Hartford Life's principal executive offices are located in Simsbury, Connecticut. The Company's home office complex consists of approximately 655 thousand square feet, and is leased from a third party by Hartford Fire Insurance Company (Hartford Fire), an indirect subsidiary of The Hartford. This lease expires in the year 2009. Expenses associated with these offices are allocated on a direct basis to Hartford Life by Hartford Fire. 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 Hartford Life, Inc. and its subsidiaries ("Hartford Life" or the "Company") as of December 31, 2000, compared with December 31, 1999, and its results of operations for the years ended December 31, 2000 and 1999. This discussion should be read in conjunction with the Consolidated Financial Statements and related Notes beginning on page.
Hartford Life derives its revenues principally from: (a) fee income, including asset management fees on separate account and mutual fund assets and mortality and expense fees, as well as cost of insurance charges; (b) fully insured premiums; (c) certain other fees; and (d) net investment income on general account assets. Asset management fees and mortality and expense fees are primarily generated from separate account assets, which are deposited with the Company through the sale of variable annuity and variable life products, and mutual funds. Cost of insurance charges are assessed on the net amount at risk for investment oriented life insurance products. Premium revenues are derived primarily from the sale of group life and group disability insurance products.
Hartford Life has the following reportable operating segments: Investment Products, Individual Life, Group Benefits (formerly Employee Benefits) and Corporate Owned Life Insurance (COLI). The Company reports corporate items not directly allocable to any of its segments, principally interest expense, as well as its international operations, which are primarily located in Latin America and the Far East, in an "Other" category. For information regarding the Company's reportable segments, see Note 17 of Notes to Consolidated Financial Statements.
Benefits, claims and expenses increased $352, or 7%, primarily related to the growth in Hartford Life's principal operating segments described above. Net income increased $108, or 23%, led by the Investment Products segment where net income increased $94, or 28%. Additionally, net income related to each of the remaining three operating segments increased 10% or more. Hartford Life also recorded a benefit related to the settlement of certain federal tax matters of $24 in 2000 (see Note 16 (c) of Notes to Consolidated Financial Statements). This benefit, along with an $8 benefit related to state income taxes, resulted in $32 of tax benefits for the year ended December 31, 2000. Additionally, net realized capital losses increased due to portfolio rebalancing. Excluding the tax items and net realized capital losses, earnings increased $133, or 28%.
A description of each segment as well as an analysis of the operating results summarized above is included on the following pages. Reserves and Investments are discussed in separate sections.
Revenues increased $339, or 17%, primarily due to higher fee income in the individual annuity and retail mutual fund operations. Fee income generated by individual annuities increased $227, or 20%, while related average account values grew $8.2 billion, or 10%, to $88.1 billion. The growth in average account values was due, in part, to strong sales of $10.7 billion in 2000, and the significant equity market performance in 1999, partially offset by surrenders. Although average individual annuity account values in 2000 were higher than 1999, account values at December 31, 2000 declined $1.7 billion, or 2%, as compared to December 31, 1999, as strong sales were not sufficient to offset surrenders and the impact of the retreating equity markets. In addition, fee income from other investment products increased $99, or 54%, primarily driven by the Company's retail mutual fund operation, where related assets under management increased $4.0 billion, or 63%. This substantial increase in the retail mutual fund operation was due to sales of $5.2 billion in 2000, which was partially offset by redemptions.
Net income increased $94, or 28%, primarily due to the growth in revenues discussed above. Additionally, the Investment Products segment continued to maintain its profit margins related to its primary businesses, thus contributing to the segment's earnings growth. In particular, its individual annuity operation's operating expenses as a percentage of average individual annuity account values remained consistent with the prior year at 21 basis points.
The market for retirement products continues to expand as individuals increasingly save and plan for retirement. Demographic trends suggest that as the "baby boom" generation matures, a significant portion of the United States population will allocate a greater percentage of their disposable incomes to saving for their retirement years due to uncertainty surrounding the Social Security system and increases in average life expectancy. As this market grows, particularly for variable annuities and mutual funds, new companies are continually entering the market, aggressively seeking distribution channels and pursuing market share. This trend is not expected to subside, particularly in light of the Gramm-Leach-Bliley Act of 1999 (the Financial Services Modernization Act), which permits affiliations among banks, insurance companies and securities firms.
The Individual Life segment sells a variety of life insurance products, including variable life, universal life, interest sensitive whole life and term life insurance primarily to the high end estate and business planning markets.
Revenues increased $56, or 10%, resulting primarily from fee income associated with the growing block of variable life insurance. Fee income increased $59, or 15%, as variable life account values increased $352, or 14%, and variable life insurance in force increased $9.6 billion, or 40%.
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, net income increased $11, or 14%, primarily driven by the increased revenues described above.
Revenues in the COLI segment decreased $64, or 8%, primarily due to a decline in net investment income of $65, or 15%. This decline was principally due to the leveraged COLI block of business, as related account values decreased $751, or 13%, as a result of the continued downsizing caused by the HIPA Act of 1996.
Total benefits, claims and expenses decreased $70, or 9%, primarily due to the factor described above. Net income increased $4, or 13%, principally due to the variable COLI business where related account values increased $3.6 billion, or 29%, as well as earnings associated with a block of leveraged COLI business recaptured in 1998. For additional information on this recaptured business, see Note 12 of Notes to Consolidated Financial Statements.
In accordance with applicable insurance regulations under which Hartford Life operates, life insurance subsidiaries of the Company establish and carry as liabilities actuarially determined reserves which are calculated to meet their 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 Hartford Life'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 Hartford Life'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 liability for policy benefits for universal life-type contracts and interest-sensitive whole life policies is equal to the balance that accrues to the benefit of policyholders, including credited interest, amounts that have been assessed to compensate the Company for services to be performed over future periods, and any amounts previously assessed against policyholders that are refundable on termination of the contract. For investment contracts, policyholder liabilities are equal to the accumulated policy account values, which consist of an accumulation of deposit payments plus credited interest, less withdrawals and amounts assessed through the end
Invested assets in the Company's general account totaled $22.9 billion as of December 31, 2000 and were comprised of $18.2 billion of fixed maturities, $3.6 billion of policy loans, equity securities of $171 and other investments of $910. As of December 31, 1999, general account invested assets totaled $21.8 billion and were comprised of $17.0 billion of fixed maturities, $4.2 billion of policy loans, equity securities of $153 and other investments of $376. The decrease in policy loans was primarily due to the decline in leveraged COLI business (as discussed in the COLI section). Policy loans are secured by the cash value of the underlying life policy and do not mature in a conventional sense, but expire in conjunction with the related policy liabilities. The increase in other investments primarily reflects an increase in limited partnership investments.
During 2000, the Company continued its investment strategy of increasing its allocation to municipal tax-exempt securities with the objective of increasing after-tax yield. Short-term and corporate securities declined primarily as a result of the funding of scheduled
liability maturities and reallocation into other asset sectors, particularly asset backed securities and commercial mortgage backed securities. Additionally, investments were shifted from mortgage backed securities - agency to collateralized mortgage obligations to increase the prepayment protection of the portfolio.
Separate account products are those for which a separate investment and liability account is maintained on behalf of the policyholder. Separate accounts reflect two categories of risk assumption: non-guaranteed separate accounts totaling $104.2 billion and $101.8 billion as of December 31, 2000 and 1999, respectively, wherein the policyholder assumes substantially all the investment risk and reward, and guaranteed separate accounts totaling $9.8 billion and $8.9 billion as of December 31, 2000 and 1999, respectively, wherein Hartford Life contractually guarantees either a minimum return or account value to the policyholder. The primary investment objective of the Company's guaranteed separate 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 - Interest Rate Risk."
Hartford Life is exposed to two primary sources of investment risk and asset/liability management risk: credit risk, relating to the uncertainty associated with an obligor's continued ability to make timely payment of principal and/or interest, and market risk, relating to the market price and/or cash flow variability associated with changes in interest rates, security prices, market indices, yield curves or currency exchange rates. The Company does not hold any financial instruments purchased for trading purposes. The following discussion identifies the Company's policies and procedures for managing these risks and monitoring the results of the Company's risk management activities.
Downward movement in market interest rates during 2000 resulted in a significant increase in the unrealized appreciation of the fixed income security portfolio from 1999. However, Hartford Life's asset allocation and its exposure to market risk have not changed materially from its position at December 31, 1999.
The Company's general account and guaranteed separate account investment portfolios primarily consist of investment grade, fixed maturity securities, including corporate bonds, asset backed securities, commercial mortgage backed securities, tax-exempt municipal securities and collateralized mortgage obligations. The fair value of these and the Company's other invested assets fluctuates depending on the interest rate environment and other general economic conditions. During periods of declining interest rates, paydowns on mortgage backed securities and collateralized mortgage obligations increase as the underlying mortgages are prepaid. During such periods, the Company generally will not be able to reinvest the proceeds of any such prepayments at comparable yields. Conversely, during periods of rising interest rates, the rate of prepayments generally declines, exposing the Company to the possibility of asset/liability cash flow and yield mismatch. For a discussion of the Company's risk management techniques to manage this market risk, see "Asset/Liability Management Strategies Used to Manage Market Risk" below.
As described above, the Company holds a significant fixed maturity portfolio, which includes both fixed and variable rate features. The following table reflects the principal amounts of the general and guaranteed separate account fixed and variable rate fixed maturity portfolios, along with the respective weighted average coupons by estimated maturity year as of December 31, 2000. Comparative totals are included for 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 primarily based on the London Interbank Offered Rate (LIBOR). Callable bonds and notes 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 of principal over the remaining life of the securities. These estimates are developed using prepayment speeds provided in broker consensus data. Such estimates are derived from prepayment speeds previously experienced at the interest rate levels projected for the underlying collateral. Actual prepayment experience may vary from these estimates. Financial instruments with certain leverage features have been included in each of the fixed maturity categories. These instruments have not been separately displayed because they were immaterial to the Company's investment portfolio.
Derivatives play an important role in facilitating the management of interest rate risk, creating opportunities to efficiently fund obligations, hedge against risks that affect the value of certain liabilities and adjust broad investment risk characteristics as a result of any significant changes in market risks. As an end user of derivatives, the Company uses a variety of derivatives, including swaps, caps, floors, forwards and exchange traded financial futures and options, in order to hedge exposure primarily to interest rate risk on anticipated investment purchases or existing assets and liabilities. The Company does not make a market or trade derivatives for the express purpose of earning trading profits. The Company's derivative program is monitored by an internal compliance unit and is reviewed frequently by senior management and reported to The Hartford's Finance Committee. The notional amounts of derivative contracts, which represent the basis upon which pay or receive amounts are calculated and are not reflective of credit risk, totaled $8.5 billion as of December 31, 2000 ($6.5 billion related to insurance investments and $2.0 billion related to life insurance liabilities). As of December 31, 1999, the notional amounts pertaining to derivatives totaled $9.6 billion ($6.3 billion related to insurance investments and $3.3 billion related to life insurance liabilities).
The company uses derivative instruments in its management of market risk consistent with the four risk management strategies described below.
Hartford Life's insurance liabilities, other than non-guaranteed separate accounts, include accumulation vehicles such as fixed and variable annuities, other investment and universal life-type contracts, and other insurance products such as long-term disability and term life insurance.
(1) As of December 31, 2000 and 1999, the fair value of the Company's investment contracts, including guaranteed separate accounts, were $21.4 billion and $20.9 billion, respectively.
For liabilities whose cash flows are not substantially affected by changes in interest rates (fixed liabilities) and where investment experience is substantially absorbed by the Company, the sensitivity of the net economic value (discounted present value of asset cash flows less the discounted present value of liability cash flows) of those portfolios to 100 basis point shifts in interest rates is shown in the table below. These fixed liabilities represented approximately 60% and 55% of the Company's general and guaranteed separate account liabilities at December 31, 2000 and 1999, respectively. The remaining liabilities generally allow the Company significant flexibility to adjust credited rates to reflect actual investment experience and thereby pass through a substantial portion of actual investment experience to the policyholder. The fixed liability portfolios are managed and monitored relative to defined objectives and are analyzed regularly by management for internal risk management purposes using scenario simulation techniques, and are evaluated annually in compliance with regulatory requirements.
Capital resources and liquidity represent the overall financial strength of Hartford Life and its ability to generate strong cash flows from each of the business segments and borrow funds at competitive rates to meet operating and growth needs. The Company maintained cash and short-term investments totaling $1.1 billion and $1.4 billion as of December 31, 2000 and 1999, respectively.
(1) Excludes net unrealized capital gains (losses) on securities, net of tax. (2) Excluding TruPS from debt, the debt to equity ratios were 21% and 25%, and the debt to capitalization ratios were 16% and 18% as of December 31, 2000 and 1999, respectively.
On June 27, 2000, The Hartford acquired all of the outstanding shares of Class A common stock of Hartford Life which The Hartford did not already own (The Hartford Acquisition). The Hartford Acquisition was accomplished through an offer to all Hartford Life shareholders to tender their shares to The Hartford for cash consideration of $50.50 per share. Subsequent to the tender offer, a newly formed wholly owned subsidiary of The Hartford was merged into Hartford Life, as a result of which Hartford Life became an indirect wholly owned subsidiary of The Hartford. Those shareholders who had not tendered their shares in the tender offer also received $50.50 in cash in exchange for their shares in the subsequent merger.
Hartford Life declared $28 in dividends for 2000 to Hartford Fire Insurance Company. Prior to The Hartford Acquisition, Hartford Life declared $28 in dividends for the six months ended June 30, 2000 to holders of Class A and Class B Common Stock (owned by The Hartford). Future dividend decisions will be based on, and affected by, a number of factors, including the operating results and financial requirements of Hartford Life on a stand-alone basis and the impact of regulatory restrictions discussed in Liquidity Requirements below.
(1) Formerly Duff & Phelps. (2) A.M. Best ratings were adjusted to reflect the integration of A.M. Best's debt and preferred stock scales.
Ratings are an important factor in establishing the competitive position of an insurance company such as Hartford Life. There can be no assurance that the Company's ratings will continue for any given period of time or that they will not be changed. In the event that the Company's ratings are downgraded, the level of sales or the persistency of the Company's block of in force business may be adversely impacted.
On January 26, 2001, Moody's confirmed the insurance and debt financial ratings of The Hartford and Hartford Life following the announcement of the Fortis acquisition, but changed the outlook on both companies' debt ratings to negative from stable. Moody's stated that the revision in debt ratings outlook was based upon Moody's concerns that the Fortis acquisition, would increase The Hartford's operating and financial leverage over the medium term and fixed charge coverage would weaken. The revision in ratings outlook does not constitute a ratings "downgrade", nor has Moody's placed the Company on their "watchlist" for possible downgrade.
The liquidity requirements of Hartford Life 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. Hartford Life is a holding company which receives operating cash flow in the form of dividends from its subsidiaries, enabling it to service its debt, pay dividends on its common stock and support its other obligations.
The increase in cash provided by operating activities was primarily the result of the timing of the settlement of receivables, payables and other related liabilities, as well as increased future policy benefits and net income associated with growth in the business. The decrease in cash (used for) provided by investing activities and the decrease in cash used for financing activities primarily relates to the significant downsizing of the leveraged COLI block of business during 1999 as compared to 2000. Operating cash flows in the periods presented have been more than adequate to meet liquidity requirements.
On January 25, 2001, The Hartford, through Hartford Life, agreed to acquire the U.S. individual life insurance, annuity and mutual fund business of Fortis for $1.12 billion in cash. The Company will effect the acquisition through several reinsurance agreements with subsidiaries of Fortis and the purchase of 100% of the stock of Fortis Advisors, Inc. and Fortis Investors, Inc., wholly-owned subsidiaries of Fortis. The Fortis transaction, which is subject to insurance regulatory approval and other customary conditions, is expected to be completed in the second quarter of 2001. The acquisition will be accounted for as a purchase transaction. Hartford Life plans to finance the acquisition through (1) a capital contribution from The Hartford of $615 from its recently completed offering of common stock, (2) proceeds from the March 1, 2001, issuance of $400 of senior debt securities under Hartford Life's shelf registration and (3) proceeds from the March 6, 2001, issuance of $200 of trust preferred securities, also under Hartford Life's shelf registration (For additional information on the shelf registration, see Notes 7 and 8 of Notes to Consolidated Financial Statements).
Hartford Life distributes its annuity and life insurance products through a variety of distribution channels, including broker-dealers, banks, wholesalers, its own internal sales force and other third party marketing 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 service providers. 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 contract with 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.