office and claim reorganizations. Partially offsetting this decrease was a reduction in property catastrophe losses and improvement in Commercial mid-market results.
1999 COMPARED TO 1998 -- Core earnings were $456, a decrease of $46, or 9%. The decrease was primarily the result of a $43 increase in other expenses, due primarily to proceeds received in 1998 related to the IRI transaction and an $8, or 7%, decrease in after-tax underwriting results. Partially offsetting the decrease was an increase in net investment income of $28, or 4%.
Commercial provides workers' compensation, property, automobile, liability, financial products, marine, agricultural and bond coverages to commercial accounts primarily throughout the United States. Excess and surplus lines business not normally written by standard lines insurers is also provided. Commercial is organized into three customer markets: Business Insurance, Commercial Affinity and Commercial Specialty.
Business Insurance provides standard commercial business for small accounts ("Select Customer") and mid-sized insureds ("Key Accounts"). Commercial Affinity provides commercial risk management products and services to small and mid-sized members of affinity groups and customers of financial institutions in addition to marine coverage. Commercial Specialty provides insurance through retailers and wholesalers to large commercial clients ("Major/National") and insureds requiring a variety of specialized coverages. Its results also include the bond lines and First State Management Group, a leading underwriter of excess and surplus lines business produced primarily through wholesale brokers. Agricultural and livestock products are also included within Commercial Specialty.
1999 COMPARED TO 1998 -- Written premiums decreased slightly. Solid premium growth in The Hartford's small commercial businesses resulted in growth of 15% driven by enhanced product offerings, targeted geographic strategies and partnerships with other entities. These increases, however, were more than offset by declines in the middle and large national account businesses primarily due to intense price competition in the casualty lines, where The Hartford maintained underwriting discipline, allowing business to move to other carriers while the Company's margins were preserved.
Market conditions in the commercial sector are expected to continue to improve in 2001 although price competition within many markets of the commercial industry will continue to remain a challenge into the foreseeable future. Management expects growth in small commercial businesses to continue to be achieved, in part, due to strategic actions being taken which include providing a complete product solution for the small commercial coverage needs of the commercial segment's customers; expanding non-traditional distribution alternatives; executing geographic market share strategies and developing technology solutions that deliver superior business tools to The Hartford's agents, alliances and policyholders. Continued pricing and underwriting actions in the mid-market standard commercial business should have a positive impact on overall profitability in 2001. The acquisition of Reliance in 2000 creates an opportunity to broaden the portfolio of products offered by the Commercial segment. Additionally, the alliance formed with USAA in late 2000, to be the exclusive provider of small business insurance to USAA members, is also expected to achieve new premium growth.
Personal provides automobile, homeowners, home-based business and fire coverages to individuals across North America. Personal is organized to provide customized products and services to the following markets: the membership of AARP through a direct marketing operation; customers who prefer local agent involvement through a network of independent agents in the standard personal lines market and through Omni Insurance Group, Inc. ("Omni"), which was acquired in 1998, in the non-standard automobile market; customers of Sears, Roebuck & Co. ("Sears") and Ford Motor Company and Ford Motor Credit Company (collectively, "Ford") as well as customers of financial institutions through an affinity center; and customer service for all health insurance products offered through AARP's Health Care Options effective January 1, 1998. AARP's exclusive licensing arrangement continues through 2002 for automobile, homeowners and home-based business and through 2007 for Health Care Options, thus providing the Personal segment with an important competitive advantage.
2000 COMPARED TO 1999 -- Written premiums increased $177, or 7%. Written premiums increased $87, or 6%, in the AARP program and $57, or 8%, in the standard Agency business for the year due primarily to policy count growth and improved renewal retention. Affinity growth of $45, or 37%, for the year included increased business from the Ford and Sears accounts. Non-standard automobile written premiums through Omni decreased $12, or 5%, for the year as a result of an expected consumer reaction to rate increases in certain states.
Underwriting results decreased $32 with a corresponding 0.5 point increase in the combined ratio. The decrease in underwriting results and related increase in the combined ratio were primarily due to increased Agency and Omni automobile loss costs. Partially offsetting this decrease was strong growth in Agency and AARP homeowners lines. A 1.3 point decrease in the expense ratio for the year reflected the continued trend of productivity gains from prior initiatives.
1999 COMPARED TO 1998 -- Written premiums increased $250, or 11%. Omni written premiums increased $88, or 53%, contributing 4% to the segment's total written premium growth in 1999. AARP written premiums increased $65, or 5%, contributing 3% to the segment's total written premium growth in 1999. Agency written premium growth was $31, or 5%, contributing 1% to the segment's total written premium growth in 1999. The Affinity unit experienced written premium growth of $66, or 120%, contributing 3% to the segment's total written premium growth in 1999. Written premium increases in all the units were achieved in light of very competitive pricing in the personal lines market, primarily in the personal automobile line. Servicing revenues from AARP's Health Care Options unit declined by $38 due to revenues related to the transfer of business from the prior carrier in 1998.
The Hartford assumes reinsurance worldwide through its thirteen Hartford Reinsurance Company ("HartRe") offices located in the United States, Canada, the United Kingdom, France, Italy, Germany, Spain, Hong Kong and Taiwan. HartRe primarily writes treaty reinsurance through professional reinsurance brokers covering various property, casualty, specialty and marine classes of business.
The worldwide reinsurance market remains highly competitive. Market pricing improved during 2000 in the worldwide reinsurance sector, and management expects that this pricing will continue to firm in 2001. HartRe is committed to the effective execution of its pricing strategy in both traditional and alternative risk transfer products and is prepared to capitalize on new business opportunities resulting from the changing marketplace.
On February 8, 2001, The Hartford completed the sale of Hartford Seguros to Liberty International, a subsidiary of Liberty Mutual Group. The Hartford received $29, before costs of sale.
On December 22, 2000, The Hartford completed the sale of Zwolsche to Assurances Generales de France, a subsidiary of Allianz AG. The Hartford received $547, before costs of sale, for Zwolsche. The gain from the sale of Zwolsche of $69, after-tax, has been reported in the 2000 investment results of North American Property & Casualty. Zwolsche's operating results are included in the International and Other Operations segment through the date of sale.
On November 16, 1998, The Hartford completed the sale of London & Edinburgh. The Hartford received approximately $525, before costs of sale, for the ongoing operations of London & Edinburgh. The Hartford retained ownership of Excess Insurance Co. Ltd. ("Excess"), London & Edinburgh's property and casualty insurance and reinsurance subsidiary, which discontinued writing new business in 1993. Excess is included in Other Operations. The gain from the sale of London & Edinburgh of $33, after-tax, has been reported in the 1998 investment results of North American Property & Casualty. London & Edinburgh's operating results are included in the International and Other Operations segment 1998 results through the date of sale and, therefore, are not comparable to current and prior year results.
Other Operations consist of the property and casualty insurance operations of The Hartford which have discontinued writing new business. These operations primarily include First State Insurance Company, Heritage Reinsurance Company, Ltd. and Excess. The main 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.
In accordance with applicable insurance regulations under which Worldwide Life operates, life insurance subsidiaries of The Hartford establish and carry as liabilities actuarially determined reserves which are calculated to meet The Hartford's future obligations. Reserves for life insurance and disability contracts are based on actuarially recognized methods using prescribed morbidity and mortality tables in general use in the United States, which are modified to reflect The Hartford's actual experience when appropriate. These reserves are computed at amounts that, with additions from estimated premiums to be received and with interest on such reserves compounded annually at certain assumed rates, are expected to be sufficient to meet The Hartford's policy obligations at their maturities or in the event of an insured's death. Reserves also include unearned premiums, premium deposits, claims incurred but not reported and claims reported but not yet paid. Reserves for assumed reinsurance are computed in a manner that is comparable to direct insurance reserves.
The persistency of The Hartford's annuity and other interest-sensitive life insurance reserves is enhanced by policy restrictions on the withdrawal of funds. Withdrawals in excess of allowable penalty-free amounts are assessed a surrender charge during a penalty period, which is usually at least seven
The Hartford continues to receive claims that assert damages from environmental exposures and for injuries from asbestos and asbestos-related products, both of which affect North American Property & Casualty and the International and Other Operations segment. Environmental claims relate primarily to pollution and related clean-up costs. With regard to these claims, uncertainty exists which impacts the ability of insurers and reinsurers to estimate the ultimate reserves for unpaid losses and related settlement expenses. The Hartford finds that conventional reserving techniques cannot estimate the ultimate cost of these claims because of inadequate development patterns and inconsistent emerging legal doctrine. The majority of environmental claims and many types of asbestos claims, differ from any other type of contractual claim because there is almost no agreement or consistent precedent to determine what, if any, coverage exists or which, if any, policy years and insurers or reinsurers may be liable. Further uncertainty arises with environmental claims since claims are often made under policies, the existence of which may be in dispute, the terms of which may have changed over many years, which may or may not provide for legal defense costs, and which may or may not contain environmental exclusion clauses that may be absolute or allow for fortuitous events. Courts in different jurisdictions have reached disparate conclusions on similar issues and in certain situations have broadened the interpretation of policy coverage and liability issues. In light of the extensive claim settlement process for environmental and asbestos claims, which involves comprehensive fact gathering, subject matter expertise and intensive litigation, The Hartford established an environmental claims facility in 1992 to defend itself aggressively against unwarranted claims and to minimize costs.
The study included a review of identified environmental and asbestos exposures of North American Property & Casualty, along with the U.S. exposures of The Hartford's International and Other Operations segment. The methodology utilized a ground-up analysis of policy, site and exposure level data for a representative sample of The Hartford's claims. The results of the evaluation were extrapolated against the balance of the claim population to estimate the Company's overall exposure for reported claims.
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.
An international actuarial firm reviewed The Hartford's approach and concluded that the way the Company studied its exposures, the thoroughness of its analysis and the way The Hartford came to its estimates were reasonable and comprehensive. The Company believes that its methodology and estimates continue to be reasonable and comprehensive. Reserve activity for both reported and unreported environmental and asbestos claims, including reserves for legal defense costs, for the years ended December 31, 2000, 1999 and 1998, was as follows (net of reinsurance):
The primary investment objective of Worldwide Life's general account is to maximize after-tax returns consistent with acceptable risk parameters, including the management of the interest rate sensitivity of invested assets relative to that of policyholder obligations, as discussed in the Capital Markets Risk Management section under "Market Risk - Worldwide Life - Interest Rate Risk".
Policy loans are secured by the cash value of the life policy and do not mature in a conventional sense, but expire in conjunction with the related policy liabilities. The decrease in policy loans was primarily due to the decline in leveraged COLI business, as discussed in the COLI section. The increase in other investments primarily reflects an increase in limited partnership investments.
The following table identifies by type the fixed maturity securities held in the general account as of December 31, 2000 and 1999.
The investment objective for the majority of Worldwide Property & Casualty is to maximize economic value while generating after-tax income and sufficient liquidity to meet corporate and policyholder obligations. For Worldwide Property & Casualty's Other Operations, the investment objective is to ensure the full and timely payment of all liabilities. Property and casualty investment strategies are developed based on a variety of factors including business needs, regulatory requirements and tax considerations.
The following table identifies the invested assets by type held as of December 31, 2000 and 1999.
The following table below summarizes Worldwide Property & Casualty's investment results.
1999 COMPARED TO 1998 -- Before-tax net investment income decreased by $82, or 7% and after-tax net investment income decreased by $49, or 6%. These decreases were primarily due to the effects of the London & Edinburgh sale in November 1998, partially offset by increases in income from limited partnership investments.
Net realized capital gains decreased $265, primarily as a result of opportunities taken in 1998 in a strong equity market. Net realized capital gains for 1999 were partially offset by a $9, after-tax, other than temporary impairment and sale of asset-backed securities securitized and serviced by CFS.
Separate account products are those for which a separate investment and liability account is maintained on behalf of the policyholder. The Company's separate accounts reflect two categories of risk assumption: non-guaranteed separate accounts totaling $104.3 billion and $102.6 billion as of December 31, 2000 and 1999, respectively, wherein the policyholder assumes substantially all the risk and reward; and guaranteed separate accounts totaling $9.8 billion and $9.1 billion as of December 31, 2000 and 1999, respectively, wherein The Hartford contractually guarantees either a minimum return or the account value to the policyholder. The primary investment objective of guaranteed separate accounts is to maximize after-tax returns consistent with acceptable risk parameters, including the management of the interest rate sensitivity of invested assets relative to that of policyholder obligations, as discussed in the Capital Markets Risk Management section under "Market Risk - Worldwide Life - - Interest Rate Risk."
Investment objectives for non-guaranteed separate accounts vary by fund account type, as outlined in the applicable fund prospectus or separate account plan of operations. Non-guaranteed separate account products include variable annuities, variable life insurance contracts and variable COLI. Guaranteed separate account products primarily consist of modified guaranteed individual annuities and modified guaranteed life insurance, and generally include market value adjustment features and surrender charges to mitigate the risk of disintermediation.
In connection with The HLI Repurchase, the carrying value of the purchased fixed maturity security investments was adjusted to fair market value as of the date of the repurchase. This adjustment was reported in Corporate. The amortization of the adjustment to the fixed maturity security investment's carrying values is reported in Corporate's net investment income. The total amount of amortization for the year ended December 31, 2000 was $10, before-tax. Also reported in Corporate are $5 of fixed maturity security investments of The Hartford Bank, FSB.
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. Credit risk is measured as the amount owed to the Company based on current market conditions and potential payment obligations between the Company and its counterparties. Credit exposures are generally quantified weekly and netted, and collateral is pledged to and held by, or on behalf of, the Company to the extent the current value of derivatives exceeds exposure policy thresholds.
The Hartford utilizes a variety of derivative instruments, including swaps, caps, floors, forwards and exchange traded futures and options, in compliance with Company policy and regulatory requirements in order to achieve one of three Company approved objectives: to hedge risk arising from interest rate, price or currency exchange rate volatility; to manage liquidity; or to control transaction costs. The Company does not make a market or trade derivatives for the express purpose of earning trading profits.
The Company uses derivative instruments in its management of market risk consistent with four risk management strategies: hedging anticipated transactions, hedging liability instruments, hedging invested assets and hedging portfolios of assets and/or liabilities. (For additional information on these strategies along with tables reflecting outstanding derivative instruments, see the Worldwide Life and Worldwide Property & Casualty discussions below.)
Derivative activities are monitored by an internal compliance unit, reviewed frequently by senior management and reported to the Company's Finance Committee. The notional amounts of derivative contracts represent the basis upon which pay or receive amounts are calculated and are not reflective of credit risk. Notional amounts pertaining to derivative instruments for both general and guaranteed separate accounts at December 31, 2000 and 1999 totaled $8.8 billion and $9.8 billion, respectively.
The following discussions focus on the key market risk exposures within Worldwide Life and Worldwide Property & Casualty.
Worldwide Life's general account and guaranteed separate account exposure to interest rate risk relates to the market price and/or cash flow variability associated with changes in market interest rates. Changes in interest rates can potentially impact Worldwide Life's profitability. Under certain circumstances of interest rate volatility, Worldwide Life could be exposed to disintermediation risk and reduction in net interest rate spread or profit margins. For Worldwide Life's non-guaranteed separate accounts, the Company's exposure is not significant, as the policyholder assumes substantially all of the investment risk.
Worldwide Life's general account and guaranteed separate account investment portfolios primarily consist of investment grade, fixed maturity securities, including corporate bonds, asset-backed securities, commercial mortgage-backed securities, tax-exempt municipal securities and collateralized mortgage obligations. The fair value of these and Worldwide Life's other invested assets fluctuates depending on the interest rate environment and other general economic conditions. During periods of declining interest rates, paydowns on mortgage-backed securities and collateralized mortgage obligations increase as the underlying mortgages are prepaid. During such periods, the Company generally will not be able to reinvest the proceeds of any such prepayments at comparable yields. Conversely, during periods of rising interest rates, the rate of prepayments generally declines, exposing the Company to the possibility of asset/liability cash flow and yield mismatch. (For further discussion of the Company's risk management techniques to manage this market risk, see the "Asset and Liability Management Strategies Used to Manage Market Risk" discussed below.)
The table below provides information as of December 31, 2000 on debt obligations and TruPS and reflects principal cash flows and related weighted average interest rates by maturity year. Comparative totals are included as of December 31, 1999.
Portfolio Hedging -- Worldwide Life periodically compares the duration and convexity of its portfolios of assets to its corresponding liabilities and enters into portfolio hedges to reduce any difference to desired levels. Portfolio hedges reduce the mismatch between assets and liabilities and offset the potential impact to cash flows caused by changes in interest rates. The notional amounts of portfolio hedges as of December 31, 2000 and 1999, were $1.0 billion and $1.2 billion, respectively.
aforementioned hedging strategies. For interest rate swaps, caps and floors, the tables present notional amounts with weighted average pay and receive rates for swaps and weighted average strike rates for caps and floors by maturity year. For interest rate futures, the table presents contract amount and weighted average settlement price by expected maturity year.
Management of the duration of investments with respective policyholder obligations is an explicit objective of Worldwide Life's management strategy. The estimated cash flows of insurance policy liabilities based upon internal actuarial assumptions as of December 31, 2000 are reflected in the table below by expected maturity year. Comparative totals are included for December 31, 1999.
Change in Net Economic Value 2000 1999 ---------------------------------------- Basis point shift - 100 + 100 - 100 + 100 - ------------------------------------------------------------------- Amount $ (15) $ (27) $ (4) $ (5) Percent of liability value (0.09)% (0.16)% (0.03)% (0.03)% - --------------------------------------------------------------------
The principal amounts of the fixed and variable rate fixed maturity portfolios, along with the respective weighted average coupons by estimated maturity year at December 31, 2000, are reflected in the following table. Comparative totals are included as of December 31, 1999. Expected maturities differ from contractual maturities due to call or prepayment provisions. The weighted average coupon on variable rate securities is based on spot rates as of December 31, 2000 and 1999, and is based primarily on LIBOR. Callable bonds and notes are primarily municipal bonds, and are distributed to either call dates or maturity depending on which date produces the most conservative yield. Asset-backed securities, collateralized mortgage obligations and mortgage-backed securities are distributed based on estimates of the rate of future prepayments
The table below provides information as of December 31, 2000 on debt obligations and QUIPS and reflects principal cash flows and related weighted average interest rates by maturity year. Comparative totals are included as of December 31, 1999.
Worldwide Property & Casualty holds a diversified portfolio of investments in equity securities representing firms in various countries, industries and market segments ranging from small market capitalization stocks to Standard & Poor's 500 stocks. The risk associated with these securities relates to potential decreases in value resulting from changes in equity prices.
As of December 31, 2000, Worldwide Property & Casualty had immaterial currency exposures resulting from its international operations.
The primary exposure to interest rate risk in Corporate relates to the debt issued in connection with The HLI Repurchase. Corporate also has $5 in fixed maturity security investments that represent an immaterial interest rate exposure.
The table below provides information as of December 31, 2000 on Corporate's debt obligations and reflects principal cash flows and related weighted average interest rates by maturity year. Because the debt was issued in 2000, comparative totals are not presented.
Capital resources and liquidity represent the overall financial strength of The Hartford and its ability to generate strong cash flows from each of the business segments and borrow funds at competitive rates to meet operating and growth needs. The capital structure of The Hartford as of December 31, 2000 consists of debt and equity, and as of December 31, 1999 and 1998 also consisted of minority interest, summarized as follows:
Purchase accounting for this transaction resulted in adjustments to the cost basis of certain assets and liabilities acquired based on assessments of fair value, including the recognition of an asset representing the present value of estimated net cash flows (present value of the future gross profits to be earned, PVP) embedded in HLI's existing insurance and investment contracts.
The Hartford's total capitalization, excluding unrealized gain (loss) on securities, net of tax, increased by $1.3 billion as of December 31, 2000 compared to December 31, 1999. This change was primarily the result of earnings and financing activities related to The HLI Repurchase, partially offset by dividends declared and the effect of treasury stock acquired in the first quarter of 2000.
On November 9, 2000, The Hartford filed with the Securities and Exchange Commission a shelf registration statement and a prospectus, as amended on January 31, 2001, for the potential offering and sale of up to $2.6 billion in debt and equity securities. (For a further discussion of the shelf registration, see Note 6 of Notes to Consolidated Financial Statements.)
COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUSTS HOLDING SOLELY JUNIOR SUBORDINATED DEBENTURES (QUIPS AND TRUPS)
On March 6, 2001, HLI issued and sold $200 of trust preferred securities from its existing shelf registration. (For additional information, see Note 17 of Notes to Consolidated Financial Statements.)
Dividends - The Hartford declared $214 and paid $210 in dividends to shareholders in 2000 and declared $209 and paid $207 in 1999.
Dividends to The Hartford Financial Services Group, Inc. from its subsidiaries are restricted. The payment of dividends by Connecticut-domiciled insurers is limited under the insurance holding company laws of Connecticut. Under these laws, the insurance subsidiaries may only make their dividend payments out of restricted surplus. These laws require notice to and approval by the state insurance commissioner for the declaration or payment of any dividend, which, together with other dividends or distributions made within the preceding twelve months, exceeds the greater of (i) 10% of the insurer's policyholder surplus as of December 31 of the preceding year or (ii) net income (or net gain from operations, if such company is a life insurance company) for the twelve-month period ending on the thirty-first day of December last preceding, in each case determined under statutory insurance accounting 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.
The National Association of Insurance Commissioners ("NAIC") has regulations establishing minimum capitalization requirements based on risk-based capital ("RBC") formulas for both life and property and casualty companies. The requirements consist of formulas, which identify companies that are undercapitalized and require specific regulatory actions. The RBC formula for life companies establishes capital requirements relating to insurance, business, asset and interest rate risks. RBC is calculated for property and casualty companies after adjusting capital for certain underwriting, asset, credit and off-balance sheet risks. As of December 31, 2000, each of The Hartford's insurance subsidiaries within Worldwide Life and Worldwide Property & Casualty had more than sufficient capital to meet the NAIC's RBC requirements.
The business of insurance is primarily regulated by the states and is also affected by a range of legislative developments at the state and federal levels. Passage in November 1999 of the Financial Services Modernization Act, which permits affiliations among banks, insurance companies and securities firms, may have competitive, operational and other implications for the Company. Among other provisions, the measure includes privacy protections requiring all financial service providers to disclose their privacy policies and restrict the sharing of personal information for marketing purposes. Various states are considering even more restrictive privacy measures that could potentially affect the Company's operations.
Federal measures which have been previously considered by Congress and which, if adopted, could affect the insurance business, include tax law changes pertaining to the tax treatment of insurance companies and life insurance products, as well as changes in individual income tax rates and the estate tax, a number of which changes could have an impact on the relative desirability of various personal investment vehicles. Other proposals pertain to medical testing for insurability, and the use of gender in determining insurance and pension rates and benefits. It is too early to determine whether any of these proposals will ultimately be enacted by Congress. Therefore, the potential impact to the Company's financial condition or results of operations cannot be reasonably estimated at this time.
In all states, insurers licensed to transact certain classes of insurance are required to become members of an insolvency fund. In most states, in the event of the insolvency of an insurer writing any such class of insurance in the state, members of the fund are assessed to pay certain claims of the insolvent insurer. A particular state's fund assesses its members based on their respective written premiums in the state for the classes of insurance in which the insolvent insurer is engaged. Assessments are generally limited for any year to one or two percent of premiums written per year depending on the state. Such assessments paid by The Hartford approximated $2 in 2000, $4 in 1999 and $12 in 1998.
The Company distributes its annuity, life and certain property and casualty insurance products through a variety of distribution channels, including broker-dealers, banks, wholesalers, its own internal sales force and other third party organizations. The Company periodically negotiates provisions and renewals of these relationships and there can be no assurance that such terms will remain acceptable to the Company or such third parties. An interruption in the Company's continuing relationship with certain of these third parties could materially affect the Company's ability to market its products. During the first quarter of 1999, the Company modified its existing, exclusive contract with one such third party, Putnam Mutual Funds Corp. ("Putnam") to eliminate the exclusivity provision which will allow both parties to pursue new market opportunities. Putnam is contractually obligated to support and service the related annuity in force block of business and to market, support and service new business. However, there can be no assurance that this contract modification will not adversely impact the Company's ability to distribute Putnam related products.
As of December 31, 2000, The Hartford had not experienced any Year 2000-related business interruptions arising either from its own systems or those of third parties. As an insurer, The Hartford has received claims from insureds who have incurred losses as a result of Year 2000 issues. Insurance coverage, if any, will depend upon the provisions of the policies and the facts and circumstances of each claim. The Hartford does not believe that the claim and claim adjustment expenses related to such claims will have a material impact upon The Hartford's financial condition or results of operations.
For further information on other contingencies, see Note 15 of Notes to Consolidated Financial Statements.