Certain of the statements contained herein (other than statements of historical fact) are forward-looking statements. Such forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and include estimates and assumptions related to economic, competitive and legislative developments. These forward-looking statements are subject to change and uncertainty which are, in many instances, beyond the company's control and have been made based upon management's expectations and beliefs concerning future developments and their potential effect upon The Hartford Financial Services Group, Inc., formerly ITT Hartford Group, Inc., and its subsidiaries ("The Hartford" or the "Company"). There can be no assurance that future developments will be in accordance with management's expectations or that the effect of future developments on The Hartford will be those anticipated by management. Actual results could differ materially from those expected by The Hartford, depending on the outcome of certain factors, including those described with the forward-looking statements herein.
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 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 lines of business 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 1997 increased $832, or 7%, from 1996, while revenues for 1996 were up $323, or 3%, from 1995. The growth in both years was primarily due to increases in the Annuity division fee income earned on separate account assets, higher group life and disability sales and premium growth in reinsurance operations and business written under an exclusive licensing arrangement with The American Association of Retired Persons ("AARP"). Partially offsetting these increases were a decrease in corporate owned life insurance "COLI" premiums as a result of the Health Insurance Portability and Accountability Act of 1996 ("HIPA Act of 1996"), which phases out the deductibility of interest on policy loans under leveraged COLI by 1998, and a decrease in premium in mid-to-large commercial accounts and agency personal lines. Higher net investment income and, for 1997, net realized capital gains also contributed to the revenue increase. (For an analysis of net investment income and net realized capital gains, see the Investments section.)
Net income for 1996 includes other charges related to environmental and asbestos reserve increases, net of taxes, of $429 in the North American Property & Casualty segment and $81 in Other Operations (as discussed in the Environmental and Asbestos Claims section), recognition of losses on guaranteed rate contract business ("Closed Book GRC") of $169 (as discussed in the Life section) and other, primarily foreign tax-related items, of $2 in each of the North American Property & Casualty and Life segments and $10 in Other Operations.
Minority interest in consolidated subsidiary represents an 18.6% minority interest in HLI's operating results. (For additional information, see Note 3 of Notes to Consolidated Financial Statements and Capital Resources and Liquidity section under "The Offering".)
1997 1996 1995 - ----------------------------------------------------------------- Basic earnings per share $11.29 $(0.84) $4.77 Weighted average common shares outstanding [1] 118.0 117.3 117.1 Diluted earnings per share $11.16 $(0.84) $4.75 Weighted average common shares outstanding and dilutive potential common shares [1] 119.4 117.3 117.7 Return on equity [2] 28.3% (2.3)% 12.6% - ---------------------------------------------------------------- [1] 1995 weighted average common shares outstanding represents actual number of common shares outstanding at December 31, 1995. [2] Calculated by dividing net income (loss) by average equity excluding unrealized gain, after-tax. In 1997 and 1996, return on equity excluding other items (as discussed earlier) from net income (loss) was 20.5% and 13.8%, respectively.
The Hartford's reporting segments consist of North American Property & Casualty, Life, International and Other Operations. Included in Other Operations is the effect of an 18.6% minority interest in HLI's operating results. Other Operations include operations which have ceased writing new and renewal business.
The following is a summary of net income (loss) by segment.
Revenues for 1997 increased $379, or 6%, over 1996, while revenues for 1996 were essentially flat compared to 1995. For a further discussion of premiums, see Summary Underwriting Results below and for net investment income and net realized capital gains, see the Investments section.
The following discussion summarizes underwriting results by major operation (as defined below) and net miscellaneous expenses. As previously noted, net investment income and net realized capital gains are covered in a separate discussion in the Investments section. Other items, consisting primarily of an increase in environmental and asbestos reserves, are discussed in the Environmental and Asbestos Claims section.
1997 1996 1995 - --------------------------------------------------------------- Written premiums $ 5,771 $ 5,688 $ 5,670 Underwriting results [1] $ (126) $ (326) $ (270) Combined ratio [1] [2] 102.3 105.2 104.5 - ---------------------------------------------------------------
[1] 1996 excludes the impact of a $660, before-tax, environmental and asbestos charge. Including the impact of this charge, the combined ratio for 1996 was 116.9 for the North American Property & Casualty segment.
Commercial provides workers' compensation, property, automobile, liability, marine, agricultural and bond coverages to commercial accounts throughout the United States and Canada. Excess and surplus lines business not normally written by standard lines insurers is also provided. Commercial is organized into three customer market segments: Business Insurance, Commercial Affinity and Commercial Specialty. Business Insurance provides standard commercial business for small accounts (Select Customer) and mid-sized insureds. Commercial Affinity provides commercial risk management products and services to members of affinity groups and customers of financial institutions. Commercial Specialty provides insurance through retailers and wholesalers to large commercial clients and insureds requiring a variety of specialized coverages. Its results include the bond lines and First State Management Group, a leading underwriter of excess and surplus lines business produced primarily through wholesale brokers. Agricultural, livestock and marine products are also managed within Commercial Specialty.
Underwriting results improved $57, or 1.3 combined ratio points, in 1997 as compared with 1996. 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 as a result of the charge taken in 1996. Also, continued favorable loss and loss expense development trends, particularly in workers' compensation and other casualty lines, have been generated through the execution of the operation's total cost containment strategy which includes 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 premium from large national accounts over the last two years, which have a high percentage of January renewals and therefore a more significant impact on earned premiums.
In 1996, underwriting results improved $43, or 1.3 combined ratio points, compared with the prior year. This improvement reflected the impact in 1995 of a $40 loss, net of reinsurance, in connection with a settlement of claims against Dow Corning Corporation alleging product defects arising from breast implants and a net $32 loss resulting from a single industrial fire covered by the IRI pool. Excluding the impact of these items on the prior year comparison, 1996 underwriting results decreased $29 from 1995, reflecting a 0.8 point increase in the combined ratio from the adjusted 1995 level. This decline was primarily due to a decrease in property results of approximately $50 which were adversely impacted by property catastrophe and other severe weather-related losses. Despite intense competition, favorable workers' compensation results partially offset this decrease reflecting the impacts of legislative reforms, depopulation in residual pools and effective managed care related initiatives.
1997 1996 1995 - --------------------------------------------------------------- Written premiums $ 1,893 $ 1,864 $ 1,813 Underwriting results $ 37 $ (110) $ (21) Combined ratio 98.6 105.2 100.9 - ---------------------------------------------------------------
Underwriting results improved by $147 in 1997 over 1996, with a corresponding 6.6 point improvement in the combined ratio. This improvement was primarily due to significantly lower property catastrophe and other severe weather-related losses of $137. Improved automobile and homeowners profitability resulting from expanded cost containment initiatives was partially offset by expenses related to significant investments in future growth initiatives and a $34 dividend to policyholders in two states in recognition of favorable personal lines automobile results. Underwriting results decreased by $89 in 1996, with a 4.3 point increase in the combined ratio. These results were due to an increase in property catastrophe and other severe weather-related losses of $93, partially offset by improved automobile results.
1997 1996 1995 - --------------------------------------------------------------- Written premiums $ 688 $ 571 $ 484 Underwriting results $ (14) $ (10) $ -- Combined ratio 102.6 102.1 99.9 - ---------------------------------------------------------------
The Hartford assumes reinsurance worldwide through its nine Hartford Reinsurance Company ("HartRe") offices located in Hartford, San Francisco, Miami, Philadelphia, Toronto, London, Madrid, Munich and Hong Kong. HartRe primarily writes treaty reinsurance through professional reinsurance brokers covering various property, casualty, specialty and marine classes of business.
Written premiums increased 20% in 1997 primarily due to the acquisition of renewal rights for the business of Security Re and San Francisco Re which occurred in late 1996. Written premiums grew 18% in 1996 primarily due to growth in U.S. casualty and specialty lines. This growth resulted from a combination of new business opportunities, an increased level of renewals, and continued new product development in specialty lines, partially offset by a reduction in domestic and international property and marine rates.
Miscellaneous expenses for 1996 were $89, up from $71 in 1995. This increase was primarily due to increased debt costs of $27 from additional borrowings partially offset by increased service fee income from involuntary pool servicing contracts net of other miscellaneous expenses.
Revenues increased $319, or 7%, to $4.7 billion in 1997 from $4.4 billion in 1996. Revenues were impacted by the HIPA Act of 1996, which virtually eliminated all new sales of leveraged COLI, and by GRC, where net realized capital losses and other charges were taken in the third quarter of 1996 related to Closed Book GRC. Excluding revenues associated with COLI and GRC, revenues increased $490, or 16%, in 1997 as compared to 1996. The increase was primarily due to growth in the Annuity division where revenues increased as a result of higher fee income earned on growth in separate account assets due to strong annuity sales and stock market appreciation. Additionally, strong sales and renewals of group insurance premiums within the Employee Benefits division contributed to the revenue growth.
Core earnings increased $106, or 53%, to $306 in 1997 from $200 in 1996, primarily as a result of (i) an increase in earnings in the Annuity division of $57 and in the Individual Life Insurance division of $12, both of which were driven by an increase in total account value due to strong sales and stock market appreciation, (ii) an increase in earnings of $6 in the Employee Benefits division principally due to an improvement in group insurance premiums and favorable mortality and morbidity experience and (iii) a reduction in losses of $50 in the GIC division as a result of actions taken in the third quarter of 1996 related to Closed Book GRC (discussed below), partially offset by a decrease in core earnings of $19 in the Corporate Operation due primarily to an increase in capital allocated to the divisions, as well as higher interest expense as a result of increased indebtedness in conjunction with the Offering. (For additional information, see Capital Resources and Liquidity section under "The Offering" and "Debt".)
Other items primarily consist of a $169 third quarter 1996 loss in Closed Book GRC (discussed below).
Revenues increased $297, or 30%, to $1.3 billion in 1997 from $974 in 1996. This increase was principally the result of a $229 increase in premiums and other considerations, reflecting a substantial increase in aggregate fees earned due to the division's growing block of separate account assets. The average separate account assets of this division increased to $50.7 billion in 1997 from $37.2 billion in 1996, primarily due to annual sales of individual variable annuities of approximately $9.7 billion in 1997, as well as significant stock market appreciation. In addition, the average general account assets of this division increased to $8.1 billion in 1997 from $7.2 billion in 1996 largely as a result of growth in the general account portion of the individual variable annuity products. The growth in this division in 1997 also resulted in an increase in total benefits, claims and expenses of $207, or 28%, to $957 in 1997 from $750 in 1996. A 33% growth in average account value in 1997, coupled with an overall reduction in individual annuity expenses as a percentage of total individual annuity account value to 25 basis points in 1997 from 28 basis points in 1996, contributed to the growth in core earnings of $57, or 39%, to $202 in 1997 from $145 in 1996.
Similar factors generated an increase in 1996, as compared with 1995, in revenues of $253, or 35%, average general account assets of $1.0 billion, or 16%, average separate account assets of $11.1 billion, or 42%, total benefits, claims and expenses of $196, or 35%, core earnings of $32, or 28%, and a reduction in individual annuity expenses as a percentage of total individual annuity account value to 28 basis points in 1996 from 31 basis points in 1995.
Revenues in 1997 increased $38, or 8%, to $510 from $472 in 1996. In the first quarter of 1996, a block of business was assumed from Investors Equity Life Insurance Company which increased 1996 revenues by $9. Excluding this transaction, 1997 revenues increased $47, or 10%, as compared to 1996, reflecting the impact of applying cost of insurance charges and variable life fees to a larger block of business. Account values increased $555, or 17%, to $3.8 billion in 1997 from $3.2 billion in 1996. Total benefits, claims and expenses increased $19, or 5%, to $423 in 1997 from $404 in 1996. The growth in the Individual Life Insurance division's account values, particularly variable life, along with favorable mortality experience contributed to an increase in core earnings of $12 in 1997.
Revenues in 1996 increased $64, or 16%, to $472 from $408 in 1995. This increase was primarily due to a $47 increase in premiums and other considerations, reflecting an increase in cost of insurance charges and variable life fees applied to a larger block of business as account values increased $678 to $3.2 billion in 1996 from $2.6 billion in 1995. Total benefits, claims and expenses increased $54, or 15%, to $404 in 1996
from $350 in 1995. This increase reflects the growth in the block of individual life insurance business and is partially offset by favorable mortality results and the full year impact of expense leverage due to the consolidation of the division's two individual life operations in 1995. The combination of account value growth, operational efficiencies, and favorable mortality experience resulted in an increase in core earnings of $7, or 19%, to $44 in 1996 from $37 in 1995.
Revenues increased $311, or 12%, to $2.8 billion in 1996 from $2.5 billion in 1995. This increase was largely the result of (i) a $162 increase in premiums and other considerations, reflecting a $221 increase in group insurance premiums from strong group disability sales and renewals, partially offset by a decline in leveraged COLI premiums as a result of the HIPA Act of 1996 and (ii) a $149 increase in net investment income, primarily due to an increase in COLI account value as a result of strong sales in 1995. Total benefits, claims and expenses increased $295, or 12%, to $2.7 billion in 1996 from $2.4 billion in 1995. This increase generally reflected an increased block of group disability business and an increase in COLI account value, partially offset by a $41 decrease in dividends to policyholders primarily due to the elimination of sales of leveraged COLI as a result of the enactment of the HIPA Act of 1996. This premium growth in group insurance, along with favorable mortality and morbidity experience, resulted in an increase in core earnings in this division of $13, or 20%, to $79 in 1996 from $66 in 1995.
Closed Book GRC results in 1996 and 1995 were negatively affected by lower investment rates and earnings in the related investment portfolio (primarily consisting of collateralized mortgage obligations and mortgage backed securities) due to prepayments experienced in excess of assumed and historical levels in years prior to 1995. Closed Book GRC was also negatively affected by the interest rate rise in 1994 when the duration of its assets lengthened relative to that of the liabilities. Although the Closed Book GRC asset portfolio as a whole is duration matched with its liabilities, certain investments continue to have a longer maturity than their corresponding liabilities and will need to be liquidated prior to maturity in order to meet the specific liability commitments. To protect the existing value of these investments, the Company entered into various hedge transactions in late September 1996 which substantially eliminated further fluctuation in fair value of the investments due to interest rate changes. As of December 31, 1997, Closed Book GRC had general account assets and liabilities of $2.2 billion. The scheduled maturities are $1.0 billion, or 45%, in 1998, $0.7 billion, or 32%, in 1999 and $0.5 billion, or 23%, thereafter.
During 1996, Closed Book GRC incurred a $51, after-tax, loss from operations as a result of negative interest spread, as compared with an after-tax loss from operations of $68 in 1995. With the initiation of the hedge transactions discussed above, which eliminated the possibility that the fair value of Closed Book GRC investments would recover to their current amortized cost prior to sale, an other than temporary impairment
Management expects that the net income (loss) from Closed Book GRC in the years subsequent to 1997 will be immaterial based on the actual results from 1997, current projections for the performance of the assets and liabilities associated with Closed Book GRC, and the stabilizing effect of the hedge transactions implemented in 1996. However, no assurance can be given that, under certain unanticipated economic circumstances, further losses in respect of Closed Book GRC will not occur in the future.
The HIPA Act of 1996 phases out the deductibility of interest on policy loans under COLI by the end of 1998, thus eliminating all future sales of leveraged COLI. The leveraged COLI product has been an important contributor to the Life segment's profitability in recent years and will continue to contribute to the profitability of the Life segment in the future, although the level of profit is declining. However, the Employee Benefits division has other growth opportunities particularly through its group insurance products.
In 1997, revenues of $1.7 billion were $138, or 9%, higher than 1996, primarily due to new business attributable to an agreement entered into at the end of 1996 with Nationwide Building Society ("Nationwide") at ITT London & Edinburgh to exclusively underwrite the homeowners business of Nationwide's customers. Growth over 1996, excluding Nationwide, was dampened by soft market conditions in the United Kingdom. In addition, the U.S. dollar strengthened against the guilder and peseta during 1997 compared to 1996, while weakening against sterling which overall had a negative foreign exchange impact on revenues of $17.
In 1996, revenues of $1.6 billion were $86, or 6%, higher than 1995, primarily due to growth at Zwolsche Algemeene and 1995 results at ITT Ercos only reflecting eight months of activity due to its acquisition by the Company in May 1995. Growth over 1995 was dampened by soft market conditions in the United Kingdom. Additionally, the U.S. dollar strengthened during 1996 compared to 1995, resulting in unfavorable foreign exchange translation movements during 1996 resulting in a negative foreign exchange impact on revenues of $37.
Core earnings of $79 in 1996 decreased $15, or 16%, from 1995. The decrease in earnings from 1995 was primarily the result of decreased underwriting results due to heightened competition in the United Kingdom and unfavorable foreign exchange impacts, partially offset by growth in net investment income.
Zwolsche Algemeene's 1996 revenues of $459 and core earnings of $32 improved $43, or 10%, and $7, or 28%, respectively, compared with 1995. These increases were due to improved premium growth and stronger underwriting results. Property and casualty growth in 1996 was relatively strong in the automobile line as market pricing improved. In 1996, performance was also strong in life savings and mortgage products business. Due to the strengthening U.S. dollar, foreign exchange had an adverse effect of $20 on revenues and a negligible impact on core earnings.
The outlook at Zwolsche Algemeene for 1998 is for moderate written premium growth in property and casualty due to an increase in competition. Continued strong growth is expected for life operations. Growth expectations for life savings and pension products in the Netherlands continue to be strong due to their associated tax advantages and expected continued low interest rate environment. The Company will continue to explore the viability of opportunities in both life and property and casualty business in the Netherlands during 1998 as the government continues to review moving certain social security programs into the private sector. In February 1998, the Company obtained a bank license to support growth of the asset management business.
The International segment continues to explore acquisition opportunities in Western Europe, Latin America and Asia. In January 1998, the Company acquired a 49% interest in The People's Insurance Company Limited ("PIC"), a Singapore company. This is intended to provide a base of operations for further Asian development. The recent Asian economic crisis has had little impact on the underlying value of the investment in PIC.
London & Edinburgh in the International segment for all periods presented. The primary focus of these operations is the proper disposition of claims, resolving disputes and collecting reinsurance proceeds related largely to business underwritten and reinsured prior to 1985.
Other items for 1997 consisted of a $368 non-taxable equity gain following the sale of 18.6% of The Hartford's principal Life subsidiary, HLI. (For additional information, see Note 3 of Notes to Consolidated Financial Statements and Capital Resources and Liquidity section under "The Offering".) Other items in 1996 primarily consisted of an increase in environmental and asbestos reserves at First State Insurance Company of $81 as discussed in the Environmental and Asbestos Claims section.
Revenues were essentially flat in 1997 compared to 1996 and decreased $49, or 23%, in 1996 as a result of a decline in net investment income. In 1997, core earnings included a decrease of $37 which represented an 18.6% minority interest in HLI's operating results. (For additional information regarding HLI's results, see the Life section.) Excluding minority interest, core earnings increased $13 in 1997 over 1996 and $8 in 1996 from the prior year.
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, U.S. exposures of The Hartford's International segment and exposures of the Other Operations segment, and covered the Company's Commercial, Personal, and Reinsurance operations. 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.
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.
Reserve activity for both reported and unreported environmental and asbestos claims, including reserves for legal defense costs, for the years ended December 31, 1997, 1996 and 1995, was as follows (net of reinsurance):
An important element of the financial results of The Hartford is return on invested assets. The Hartford's investment activities are divided between the reportable segments of North American Property & Casualty, Life, International, and Other Operations. The investment portfolios for these segments are managed based on the underlying characteristics and nature of their respective liabilities. For a further discussion on The Hartford's approach to managing risks, see the Capital Markets Risk Management section.
The investment portfolios of the individual segments are managed by distinct investment strategy groups which are accountable to the senior management of the segments. They are responsible for monitoring and managing the segment's 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, executes the investment plan of the strategy groups including the identification and purchase of securities that fulfill the objectives of the strategy groups. International subsidiaries maintain individual investment units with comparable responsibilities.
The investment objective of the North American Property & Casualty segment is to maximize economic value while generating after-tax income and sufficient liquidity to meet corporate and policyholder obligations. Investment strategies are developed based on a variety of factors, including business needs, regulatory requirements and tax considerations.
For the year ended December 31, 1997, before-tax net investment income was $777 compared to $661 in 1996, an increase of 18%, while after-tax net investment income increased 17%. The increase in both before- and after-tax net investment income was 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 and 1997 repayment of allocated advances by HLI, partially offset by the 1997 North American Property & Casualty segment's share of repayment of short-term debt. The increase in both before- and after-tax yield was primarily due to increased allocations to higher yielding ABS and commercial MBS along with an increase in below investment grade securities.
For the year ended December 31, 1996, before-tax net investment income was $661 compared to $646 in 1995, an increase of 2%, while after-tax net investment income increased 11%. The increase in before-tax net investment income was primarily due to increased ownership of high yield securities, duration extension of 0.6 years and an increase in invested assets. While before-tax yield decreased due to an increased allocation to common stocks and municipal bonds and the sale of taxable bonds, increases in after-tax yield and income were primarily due to the strategic decision to increase investment in municipal tax-exempt bonds.
Net realized capital gains declined to $15 in 1996 from $29 in 1995. Included in 1996 activity was the generation of $77 of net realized capital gains in the common stock portfolios which
were offset by real estate writedowns of $27 and losses incurred in the sale of lower yielding taxable bonds.
The primary investment objective of the Life segment's general account and 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 - Life Operations - Interest Rate Risk").
Corporate $ 7,970 47.3% $ 7,587 48.3% ABS 3,199 19.0% 2,693 17.1% Commercial MBS 1,606 9.5% 1,098 7.0% CMO 978 5.8% 2,150 13.7% MBS - agency 514 3.1% 402 2.6% Gov't/Gov't agencies - For. 502 3.0% 395 2.5% Municipal - taxable 267 1.6% 266 1.7% Gov't/Gov't agencies - U.S. 241 1.4% 355 2.2% Municipal - tax-exempt 171 1.0% -- -- Short-term 1,395 8.3% 765 4.9% Redeemable preferred stock 5 -- -- -- - ---------------------------------------------------------------- TOTAL FIXED MATURITIES $ 16,848 100.0% $ 15,711 100.0% - ----------------------------------------------------------------
As of December 31, 1997 and 1996, approximately 22.6% and 10.3%, respectively, of the segment's fixed maturity portfolio was invested in private placement securities (including Rule 144A offerings). Private placement securities are generally less liquid than public securities. However, covenants for private placements are designed to mitigate the impact of such increased liquidity risk. Most of the private placement securities in the segment's portfolio are rated by rating agencies.
Net investment income $ 1,536 $ 1,530 $ 1,451 Yield on average invested assets[1] 7.6% 7.7% 7.4% Net realized capital losses $ -- $ (219) $ (4) - ---------------------------------------------------------------- [1] Represents net investment income (excluding net realized capital losses) divided by average invested assets at cost (fixed maturities at amortized cost).
For the year ended December 31, 1996, before-tax net investment income increased by 5% from 1995. Yields on average invested assets increased to 7.7% in 1996 from 7.4% in 1995. The increase in net investment income was primarily due to an increase in policy loans, new business cash flow invested in fixed maturities and asset mix changes offset by asset sales and maturities in Closed Book GRC. (For additional information regarding Closed Book GRC, see the Life section.) The increase in before-tax yield was primarily due to the increase in policy loan yields, offset by a reduction in yield on fixed maturities as a result of sales and maturities of higher yielding assets reinvested at lower average yields.
The investment objectives of the International segment are to generate appropriate after-tax income and sufficient liquidity to meet corporate and policyholder obligations. The International segment primarily comprises the investment activities of ITT London & Edinburgh, Zwolsche Algemeene and ITT Ercos, which are engaged in property and casualty and life insurance. Investments are made in maturities and currencies which reflect the nature of the liabilities.
FIXED MATURITIES BY TYPE - ----------------------------------------------------------------- 1997 1996 - ---------------------------------------------------------------- TYPE FAIR PERCENT FAIR PERCENT VALUE VALUE - ----------------------------------------------------------------
Net investment income $ 185 $ 183 $ 158 Yield on average invested assets [1] 7.2% 7.4% 7.3% Net realized capital gains $ 95 $ 73 $ 47 - ---------------------------------------------------------------- [1] Represents net investment income (excluding net realized capital gains) divided by average invested assets at cost (fixed maturities at amortized cost).
Net realized capital gains increased to $95 in 1997 compared to $73 in 1996, primarily the result of opportunities in a favorable equity market. Net realized capital gains increased to $73 in 1996 from $47 in 1995 due to increased sales in 1996 of both fixed maturities and equity securities.
The investment objective of the Other Operations segment is to ensure the full and timely payment of all liabilities. The ongoing strategy is to match asset and liability cash flow in the early years and to minimize the difference between asset and liability durations.
Invested assets were $2.5 billion at December 31, 1997 and were mostly comprised of fixed maturities.
Net investment income $ 157 $ 149 $ 165 Yield on average invested assets [1] 6.7% 6.5% 7.2% Net realized capital gains $ 1 $ 5 $ 30 - ---------------------------------------------------------------- [1] 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-tax net investment income totaled $157 compared to $149 in 1996, an increase of 5%, while before-tax yields increased to 6.7% from 6.5%. 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.
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 $59.4 billion as of December 31, 1997, wherein the policyholder assumes substantially all the risk and reward, and guaranteed separate accounts totaling $10.7 billion as of December 31, 1997 wherein The Hartford contractually guarantees either a minimum return or account value to the policyholder. Investment strategy varies by fund choice, 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 COLI. Guaranteed separate account products primarily consist of modified guaranteed individual annuity and modified guaranteed life insurance, and generally include market value adjustment features to mitigate the disintermediation risk in the event of surrenders.
The Hartford has a disciplined approach to managing risks associated with its capital markets and asset/liability management activities. Investment portfolio management is organized to focus investment management expertise on specific classes of investments while asset/liability management is the responsibility of separate and distinct risk management units supporting the property and casualty and life operations. Derivative instruments are utilized in accordance with established Company policy and are monitored internally and reviewed by senior management.
FIXED MATURITIES BY CREDIT QUALITY - ---------------------------------------------------------------- 1997 1996 - ---------------------------------------------------------------- CREDIT QUALITY FAIR PERCENT FAIR PERCENT VALUE VALUE - ---------------------------------------------------------------- U.S. Gov't/Gov't agencies $ 1,083 6.1% $ 1,058 6.9% AAA 6,337 35.4% 5,739 37.3% AA 3,426 19.1% 3,095 20.1% A 3,096 17.3% 2,779 18.0% BBB 1,352 7.6% 877 5.7% BB & below 767 4.3% 581 3.8% Not Rated -- -- 256 1.7% Short-term 1,832 10.2% 998 6.5% - ---------------------------------------------------------------- TOTAL FIXED MATURITIES $ 17,893 100.0% $ 15,383 100.0% - ----------------------------------------------------------------
As of December 31, 1997, over 99% of the fixed maturity portfolio was invested in investment-grade securities.
FIXED MATURITIES BY CREDIT QUALITY - --------------------------------------------------------------- 1997 1996 - ---------------------------------------------------------------- CREDIT QUALITY FAIR PERCENT FAIR PERCENT VALUE VALUE - ----------------------------------------------------------------
The Hartford utilizes a variety of derivative instruments, including swaps, caps, floors, forwards and exchange traded futures and options, in accordance with Company policy and 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.
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 totaled $11.1 billion at December 31, 1997.
The primary exposure to interest rate risk in the property and casualty operations relates to its fixed maturity investments. Changes in market interest rates directly impact the market value of the fixed maturity securities. In addition, but to a lesser extent, interest rate risk exists on debt issued. Derivative instruments are used periodically to manage interest rate risk and as a result, their value will change as market rates change, usually in the opposite direction of the item being hedged. The total notional amount of derivatives used for hedging interest rate risk was $125 as of December 31, 1997.
The following table provides information as of December 31, 1997 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. The weighted average pay rate is based upon spot rates as of December 31, 1997.
The operations may occasionally use equity futures to hedge against a change in value on the anticipated purchase or sale of equity securities. As of December 31, 1997, there were no outstanding derivative instruments hedging equity price risk.
Currency exchange risk within the property and casualty operations relates primarily to translating both profits and net equity investment in its international subsidiaries from
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, 1997.
Currency exchange risk also exists with respect to investments in foreign equity securities. Forward foreign contracts with a notional amount of $51 are used to hedge this risk.
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 $10.9 billion at December 31, 1997 ($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.
Liability Hedging -- Several products obligate the life operations to credit a return to the contractholder which is indexed to a market rate. To hedge risks associated with these products, the life operation typically enters into interest rate swaps to convert the contract rate into a rate that trades in a more liquid and efficient market. This hedging strategy enables the life operations to customize contract terms and conditions to customer objectives and satisfies the operation's asset/liability matching policy. Additionally, interest rate swaps are used to convert certain fixed contract rates into floating rates, thereby allowing them to be appropriately matched against floating rate assets. The notional amount of derivatives used for liability hedging as of December 31, 1997 was $4.3 billion.
Life operations' insurance liabilities, other than non-guaranteed separate accounts, are primarily related to accumulation vehicles such as fixed or variable annuities and investment contracts and other insurance products such as long-term disability and term life insurance.
Interest Credited -- Products in this category credit interest to policyholders, subject to market conditions and minimum guarantees. Policyholders may surrender at book value but are subject to surrender charges for an initial period. Product examples include universal life contracts and the general account portion of the life operations' variable annuity products. Liability duration is short to intermediate-term.
Long-term Pay Out Liabilities -- Products in this category are long-term in nature and may contain significant actuarial (including mortality and morbidity) pricing and cash flow risks. The cash flows associated with these policy liabilities are not interest rate sensitive but do vary based on the timing and amount of benefit payments. The primary risks associated with these products are that the benefits will exceed expected actuarial pricing and/or that the actual timing of the cash flows differ from those anticipated resulting in an investment return lower than that assumed in pricing. Product examples include structured settlement contracts, on-benefit annuities (i.e., the annuitant is currently receiving benefits thereon) and long-term disability contracts. Contract duration is generally 6 to 10 years but, at times, exceeds 30 years.
The Hartford's total capitalization excluding unrealized gain on securities, net of tax, increased by $1.7 billion in 1997. This change primarily was the result of earnings and the effects of the Offering (see below) and additional net borrowings, partially offset by dividends declared on The Hartford's common stock. The Company's debt to equity and debt to capitalization ratios (both excluding unrealized gain on securities, net of tax) improved in 1997 as compared to 1996, primarily as a result of earnings and the impact of the Offering, partially offset by increased debt.
The 26 million shares sold in the Offering represented approximately 18.6% of the equity ownership in HLI and approximately 4.4% of the combined voting power of HLI's Class A and Class B common stock. The Hartford owns all of the 114 million outstanding shares of Class B common stock of HLI, representing approximately 81.4% of the equity ownership in HLI and approximately 95.6% of the combined voting power of HLI's Class A and Class B common stock. Holders of Class A common stock generally have identical rights to the holders of Class B common stock except that the holders of Class A common stock are entitled to one vote per share while holders of Class B common stock are entitled to five votes per share on all matters submitted to a vote of HLI's stockholders. Also, each share of Class B common stock is convertible into one share of Class A common stock (a) upon the transfer of such share of Class B common stock by the holder thereof to a non-affiliate (except where the shares of Class B common stock so transferred represent 50% or more of all the outstanding shares of common stock, calculated without regard to the difference in voting rights between the classes of common stock) or (b) in the event that the number of shares of outstanding Class B common stock is less than the 50% of all the common stock then outstanding. As of December 31, 1997, The Hartford continued to maintain an 81.4% equity ownership in HLI.
Total debt in 1997 increased $241 compared to a $624 increase in the prior year. The Hartford used the proceeds of these additional borrowings to fund the insurance operations of its
As of December 31, 1997, The Hartford had an unsecured aggregate $2.0 billion credit facility with twenty-seven participating banks which is comprised of a $1.5 billion five year revolving credit facility with four years remaining and a $500 short-term credit facility. This facility is available for general corporate purposes and to provide additional support to the Company's existing commercial paper program. At December 31, 1997, there were no outstanding borrowings under the facility.
In the first quarter of 1997, HLI borrowed $1.1 billion against a $1.3 billion unsecured short-term credit facility with four banks. During the second quarter of 1997, HLI retired the borrowing with proceeds from the Offering and the new debt issuances (discussed above), and subsequently reduced the capacity of its unsecured short-term credit facility from $1.3 billion to $250.
In connection with a shelf registration statement filed with and declared effective by the Securities and Exchange Commission ("SEC") in 1995, The Hartford registered for sale up to an aggregate $1.0 billion of debt securities and preferred stock. In 1995, the Company issued and sold $500 in senior debt securities. The intended use of the proceeds from the sale of such securities has been and will continue to be primarily for the repayment and/or replacement of outstanding commercial paper and other short-term debt. This reflects The Hartford's strategy of managing its capital within acceptable ranges of volatility and financial ratings while achieving the lowest long-term cost of capital that is reasonably possible. On October 2, 1996, this shelf registration statement was amended for an additional $1.25 billion of securities, making an aggregate of $1.75 billion available for sale. The amended registration statement also expanded the type of securities which could be offered under this shelf registration statement by including provisions for the offering of common stock, depositary shares, warrants, stock purchase contracts, stock purchase units and junior subordinated deferrable interest debentures of the Company, preferred securities of any of the Hartford Trusts (referred to below) and guarantees by the Company with respect to the preferred securities of any of the Hartford Trusts. After the issuance of QUIPS on October 30, 1996 discussed below, The Hartford had $1.25 billion remaining on this shelf registration at December 31, 1997.
On February 28, 1996, Hartford Capital I, a subsidiary trust, issued 20,000,000 Series A, 7.7% Cumulative Quarterly Income Preferred Securities. The proceeds from the sale of these securities were used to acquire $500 of Junior Subordinated Deferrable Interest Debentures from The Hartford. The Hartford used the proceeds from the sale of such debentures for the partial repayment of outstanding commercial paper and short-term bank indebtedness. (For additional information, see Note 8 of Notes to Consolidated Financial Statements.)
On October 30, 1996, Hartford Capital II, a subsidiary trust, issued 20,000,000, Series B, 8.35% Cumulative Quarterly Income Preferred Securities. The proceeds from the sale of these securities were used to acquire $500 of Junior Subordinated Deferrable Interest Debentures from The Hartford. The Hartford used the proceeds from the sale of such debentures for general corporate purposes. (For additional information, see Note 8 of Notes to Consolidated Financial Statements.)
In 1997, The Hartford declared $189 and paid $190 in dividends to shareholders. In 1996, The Hartford declared $188 and paid $140 in dividends to shareholders.
The following table summarizes The Hartford's significant U.S. member companies' current financial ratings from the major independent rating organizations.
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. Hartford Fire adheres to these laws which require notice to and approval by the state insurance commissioner for the declaration or payment of any dividend, which together with other dividends or distributions made within the preceding twelve months, exceeds the greater of (i) 10% of the insurer's policyholder surplus as of December 31 of the preceding year or (ii) net income (or net gain from operations, if such company is a life insurance company) for the twelve-month period ending on the thirty-first day of December last preceding, in each case determined under statutory insurance accounting policies. In addition, if any dividend of a Connecticut-domiciled insurer exceeds the insurer's earned surplus, it requires the prior approval of the Connecticut Insurance Commissioner. The total amount of statutory dividends which may be paid by the insurance subsidiaries of The Hartford Financial Services Group, Inc. in 1998, without prior approval, is $810.
The primary uses of funds are to pay claims, policy benefits, operating expenses and commissions, and to purchase new investments. In addition, The Hartford carries 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 (effective December 31, 1994) and life companies (effective December 31, 1993). The requirements consist of formulas which identify companies that are undercapitalized and require specific regulatory actions. RBC is calculated for property and casualty companies after adjusting capital for certain underwriting, asset, credit and off-balance sheet risks. The RBC formula for life companies establishes capital requirements relating to insurance, business, asset and interest rate risks. As of December 31, 1997, each of The Hartford's insurance subsidiaries within the North American Property & Casualty and Life segments had more than sufficient capital to meet the NAIC's RBC requirements.
1997 1996 1995 - ---------------------------------------------------------------- Net cash provided by operating activities $ 2,045 $ 994 $ 1,094 Net cash used for investing activities $ (2,247) $ (1,035) $ (1,597) Net cash provided by financing activities $ 239 $ 59 $ 533 Cash - end of year $ 140 $ 112 $ 95 - ----------------------------------------------------------------
During 1996, cash provided by operating activities decreased from the prior year due primarily to increased policy acquisition costs related to strong growth in the Life segment. The changes in cash provided by both investing and financing activities between 1996 and 1995 was primarily due to declines in investment-type contracts written in the Life segment coupled with increases in investment-type contract maturities.
On February 12, 1998, The Hartford completed the purchase of all outstanding shares of Omni Insurance Group, Inc. ("Omni"), a holding company of two non-standard auto insurance subsidiaries licensed in 25 states and the District of Columbia. The Hartford paid cash of $31.75 per share, plus transaction costs, for a total of $189. The acquisition will be reported as a purchase transaction and accordingly, the results of Omni's operations will be 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 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. President Clinton's 1998 Federal Budget Proposal currently contains certain recommendations for modifying tax rules related to the treatment of variable annuities and COLI by contractholders, which if enacted as described, could have a material adverse impact on the Company's sales of these products. It is too early to determine whether these tax proposals will ultimately be enacted by Congress and the potential impact, if any, to the Company's financial condition or results of operations. Measures which may significantly impact the property and casualty industry include possible modifications to the Superfund program, the tax laws governing property and casualty insurance companies, Federal catastrophe fund legislation and tort reform proposals.
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, all 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 $19 in 1997, $14 in 1996 and $15 in 1995.
As an insurance and financial services company, The Hartford has thousands of individual and business customers that have insurance policies, annuities, mutual funds and other financial products of The Hartford. Nearly all of these policies and products contain date sensitive data, such as policy expiration dates, birth dates, premium payment dates, and the like. In addition, The Hartford has business relationships with numerous third parties that affect virtually all aspects of The Hartford's business, including, without limitation, suppliers, computer hardware and software vendors, insurance agents and brokers, securities broker-dealers and other distributors of financial products.
In addition, as part of its Year 2000 program, The Hartford is identifying third parties with which it has significant business relations in order to attempt to assess the potential impact on The Hartford of their Year 2000 issues and remediation plans. The Hartford currently anticipates that it will substantially complete this evaluation by the end of 1998, and will conduct systems testing with certain third parties through 1999. The Hartford does not have control over these third parties and, as a result, The Hartford cannot currently determine to what extent future operating results may be adversely affected by the failure of these third parties to successfully address their Year 2000 issues. However, The Hartford expects to develop plans to attempt to minimize identified third party exposures.