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 218 thousand square feet of office space in the Netherlands, 12 thousand square feet in Spain, 7 thousand square feet in Singapore and 600 square feet of office space in the United Kingdom. In addition, The Hartford leases approximately 5.0 million square feet throughout the United States and 24 thousand square feet in other countries.
The Hartford defines "core earnings" as after-tax operational results excluding, as applicable, net realized capital gains or losses, the cumulative effect of accounting changes, allocated Distribution items (for additional information, see Note 16 of Notes to Consolidated Financial Statements) and certain other items. Core earnings is an internal performance measure 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.
Revenues for 1998 increased $1.6 billion, or 12%, from 1997. This improvement was due primarily to higher aggregate fees earned on growth in account values in the Investment Products and Individual Life operations resulting from strong sales and equity market appreciation, the recapture of an in force block of corporate owned life insurance ("COLI") business (referred to as "MBL Recapture") previously ceded to MBL Life Assurance Co. of New Jersey ("MBL Life"), an increase in earned premiums and service fee revenues in the Personal segment and higher net investment income. Partially offsetting these increases were lower net realized capital gains. In addition, revenues for 1998 also increased as a result of proceeds from the sale of renewal rights and other considerations related to the Industrial Risk Insurance pool ("IRI transaction"). (For an analysis of net investment income and net realized capital gains, see the Investments section.)
In 1997, core earnings increased $212, or 39%, from 1996 primarily due to a reduction in domestic property catastrophe and other severe weather-related losses of $132, after-tax. Also contributing to the increase were higher net investment income, growth in earnings in the Investment Products operation, the reduction of incurred environmental and asbestos losses and a reduction of losses on guaranteed investment contract ("GIC") business. Soft market conditions related to automobile insurance in the United Kingdom and increased debt service costs partially offset the increase.
Net income for 1997 includes a $368 equity gain resulting from the initial public offering of Hartford Life, Inc. ("HLI"), the holding company parent of The Hartford's significant life insurance subsidiaries, Class A common stock ("The Offering"). (For additional information, see Note 2 of Notes to Consolidated Financial Statements and Capital Resources and Liquidity section under "The Offering".)
The following is a summary of underwriting results by segment within North American Property & Casualty.
1998 1997 1996 - - ----------------------------------------------------------------- Commercial $ (213) $ (149) $ (206) Personal 77 37 (110) Reinsurance (36) (14) (10) - - ----------------------------------------------------------------- TOTAL [1] $ (172) $ (126) $ (326) - - ----------------------------------------------------------------- [1] 1996 excludes the impact of a $660, before-tax, environmental and asbestos charge.
The following is a summary of core earnings and net income (loss).
CORE EARNINGS 1998 1997 1996 - - ----------------------------------------------------------------- N. A. Property & Casualty $ 457 $ 433 $ 270 Life 386 306 200 International 42 46 79 Other Operations (69) (36) (12) - - ----------------------------------------------------------------- CORE EARNINGS $ 816 $ 749 $ 537 - - -----------------------------------------------------------------
A description of North American Property & Casualty, along with each reporting segment, as well as an analysis of the operating results summarized above, is included on the following pages. Reserves, Environmental and Asbestos Claims, and Investments are discussed in separate sections.
The following is a summary of North American Property & Casualty core earnings by major component after-tax. Core earnings exclude net realized capital gains and other items.
Underwriting results are discussed in each of the Commercial, Personal and Reinsurance segment sections. Net investment income is discussed in the Investments section.
Core earnings in 1998 for North American Property & Casualty were $457, an increase of $24, or 6%, from 1997. The increase was primarily due to a $37, or 6%, increase in net investment income and a $49 increase in net other considerations (primarily as a result of the IRI transaction), partially offset by a $30, or 37%, decrease in after-tax underwriting results and a $32, or 30%, increase in interest and other non-underwriting expenses.
Core earnings in 1997 for North American Property & Casualty were $433, an increase of $163, or 60%, from 1996. The increase was primarily due to a $130, or 61%, improvement in after-tax underwriting results and an $88, or 17%, increase in net investment income, partially offset by a $12, or 80%, decrease in net other considerations and a $43, or 67%, increase in interest and other non-underwriting expenses.
Interest and other non-underwriting expenses increased $32 in 1998 from 1997 and $43 in 1997 from 1996, on an after-tax basis. The increase in 1998 was primarily the result of an increase in certain corporate benefit and outside services expenses, while the 1997 increase was primarily the result of increased debt costs from additional borrowings and a reallocation of debt costs to North American Property & Casualty.
Written premiums decreased slightly in 1998 compared to 1997. Solid premium growth in the small commercial businesses, Select Customer and Commercial Affinity, as well as in the bond and agricultural lines, totaled 11% in 1998 compared to 1997. These growth businesses represented 42% of the Commercial segment's written premiums and contributed 4% to the segment's total written premium growth. Enhanced product offerings, specific geographic expansion strategies and partnerships with other entities were the primary drivers of these growth businesses. These increases, however, were offset by declines in the middle and large national account businesses primarily due to intense price competition in the casualty lines, where disciplined underwriting allowed business to move to other carriers rather than under pricing in order to
Underwriting results decreased $64, or 1.7 combined ratio points, in 1998 as compared with 1997. Increases in property catastrophe losses of $70, or 2.1 combined ratio points, were the primary factor in the decline, as catastrophe experience was worse in 1998 as compared to the highly favorable experience in the prior year. In addition, intense price competition in the mid and large-sized marketplace has resulted in reduced profit margins, as decreases in rate and price, particularly in the workers' compensation line, have outpaced loss cost savings. The Commercial segment, however, does continue to experience the benefit of its extensive cost containment strategies which mitigate the rate and price pressure on underwriting results.
Written premiums decreased $63, or 2%, in 1997 compared with 1996. Premium growth in several markets and lines of business including Select Customer, Commercial Affinity, bond, marine and agriculture, Specialty Property and Specialty Casualty totaled 6% in 1997, contributing 3% to the segment's total written premium growth rate. However, this total premium growth was more than offset by a 23% decline in large national accounts caused by declining workers' compensation rates and intense price competition.
In 1997, underwriting results improved $57, or 1.3 combined ratio points, compared with the prior year. The primary factors contributing to the improvement were reductions in property catastrophe and other severe weather-related losses of $76 and a reduction of asbestos and environmental incurred losses of $67. Also, favorable loss and loss expense development trends, particularly in workers' compensation and other casualty lines, were generated through the execution of the segment's total cost containment strategy which included loss prevention and avoidance, early reporting, active claim management and prompt return to work programs. Partially offsetting the favorable losses described above, was a $103 reduction in earned premiums, primarily from the declining written premiums from large national accounts.
Health Care Options, thus providing the Personal segment with an important competitive advantage.
Underwriting results improved by $40, with a corresponding 1.5 point improvement in the combined ratio, in 1998 compared with 1997. The combined ratio decrease resulted from loss cost improvements in automobile and homeowners from expanded cost containment initiatives, effecting the combined ratio by 3.8 points. Offsetting this improvement were significantly higher property catastrophes in 1998 of $71 compared to $32 in 1997, impacting the combined ratio by 1.8 points, and increased underwriting expenses impacting the combined ratio by 0.5 points. Property catastrophe and other severe weather-related experience was unusually low in 1997. The increase in underwriting expenses was primarily from investments in growth initiatives, acquisition costs related to premium growth and from investment in the Affinity unit start-up organization, partially offset by lower dividends to policyholders.
Written premiums increased $29, or 2%, in 1997 compared to 1996 due primarily to strong growth in AARP premiums of $78, or 7%, contributing 4% to the segment's total written premium growth, which benefited from the favorable expansion of this demographic group. Partially offsetting the increase in AARP was a decline in Agency premiums of $49, or 7%, contributing a reduction of 3% to the segment's total written premiums. The Agency decline in 1997 was due to the sale of the Company's Canadian personal lines as well as disruption in the incoming flow of business associated with a major strategic shift in emphasis from homeowners to automobile coverages. AARP written premiums of $1.3 billion represented 67% of the 1997 Personal premiums, up from 64% in 1996.
Underwriting results for 1998 decreased $22, or 3.1 combined ratio points, from 1997 due primarily to the impact of higher net property catastrophe losses of $47, which were somewhat offset by increased new business premiums in finite casualty which has a lower combined ratio than traditional casualty lines. Underwriting results for 1997 decreased $4, or 0.5 combined ratio points, from 1996 as favorable worldwide property catastrophe experience was offset by increasingly competitive market conditions which softened premium rate levels.
The reinsurance market is highly competitive and prices remain relatively soft in most product lines in most parts of the world. While HartRe remains focused on its long-term goals, the discipline of writing profitable business will be maintained, even at the expense of premium growth. On a positive note, responsible buyers are looking to establish core relationships with a select group of financially strong reinsurers which possess specialized product and geographic spread, service capabilities, and expertise. HartRe stands ready to capitalize on these strengths in view of the changing marketplace.
The Life segment consists of the following reportable operations: Investment Products, Individual Life, Employee Benefits and COLI. The Life segment includes in an Other category its international operations, which are primarily located in Latin America, and corporate items not directly allocable to any of its reportable operations.
Core earnings increased $80, or 26%, to $386 in 1998 from $306 in 1997, primarily as a result of an increase in earnings in the Investment Products operation of $64 and in the Individual Life operation of $9, both of which were driven by fees earned on increased separate account assets due to strong sales and equity market appreciation. Additionally, earnings in the
Revenues increased $319, or 7%, to $4.7 billion in 1997 from $4.4 billion in 1996. The growth was primarily due to the Investment Products operation where revenues increased $503 in 1997 from 1996 as a result of fee income earned on growth in separate account assets due to strong annuity sales and equity market appreciation. Investment Products revenues were also impacted by the segment's GIC business, where revenues increased $205, primarily as a result of net realized capital losses in the third quarter of 1996. Additionally, strong sales and renewals related to the Employee Benefits operation contributed $237 to the revenue growth. Partially offsetting these increases was a decrease in COLI revenues of $380 due to the HIPA Act of 1996, which virtually eliminated all new sales of leveraged COLI.
The Investment Products operation 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 annuities and other investment products. The individual annuity products offered include individual variable annuities, fixed market value adjusted (MVA) annuities and fixed and variable immediate annuities. The other investment products offered include retail mutual funds, deferred compensation and retirement plan services, structured settlement contracts, other special purpose annuity contracts and investment management services. The Company was ranked the number one writer of individual variable annuities in the United States for 1998 according to Variable Annuity and Research Data Service (VARDS) with a 10% market share. In addition, mutual fund assets of approximately $2.5 billion at December 31, 1998 were more than double prior year levels.
Revenues in 1998 increased $57, or 11%, to $567 from $510 in 1997, reflecting the impact of applying cost of insurance charges and variable life fees earned on the growing block of variable life insurance. Variable life average account values increased $562, or 67%, to $1.4 billion in 1998 from $840 in 1997 due to strong sales of $127 in 1998, a 30% increase over prior year levels, as well as equity market appreciation. Total benefits, claims and claim adjustment expenses and amortization of deferred costs increased $18 and $21, respectively, over prior year levels. The growth in the Individual Life operation's account values, particularly variable life, resulted in an increase in core earnings of $9, or 16%, in 1998.
Revenues increased $109, or 6%, to $1.8 billion in 1998 from $1.7 billion in 1997. This increase in revenues was driven by strong sales of fully insured business, excluding buyouts, which were $397 in 1998, an increase of $68, or 21%, compared to 1997. This growth in new sales was driven by group life and group disability business where sales, excluding buyouts, grew 20% compared to the prior year. Expenses increased $96, or 6%, as compared to the prior year primarily due to higher benefits, claims and claim adjustment expenses associated with this growing block of business. As a result of increased premium revenue, an increased level of investment in tax-exempt securities and favorable mortality and morbidity experience, core earnings increased $13, or 22%, to $71 in 1998 from $58 in 1997.
Similar factors generated an increase in revenues of $237, or 16%, to $1.7 billion in 1997 from $1.5 billion in 1996. Sales of fully insured business, excluding buyouts, were $329 in 1997, an increase of $91, or 38%, compared to 1996. Expenses increased $224, or 16%, as compared to the prior year primarily due to higher benefits, claims and claim adjustment expenses. As a result, core earnings increased $13, or 29%, to $58 in 1997 from $45 in 1996.
Revenues in this operation increased $587, or 60%, to $1.6 billion in 1998 from $980 in 1997. This increase was primarily due to revenues of $624 related to the recapture of an in force block of leveraged COLI business from MBL Life in the fourth quarter of 1998, as discussed earlier. In addition, revenues increased due to fee income on growing variable COLI account values, partially offset by declines in fees on leveraged COLI as that block of business continues to decline due to the HIPA Act of 1996. Benefits, claims and expenses increased $593, or 63%, to $1.5 billion in 1998 from $938 in 1997 due primarily to the MBL Recapture discussed previously. Core earnings declined $3, or 11%, to $24 in 1998 from $27 in 1997 as the growth in the Company's variable COLI business was offset by the declining block of leveraged COLI. The MBL Recapture had no impact on core earnings or net income in 1998.
Life segment's asset and fully insured premium growth and to maximize shareholder value. The Life segment's strong market position in each of its primary businesses, coupled with the growth potential management believes exists in its markets, provides opportunities to increase sales of the Life segment's products and services as individuals increasingly save and plan for retirement, protect themselves and their families against disability or death and prepare their estates for an efficient transfer of wealth between generations. Certain proposed legislative initiatives which could impact the Life segment are discussed in the Regulatory Initiatives and Contingencies section.
In 1998, revenues of $1.6 billion were $85, or 5%, lower than 1997, primarily due to the sale of London & Edinburgh which reflects operating results to the date of sale. Excluding London & Edinburgh, revenue growth over 1997 was 5%. Market conditions in property and casualty business in the Netherlands were very competitive, resulting in nominal premium growth, while life business produced modest growth. Zwolsche revenue was down 4% due to lower net realized capital gains and a negative foreign exchange impact due to weakness in the Dutch Guilder. ITT Ercos revenues were up significantly due to 62% growth in automobile written premiums. Also, People's Insurance contributed $22 of revenues in 1998. Foreign exchange impacts on total revenues were negligible in 1998 as the strength in the Sterling offset weakness in the Guilder.
Core earnings of $46 in 1997 decreased $33, or 42%, from 1996. The decrease in core earnings was due to a $33 decrease in after-tax underwriting results in the automobile line at London & Edinburgh and unfavorable foreign exchange of $5 in the Netherlands, due to the strengthening of the U.S. dollar.
As previously discussed, on November 16, 1998, the sale of London & Edinburgh to Norwich Union was completed and 1998 reported results are for the period ended at this date and, therefore, are not comparable to prior year results. During 1998, the United Kingdom market continued to be very competitive. However, revenue growth of approximately $70 in the creditor line of business and revenues of approximately $40 from the addition of homeowners business more than offset reduced growth in automobile and most lines within the commercial business. For the ten month period ended October 31, 1998, property and casualty revenue growth was 7%. During 1998, foreign exchange had a positive impact on revenues of $10.
Core earnings for the period ended November 16, 1998 were $20. During 1998, improved underwriting results in personal lines were offset by higher losses from weather events and losses associated with professional liability claims. While overall operating results improved in 1998 versus the prior year, soft market conditions continued to prevail in most areas.
In 1997, revenues at London & Edinburgh of $1.2 billion increased $169, or 16%, over 1996. In local currency, 1997 revenues grew 10% overall with 25% growth in net written premiums. The increase in revenues and net written premiums was primarily due to a new business agreement entered into at the end of 1996 with Nationwide. In 1997, the weakening of the U.S. dollar against the Sterling resulted in a positive foreign exchange impact on revenues of $59.
In 1998, core earnings at Zwolsche of $31 decreased $2, or 6%, from 1997. On a local currency basis, core earnings also decreased 6% from 1997. Life core earnings increased 4% on a local currency basis, with continued favorable operating performance in savings and asset management product areas. Property and casualty core earnings on a local currency basis decreased 18% due to a slightly increased loss ratio and higher expenses associated with Year 2000 and Euro conversion initiatives. A strengthening U.S. dollar against the Guilder negatively impacted core earnings by $1.
In 1998, revenues at ITT Ercos of $95 increased $20, or 27%, from 1997. On a local currency basis, revenues also increased 27% from 1997. Property and casualty net written premiums increased 38% on a local currency basis, with automobile business up 62%. This significant increase was attributable to a new centralized agent service center combined with risk segmentation and pricing initiatives. Life net written premiums
increased 12% on a local currency basis due to further penetration of the existing agent distribution network.
In 1998, the core earnings loss of $2 decreased $4 from 1997. In the property and casualty business, the combined ratio of 105.6 increased from 98.1 in 1997. This increase was primarily due to a significantly higher automobile loss ratio that resulted from higher claims due to increased frequency and severity. Various actions, including rate increases and agent cancellations, have been implemented to remediate this situation.
In 1997, core earnings of $2 decreased $1, or 33%, from 1996. In local currency, 1997 core earnings decreased 13%. Despite improved expense ratios, operating performance was down due to worsening underwriting performance and lower yields on the investment portfolio. The strengthening of the U.S. dollar in 1997 had a negligible foreign exchange impact on core earnings.
The International segment continues to explore acquisition opportunities in Western Europe, Latin America and Asia. People's Insurance is intended to provide a base of operations for further Asian development.
In accordance with the insurance laws and regulations under which the Life segment operates, life insurance subsidiaries of The Hartford establish actuarially determined reserves to meet their obligations on their outstanding life and disability insurance contracts, as well as reserves for their universal life and investment contracts. Reserves for life insurance and disability contracts are based on mortality and morbidity tables in general use in the United States, modified to reflect The Hartford's experience. Management believes that these reserves, with additions from premiums to be received, and with interest on such reserves compounded annually at certain assumed rates, will be sufficient to meet The Hartford's policy obligations at their maturities or in the event of an insured's death. Reserves for universal life insurance and investment products represent policy account balances before applicable surrender charges.
The Hartford continues to receive claims asserting damages from environmental exposures and for injuries from asbestos and asbestos-related products, both of which affect North American Property & Casualty along with the International and Other Operations segments. 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. For the majority of environmental claims and many types of asbestos claims, unlike any other type of contractual claim, 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, involving 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 investment portfolios of North American Property & Casualty, Life, International and Other Operations are managed by distinct investment strategy groups which are accountable to senior management. They are responsible for monitoring and managing the asset/liability profile, establishing investment objectives and guidelines, and determining, within specified risk tolerances and investment guidelines, the appropriate asset allocation, duration and convexity characteristics of the portfolios. Hartford Investment Management Company, a wholly owned subsidiary of The Hartford Financial Services Group, Inc., executes the investment plan of the strategy groups for North American Property & Casualty, Life and Other Operations, including the identification and purchase of securities that fulfill the objectives of the strategy groups. International subsidiaries maintain individual investment units with comparable responsibilities.
Municipal - tax-exempt $ 8,804 61.5% $ 7,873 58.5% Corporate 2,119 14.8% 2,257 16.8% Commercial MBS 834 5.8% 687 5.1% Gov't/Gov't agencies - For. 501 3.5% 459 3.4% ABS 500 3.5% 559 4.2% CMO 415 2.9% 483 3.6% MBS - agency 348 2.4% 540 4.0% Gov't/Gov't agencies - U.S. 46 0.3% 32 0.2% Municipal - taxable 24 0.2% 31 0.2% Short-term 663 4.6% 479 3.6% Redeemable pref'd stock 65 0.5% 56 0.4% - - ---------------------------------------------------------------- Total fixed maturities $ 14,319 100.0% $ 13,456 100.0% ================================================================
During 1998, North American Property & Casualty adjusted its investment strategy to increase its allocation to municipal tax-exempt bonds while decreasing its allocation to agency mortgage backed securities ("MBS") and corporate bonds. In addition, the percentage ownership of equity securities to total invested assets significantly decreased, primarily as a result of continued opportunities taken in a favorable equity market and the redeployment of these funds to fixed maturities.
The taxable equivalent duration of the December 31, 1998 fixed maturity portfolio was 4.8 years compared to 4.7 years at December 31, 1997. Duration is defined as the market price sensitivity of the portfolio to parallel shifts in the yield curve.
Net investment income, before-tax $ 824 $ 777 $ 661 Net investment income, after-tax[1] $ 658 $ 619 $ 531 Yield on average invested assets, before-tax [2] 5.8% 5.9% 5.5% Yield on average invested assets, after-tax [1] [2] 4.6% 4.7% 4.4% Net realized capital gains, before-tax $ 231 $ 231 $ 15 - - ---------------------------------------------------------------- [1] Due to the significant holdings in tax-exempt investments, after-tax net investment income and yield are included. [2] Represents net investment income (excluding net realized capital gains) divided by average invested assets at cost (fixed maturities at amortized cost).
For the year ended December 31, 1997, before and after-tax net investment income increased 18% and 17%, respectively. These increases were primarily due to an increase in invested assets as a result of increased operating cash flow, investment of the proceeds from the 1996 sale of Quarterly Income Preferred Securities (QUIPS) and 1997 repayment of allocated advances by HLI, partially offset by the 1997 North American Property & Casualty's share of repayment of short-term debt. The increase in both before and after-tax yields was primarily due to increased allocations to higher yielding asset backed securities ("ABS") and commercial MBS ("CMBS") along with an increase in securities rated below investment grade.
Net realized capital gains for 1998 were unchanged from 1997. During the year, net gains from the sale of fixed maturities and equity securities were partially offset by a $7 after-tax impairment of asset backed securities securitized and serviced by Commercial Financial Services, Inc. ("CFS"). (For additional information on CFS, see Note 15 of Notes to
The primary investment objective of the Life segment'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 - Life Operations - Interest Rate Risk".
Corporate $ 7,898 44.6% $ 7,970 47.3% ABS 2,465 13.9% 3,199 19.0% Commercial MBS 2,036 11.5% 1,606 9.5% Municipal - tax-exempt 916 5.2% 171 1.0% CMO 831 4.7% 978 5.8% Gov't/Gov't agencies - For. 530 3.0% 502 3.0% MBS - agency 503 2.9% 514 3.1% Municipal - taxable 223 1.3% 267 1.6% Gov't/Gov't agencies - U.S. 166 0.9% 241 1.4% Short-term 2,119 12.0% 1,395 8.3% Redeemable preferred Stock 5 -- 5 -- - - ---------------------------------------------------------------- Total fixed maturities $ 17,692 100.0% $ 16,848 100.0% ================================================================
During 1998, the Life segment, in executing its investment strategy, increased its allocation to municipal tax-exempt securities with the objective of increasing after-tax yields, and also increased its allocation to CMBS while decreasing its allocation to ABS. The increase in short-term investments as of December 31, 1998 as compared to 1997 is primarily related to the settlement of the MBL Recapture in the fourth quarter 1998 which resulted in short-term investment proceeds of approximately $300.
Net investment income - ex. policy loans $ 1,166 $ 1,111 $ 1,053 Policy loan income 789 425 477 ----------------------------- Net investment income - total $ 1,955 $ 1,536 $ 1,530 Yield on average invested assets [1] 7.9% 7.6% 7.7% Net realized capital losses $ -- $ -- $ (219) ================================================================ [1] Represents net investment income (excluding net realized capital losses) divided by average invested assets at cost (fixed maturities at amortized cost). In 1998, average invested assets were calculated assuming the MBL Recapture proceeds were received on January 1, 1998.
Net investment income $ 164 $ 185 $ 183 Yield on average invested assets [1] 7.0% 7.2% 7.4% Net realized capital gains $ 70 $ 95 $ 73 - - ---------------------------------------------------------------- [1] Represents net investment income (excluding net realized capital gains) divided by average invested assets at cost (fixed maturities at amortized cost).
The decrease in net realized capital gains in 1998 was primarily due to the weakening of the equity market in the Netherlands. Net realized capital gains increased in 1997 from 1996 as a result of opportunities taken in a favorable equity market.
The investment objective of Other Operations is to ensure the full and timely payment of all liabilities. The ongoing strategy is to match asset and liability cash flows in the early years and to match asset and liability durations in the long-term.
Corporate $ 1,603 64.7% $ 1,530 61.7% ABS 224 9.0% 142 5.7% Commercial MBS 145 5.9% 149 6.0% Gov't/Gov't agencies - U.S. 82 3.3% 88 3.5% Gov't/Gov't agencies - For. 50 2.0% 83 3.3% MBS - agency 41 1.7% 56 2.3% Municipal - taxable 40 1.6% 39 1.6% CMO 20 0.8% 27 1.1% Short-term 262 10.6% 357 14.4% Redeemable preferred Stock 9 0.4% 9 0.4% - - ---------------------------------------------------------------- Total fixed maturities $ 2,476 100.0% $ 2,480 100.0% - - ----------------------------------------------------------------
For the year ended December 31, 1997, before-tax net investment income increased 5%, while before-tax yields increased slightly. The increase in net investment income and yield was due primarily to an increase in invested assets and the receipt of interest income in an arbitration settlement.
The Company invests primarily in securities rated investment grade and has established exposure limits, diversification standards and review procedures for all credit risks including borrower, issuer and counterparty. Creditworthiness of specific obligors is determined by an internal credit assessment and ratings assigned by nationally recognized ratings agencies. Obligor, asset sector and industry concentrations are subject to established limits and monitored on a regular interval.
As of December 31, 1998 and 1997, over 98% of the fixed maturity portfolio was invested in securities rated investment grade.
U.S. Gov't/Gov't agencies $ 2,596 9.3% $ 2,907 10.6% agencies AAA 3,907 14.0% 4,252 15.4% AA 2,716 9.7% 2,990 10.9% A 8,878 31.8% 9,351 33.9% BBB 7,019 25.2% 5,966 21.7% BB & below 492 1.8% 205 0.7% Short-term 2,298 8.2% 1,880 6.8% - - ---------------------------------------------------------------- Total fixed maturities $27,906 100.0% $ 27,551 100.0% ================================================================
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, 1998 and 1997, totaled $11.3 billion and $11.1 billion, respectively.
The following discussions focus on the key market risk exposures within each of the property and casualty and life operations.
The following table provides information as of December 31, 1998 on interest rate swaps used to manage interest rate risk on
fixed maturities and presents notional amounts with weighted average pay and receive rates by maturity year. Comparative totals are included as of December 31, 1997. The weighted average pay rate is based on spot rates as of December 31, 1998 and 1997.
The property and casualty operations hold a well diversified portfolio of investments in equity securities representing firms in various countries, industries and market segments ranging from small market capitalization stocks to the Standard & Poor's 500 stocks. The risk associated with these securities relates to potential decreases in value resulting from changes in equity prices.
The operations occasionally use equity futures to hedge against a change in value on the anticipated purchase or sale of equity securities. As of December 31, 1998 and 1997, there were no outstanding derivative instruments hedging equity price risk.
The following table reflects equity securities owned at December 31, 1998 and 1997, grouped by major market type.
1998 1997 Fair Value Percent Fair Value Percent - - ----------------------------------------------------------------- Equity Securities Domestic Large cap $ 390 42.2% $ 793 45.5% Midcap/small cap 105 11.3% 293 16.8% Foreign EAFE [1]/Canadian 411 44.3% 562 32.3% Emerging 20 2.2% 93 5.4% - - ----------------------------------------------------------------- Total $ 926 100.0% $ 1,741 100.0% - - ----------------------------------------------------------------- [1] Europe, Australia, Far East countries index.
the subsidiary's local currency to U.S. dollars. The following table represents the property and casualty operations' net equity investments in its primary foreign subsidiaries, the related foreign currency and the impact to the net equity investment based upon a 10% change in foreign currency rates at December 31, 1998 and 1997. The property and casualty operations also had immaterial exposures to the Singapore Dollar, British Sterling and Spanish Peseta.
Impact of 10% Net Equity Changes Company Investment -10% +10% Currency [1] - - ------------------- ------------- ------- -------- ------------- Zwolsche $348 $(35) $35 Guilder London & Edinburgh $362 $(36) $36 Sterling Zwolsche 353 (35) 35 Guilder - - ------------------- ------------- ------- -------- ------------- [1] On January 1, 1999, the Netherlands and Spain became members of the European Monetary Union and their currencies, the Guilder and Peseta, were replaced by the Euro.
As described above, the life operations hold a significant fixed maturity portfolio which includes both fixed and variable rate features. The following table reflects the principal amounts of the life operations' general and guaranteed separate account fixed and variable rate fixed maturity portfolios, along with the respective weighted average coupons by estimated maturity year at December 31, 1998. Comparative totals are included as of December 31, 1997. 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, 1998 and 1997, and is primarily based on 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 to maturity year 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 life investment portfolio.
Asset and Liability Management Strategies Used to Manage Market Risk - - --------------------------------------------------------------------
The life operations employ several risk management tools to quantify and manage market risk arising from its investments and interest sensitive liabilities. For certain portfolios, 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.
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 life operations use 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. Notional amounts pertaining to derivatives totaled $11.2 billion at December 31, 1998 ($6.0 billion related to insurance investments and $5.2 billion related to life insurance liabilities). At December 31, 1997, notional amounts pertaining to derivatives totaled $10.9 billion ($6.6 billion related to insurance investments and $4.3 billion related to life insurance liabilities). The strategies described below are used to manage the aforementioned risks.
Anticipatory Hedging -- For certain liabilities, life operations commits to the price of the product prior to receipt of the associated premium or deposit. Anticipatory hedges are executed to offset the impact of changes in asset prices arising from interest rate changes pending the receipt of premium or deposit and the subsequent purchase of an asset. These hedges involve taking a long position in interest rate futures or entering into an interest rate swap with duration characteristics equivalent to the associated liabilities or anticipated investments. The notional amount of anticipatory hedges as of December 31, 1998 and 1997 was $712 and $255, respectively.
The following tables provide information as of December 31, 1998 with comparative totals for December 31, 1997 on derivative instruments used in accordance with the 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 the life operations' management strategy. The estimated cash flows of insurance policy liabilities based upon internal actuarial assumptions as of December 31, 1998 are reflected in the table below by expected maturity year. Comparative totals are included for December 31, 1997.
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 life operations, 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 are shown in the following tables. These fixed liabilities represented about 60% of the life operations' general and guaranteed separate account liabilities at December 31, 1998 and 1997. The remaining liabilities generally allow the life operation 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 evaluated annually consistent with regulatory requirements.
COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUSTS HOLDING SOLELY JUNIOR SUBORDINATED DEBENTURES ("QUIPS AND "TRUPS")
The following table summarizes The Hartford's significant U.S. member companies' financial ratings from the major independent rating organizations as of February 19, 1999.
On February 8, 1999, A.M. Best assigned first time ratings of a+ ("strong") to The Hartford Financial Services Group, Inc.'s senior debt, Hartford Capital I and II quarterly income preferred securities, Hartford Life, Inc.'s senior debt and Hartford Life, Inc.'s Capital I trust preferred securities.
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. 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 primary uses of funds are to pay claims, policy benefits, operating expenses and commissions, and to purchase new investments. In addition, The Hartford has a policy of carrying a significant short-term investment position and accordingly does not anticipate selling intermediate and long-term fixed maturity investments to meet any liquidity needs. (For a discussion of the Company's investment objectives and strategies, see the Investments and Capital Markets Risk Management sections.)
The National Association of Insurance Commissioners ("NAIC") adopted regulations establishing minimum capitalization requirements based on risk-based capital ("RBC") formulas for both property and casualty companies
1998 1997 1996 - - ----------------------------------------------------------------- Net cash provided by operating activities $ 907 $ 2,045 $ 994 Net cash provided by (used for) investing activities $ 411 $ (2,247) $ (1,035) Net cash (used for) provided by financing activities $ (1,340) $ 239 $ 59 Cash - end of year $ 123 $ 140 $ 112 - - -----------------------------------------------------------------
During 1998, the decrease in cash provided by operating activities was primarily the result of lower underwriting cash flows, due in part to higher claim payments on catastrophes, an increase in income taxes paid and timing in the settlement of other receivables and payables. The decrease in cash (used for) provided by financing activities was primarily the result of proceeds from the HLI offering in May 1997, treasury stock purchases in 1998 in accordance with the Company's share repurchase program and a decrease in investment-type contracts written in the Life segment. The change in cash provided by (used for) investing activities primarily reflects net investment proceeds used to fund financing activities.
On August 26, 1998, HLI completed the purchase of all outstanding shares of PLANCO Financial Services, Inc. ("PLANCO") and its affiliate, PLANCO, Incorporated. PLANCO, a primary distributor of HLI's annuity and investment products, is the nation's largest wholesaler of individual annuities and has played a significant role in HLI's growth over the past decade. As a wholesaler, PLANCO distributes HLI's annuity and investment products, including fixed and variable annuities, mutual funds and single premium variable life insurance, as well as providing sales support to registered representatives, financial planners and broker-dealers at brokerage firms and banks across the United States. The acquisition has been accounted for as a purchase and accordingly, the results of PLANCO's operations have been included in The Hartford's consolidated financial statements from the closing date of the transaction.
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. Current and proposed Federal measures which may significantly affect the life insurance business include medical testing for life 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. In particular, President Clinton's 1999 Federal Budget Proposal currently contains certain recommendations for modifying tax rules related to the treatment of COLI by contractholders which, if enacted as described, could have a material adverse impact on the Company's sales of these products. The budget proposal also includes provisions which would result in a significant increase in the "DAC tax" on certain of the Company's products and would apply a tax to the Company's policyholder surplus account. It is too early to determine whether these tax 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. 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 and Federal catastrophe fund legislation. Measures which may significantly impact the company overall include tort reform, privacy and new restrictions and liability for managed care plans, and financial services modernization legislation.
The NAIC adopted the Codification of Statutory Accounting Principles ("SAP") in March, 1998. The proposed effective date for the statutory accounting guidance is January 1, 2001. It is expected that each of The Hartford's domiciliary states will adopt SAP and the Company will make the necessary changes required for implementation. These changes are not anticipated to have a material impact on the statutory financial statements of The Hartford.
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 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.
Beginning in 1990, The Hartford began working on making its IT systems Year 2000 ready, either through installing new programs or replacing systems. Since January 1998, The Hartford's Year 2000 efforts have focused on the remaining Year 2000 issues related to IT and non-IT systems in all of The Hartford's business segments. These Year 2000 efforts include the following five main initiatives: (1) identifying and assessing Year 2000 issues; (2) taking actions to remediate IT and non-IT systems so that they are Year 2000 ready; (3) testing IT and non-IT systems for Year 2000 readiness; (4) deploying such remediated and tested systems back into their respective production environments; and (5) conducting internal and external integrated testing of such systems. As of December 31, 1998, The Hartford substantially completed initiatives (1) through (4) of its internal Year 2000 efforts. The Hartford has
The Hartford is in the process of developing certain contingency plans so that if, despite its Year 2000 efforts, Year 2000 problems ultimately arise, the impact of such problems may be avoided or minimized. These contingency plans are being developed based on, among other things, known or reasonably anticipated circumstances and potential vulnerabilities. The contingency planning also includes assessing the dependency of The Hartford's business on third parties and their Year 2000 readiness. The Hartford currently anticipates that internal and external contingency plans will be substantially complete by the end of the second quarter of 1999. However, in many contexts, Year 2000 issues are dynamic, and ongoing assessments of business functions, vulnerabilities and risks must be made. As such, new contingency plans may be needed in the future and/or existing plans may need to be modified as circumstances warrant.
As an insurer, The Hartford may incur claims and claim adjustment expenses, including attorneys' fees and other legal expenses, resulting from claims from insureds who may incur losses as a result of Year 2000 problems. To the extent claims are made, insurance coverage, if any, will depend upon the provisions of the policies and the facts and circumstances of each claim. It is not possible to determine in advance whether and to what extent insureds would incur losses, the amount of the losses, or whether any such losses would be covered under The Hartford's insurance policies. Because of this uncertainty, it is also not possible to determine in advance whether such claims and claim adjustment expenses would have a material impact upon The Hartford's financial condition or results of operations.