(4) 1996 includes a $169 third quarter charge related to Closed Book GRC (see the discussions related to Closed Book GRC in the "Guaranteed Investment Contracts" discussion within the MD&A).
(6) Dividends per common share represent amounts paid subsequent to the Company's IPO. In the third and fourth quarters of 1997, Hartford Life declared and paid a dividend of $0.09 per share of common stock totaling $25. In 1998, Hartford Life expects to continue paying quarterly dividends on its common stock of $0.09 per share. The table does not include dividends paid to the parent in periods prior to the IPO. For further explanation see the "Dividends" discussion within the Capital Resources and Liquidity section of the MD&A.
Hartford Life is a leading insurance and financial services company that provides pre-retirement savings, estate planning and employee benefit products. The Company offers variable and fixed annuities, retirement plan services, mutual funds, and life and disability insurance on both a group and an individual basis.
Revenues increased $315, or 7%, to $4.7 billion in 1997 from $4.4 billion in 1996. Revenues were impacted by the Health Insurance Portability and Accountability Act of 1996 ("HIPA Act of 1996"), which phases out the deductibilty of interest expense on policy loans by the end of 1998, virtually eliminating all new sales of leveraged corporate owned life insurance ("COLI"), and by the Guaranteed Investment Contracts segment ("GIC"), which had a loss of $225 in 1996, primarily related to a closed block of guaranteed rate contract business ("Closed Book GRC"). Excluding COLI and GIC, revenues increased $490, or 16%, to $3.5 billion in 1997 as compared to $3.0 billion 1996. This growth was driven by premiums and other considerations related to the Annuity segment and the Group Insurance operation of the Employee Benefits segment. Annuity premiums and other considerations increased $230 in 1997, primarily resulting from increased variable annuity fee income, which grew $198, or 54%, in 1997 as compared to 1996. Average variable annuity account value increased $13.1 billion, or 49%, to $39.7 billion in 1997. This solid growth in average account value was due to strong variable annuity sales of $9.7 billion and significant stock market appreciation. Premium revenue related to the Group Insurance operation of the Employee Benefits segment increased $209, or 16%, in 1997 due to strong sales of $480, a 17% increase over 1996, and good persistency. Revenues increased $294, or 7%, to $4.4 billion in 1996 from $4.1 billion on 1995. Excluding COLI and GIC, revenues increased $549, or 22%, to $3.0 billion in 1996 as compared to $2.4 billion 1995. This increase was driven by increases in premiums and other considerations, which included an increase in fees from the Annuity segment of $216, as the separate account assets grew due to sales growth and market appreciation, as well as increased premiums and other considerations of $226 from the Group Insurance operation due to strong sales and renewals.
Total benefits, claims and expenses decreased $134 in 1997 as compared to 1996. Excluding COLI and GIC for the reasons described above, total benefits, claims and expenses increased $391, or 15%, to $3.0 billion in 1997 as compared to $2.6 billion in 1996. Benefits, claims and claim adjustment expenses related to the Group Insurance operation increased $161, or 14%, reflecting the growth in that operation's group life and group disability business. Amortization of deferred policy acquisition costs ("DPAC") increased $105 in 1997 primarily due to the Annuity segment, which increased $76, or 44%, as a result of strong sales in both 1997 and 1996. Also, other business expenses increased $157 in 1997 as compared to 1996. Total benefits, claims and expenses increased $489 in 1996 as compared to 1995. Excluding COLI and GIC, total benefits, claims and expenses increased $508, or 24%, to $2.6 billion in 1996 as compared to $2.1 billion in 1995. This increase was related to increased benefits, claims and claim adjustment expenses of approximately $205, $99, and $49 related to the Group Insurance operation, the Annuity segment and the Individual Life Insurance segment, respectively, as these blocks of business all experienced strong growth. Also, increased prior year sales and total account value in the Annuity segment caused an increase in amortization of DPAC of $57 in 1996 as compared to 1995.
The Annuity segment focuses on the savings and retirement needs of the growing number of individuals who are preparing for retirement or have already retired. This segment consists of two areas of operation: Individual Annuity and Group Annuity. The variety of products sold within this segment reflects the diverse nature of the market. These products include, in the Individual Annuity operation, individual variable annuities, fixed market value adjusted ("MVA") annuities, and mutual funds; and in the Group Annuity operation, deferred compensation and retirement plan services for municipal governments and corporations, structured settlement contracts and other special purpose annuity contracts, and investment management contracts. The Company was rated the number one writer of variable annuities for 1997 with an 11% market share according to the Variable Annuity Research and Data Service, and sold approximately $869 of mutual funds in its first full year offering the product, resulting in total mutual fund assets of $972 at December 31, 1997.
The growth in this segment in 1997 also resulted in an increase in total benefits, claims and expenses of $208, or 28%, to $957 in 1997 from $749 in 1996. Benefits, claims and claim adjustment expenses grew $29, or 7%, in 1997 primarily related to increased interest credited on Group Annuity general account liabilities. Amortization of DPAC related to the Individual Annuity operation grew $82, or 52%, in 1997 as prior and current year sales remained strong. Also, other business expenses increased $103, in 1997, as a result of the growth in this segment.
Management believes it has developed and implemented strategies to maintain and enhance its position as a market leader in the financial services industry as individuals increasingly save and plan for retirement.
The Individual Life Insurance segment, which focuses on the high end estate and business planning markets, sells a variety of life insurance products, including variable life, universal life, interest-sensitive whole life, and term life insurance policies. The Company is among the top five writers of individual life insurance based on average face value per policy. In addition, the Company is among the top five writers of individual variable life for the nine months ended September 30, 1997, based on the Tillinghast Value Variable Life Survey.
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 ("IEL") 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. Sales were $140 in 1997, an increase of 8% over 1996. Variable life product sales constituted 70%, or $98, of total 1997 sales and grew $23, or 31%, over 1996 levels.
The growth in this segment's account values, particularly variable life, along with favorable mortality experience, contributed to an increase in net income of $12, or 27%, 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 net income of $7, or 19%, to $44 in 1996 from $37 in 1995.
Benefits, claims and expenses decreased $212 to $2.5 billion in 1997, which generally reflected a decrease in dividends to policyholders of $394, or 62%, primarily due to the elimination of sales of leveraged COLI as discussed above. Benefits, claims and expenses, excluding COLI, increased $172, or 12%, to $1.6 billion, in 1997 from $1.4 billion in 1996. The increase in benefits, claims, and claim adjustment expenses is directly related to an increase in benefits of $161, or 14%, due to growth in the Company's group life and group disability business.
Revenues increased $318, or 13%, to $2.8 billion in 1996 from $2.5 billion in 1995. This increase was largely the result of (i) a $167 increase in premiums and other considerations, reflecting a $226 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 $151 increase in net investment income, primarily due to an increase in COLI account value related to strong sales in 1995. Total benefits, claims and expenses increased $304, or 13%, 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 the Company's 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
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 loss of $82, after-tax, was determined to have occurred and was recorded in September 1996. An additional other than temporary impairment loss of $6, after-tax, occurred in the fourth quarter of 1996 bringing the total 1996 impairment to $88. Also, during the third quarter of 1996, Closed Book GRC had asset sales resulting in proceeds of approximately $500 and a realized loss of $55, after-tax. The asset sales were undertaken as a result of liquidity needs and favorable market conditions for certain securities. Other charges of $32, after-tax, were also incurred in the third quarter of 1996.
The Company's investments are managed by its investment strategy group which consists of a risk management unit and a portfolio management unit and reports directly to senior management of the Company. The risk management unit is responsible for monitoring and managing the Company's asset/liability profile and establishing investment objectives and guidelines. The portfolio management unit is responsible for determining, within specified risk tolerances and investment guidelines, the general asset allocation, duration, convexity and other characteristics of the Company's general account and guaranteed separate account investment portfolios. The Hartford Investment Management Company, a wholly owned subsidiary of The Hartford, executes the investment plan of the investment strategy group including the identification and purchase of securities that fulfill the objectives of the strategy group.
The Company's separate accounts reflect two categories of risk assumption: non-guaranteed separate accounts totaling $58.7 billion as of December 31, 1997, wherein the policyholder assumes substantially all the investment risk and reward, and guaranteed separate accounts totaling $10.7 billion as of December 31, 1997, wherein Hartford Life contractually guarantees either a minimum return or account value to the policyholder. Non-guaranteed separate account products include variable annuities, variable life and COLI. Guaranteed separate account products primarily consist of fixed MVA individual annuities and modified guaranteed life insurance, and generally include market value adjustment features to mitigate the disintermediation risk in the event of surrenders.
The Company's general account consists of a diversified portfolio of investments. Although all the assets of the general account support all the Company's liabilities, the Company's investment strategy group has developed separate investment portfolios for specific classes of product liabilities within the general account. The strategy group works closely with the business lines to develop specific investment guidelines, including duration targets, asset allocation and convexity constraints, asset/liability mismatch tolerances and return objectives, for each product line in order to achieve each product line's individual risk and return objectives.
Invested assets in the Company's general account totaled $21 billion at December 31, 1997 and were comprised of $16.8 billion of fixed maturities, $3.8 billion of policy loans, and other investments of $363. Policy loans, which had a weighted-average interest rate of 11.2%, as of December 31, 1997, are secured by the cash value of the underlying life insurance policies. These loans do not mature in a conventional sense, but expire in conjunction with the related policy liabilities.
The following table sets forth by type the fixed maturity securities held in the Company's general account as of December 31, 1997 and 1996.
There were no net realized capital gains or losses for the year ended December 31, 1997, as compared to net realized losses of $219 in 1996 and $4 in 1995. The 1996 capital losses were primarily attributable to the writedown and sale of certain securities within Closed Book GRC.
As described below, credit risk and market risk are the primary sources of investment risk to the Company. The following discussion identifies the Company's policies and procedures for managing these risks and monitoring the results of the Company's risk management activities.
The Company invests primarily in investment grade securities and has established exposure limits, diversification standards and review procedures for all credit risks whether borrower, issuer or counterparty. The creditworthiness of specific obligors is determined by an internal credit evaluation supplemented by consideration of external determinants of creditworthiness, typically ratings assigned by nationally recognized ratings agencies. Obligor, geographic, asset sector and industry concentrations are subject to established limits and monitored at regular intervals.
Hartford Life's exposure to market risk relates to the market price and/or cash flow variability associated with changes in market interest rates. The following discussion focuses on the Company's exposure to interest rate risk, asset/liability management strategies utilized to manage this risk, and characteristics of the Company's insurance liabilities and their sensitivity to movements in interest rates.
Changes in interest rates can potentially impact the Company' profitability. Under certain circumstances of interest rate volatility, the Company could be exposed to disintermediation risk and reduction in net interest rate spread or profit margins. For the Company's non-guaranteed separate accounts, exposure is not significant since the policyholder assumes substantially all of the investment risk.
and other general economic conditions. During periods of declining interest rates, paydowns on mortgage backed securities and collateralized mortgage obligations increase as the underlying mortgages are prepaid. In addition, during such periods, the Company generally will not be able to reinvest the proceeds of any such prepayments at comparable yields. Conversely, during periods of rising interest rates, the rate of prepayments generally declines, which also exposes the Company to the possibility of asset/liability cash flow mismatch. For a discussion of the Company's risk management techniques to manage this market risk, see the "Asset/Liability Management Strategies used to Manage Market Risk" section below.
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. The Company uses a variety of derivatives, including swaps, caps, floors, forwards and exchange-traded financial futures and options, in order to hedge exposure primarily to interest rate risk on anticipated investment purchases or existing assets and liabilities. The Company does not make a market or trade derivatives for the express purpose of earning trading profits. The Company's derivative program is monitored by an internal compliance unit and is reviewed by senior management and Hartford Life's Finance Committee. The notional amounts of derivative contracts, which represent the basis upon which pay or receive amounts are calculated and are not reflective of credit risk, totaled $10.9 billion at December 31, 1997 ($6.6 billion related to insurance investments and $4.3 related to life insurance liabilities).
Anticipatory Hedging -- For certain liabilities, the Company commits to the price of the product prior to receipt of the associated premium or deposit. Anticipatory hedges are routinely 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, 1997 was $255.
Liability Hedging -- Several products obligate the Company to credit a return to the contract holder which is indexed to a market rate. To hedge risks associated with these products, the Company 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 Company 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.
Asset Hedging -- To meet the various policyholder obligations and to provide cost effective prudent investment risk diversification, the Company may combine two or more financial instruments to achieve the investment characteristics of a fixed maturity security or that match an associated liability. The use of derivative instruments in this regard effectively transfers unwanted investment risks or attributes to others. The selection of the appropriate derivative instruments depends on the investment risk, the liquidity and efficiency of the market, and the asset and liability characteristics. The notional amount of asset hedges as of December 31, 1997 was $3.2 billion.
Portfolio Hedging -- The Company periodically compares the duration and convexity of its portfolios of assets to their corresponding liabilities and enters into portfolio hedges to reduce any difference to desired levels. Portfolio hedges reduce the mismatch between assets and liabilities and offset the potential impact to cash flows caused by changes in interest rates. The notional amount of portfolio hedges as of December 31, 1997 was $3.1 billion.
The following tables provide information on derivative instruments used in accordance with the aforementioned hedging strategies. For interest rate swaps, caps, floors and options, the tables present notional amounts with weighted average pay and received rates for swaps and weighted average strike rates for caps, floors and options by maturity year. For interest rate futures, the tables present contract amount and weighted average settlement price by expected maturity year.
Fixed Rate Asset Accumulation Vehicles -- Products in this category require the Company to pay a fixed rate for a certain period of time. The cash flows are not interest sensitive because the products are written with a market value adjustment feature and the liabilities have protection against the early withdrawal of funds through surrender charges. Product examples include fixed rate annuities with a market value adjustment and fixed rate guaranteed investment contracts. Contract duration is dependent on the policyholder's choice of guarantee period.
Interest Credited Asset Accumulation Vehicles -- Products in this category credit interest to policyholders, subject to market conditions and minimum guarantees. Policyholders may surrender at book value but are subject to surrender charges for an initial period. Product examples include universal life contracts and the general account portion of the Company's variable annuity products. Liability duration is short to intermediate term.
Capital resources and liquidity represent the overall financial strength of Hartford Life and its ability to generate strong cash flows from each of the business segments and borrow funds at competitive rates to meet operating and growth needs. The Company maintained cash and short-term investments totaling $1.5 billion, $837 and $1.2 billion as of December 31, 1997, 1996 and 1995, respectively. The capital structure of Hartford Life consists of debt and equity, and is summarized as follows:
During 1997, to make shares available to employees pursuant to stock-based benefit plans, the Company repurchased 100,000 shares of its common stock in the open market at a total cost of $4. Shares repurchased in the open market are carried at cost and reflected as a reduction to stockholders' equity. Treasury shares subsequently reissued are reduced from treasury stock on a weighted average cost basis. The Company currently intends to purchase shares of its common stock to make shares available for its various employee stock-based benefit plans.
Ratings are an important factor in establishing the competitive position of an insurance company such as Hartford Life. There can be no assurance that the Company's ratings will continue for any given period of time, or that they will not be changed. In the event that the Company's ratings are downgraded, the level of sales or the persistency of the Company's block of in-force business may be adversely impacted.
Dividends to Hartford Life, 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 Life and Accident ("HLA"), a direct subsidiary of the Company, 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 Company without prior approval in 1997 is estimated to be $167.
The primary uses of funds are to pay claims, policy benefits, operating expenses and commissions, and to purchase new investments. In addition, Hartford Life 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" section of the MD&A.
During 1997, cash provided by operating activities increased from the prior year due primarily to growth in the Individual Life Insurance segment and the Group Insurance operation of the Employee Benefits segment. The change in cash used for investing activities primarily reflects the investment of cash from operating activities. The change in cash used for financing activities was
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 1% or 2% of premiums written per year depending on the state. Such assessments paid by Hartford Life approximated $15, $12 and $13 in 1997, 1996 and 1995, respectively.
The NAIC is expected to adopt its codification of Statutory Accounting Principles ("SAP") in early 1998 with a proposed effective date of January 1, 1999. The American Institute of Certified Public Accountants ("AICPA") has not yet determined whether SAP will qualify as an Other Comprehensive Basis of Accounting ("OCBOA"). If SAP is granted OCBOA status and is adopted by Hartford Life's domiciliary states, 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 Company.
The Year 2000 issue relates to the ability or inability of computer systems to properly process information and data containing or related to dates beginning with the year 2000 and beyond. The Year 2000 issue exists because many computer systems that are in use today were developed years ago when a year was identified using a two-digit field rather than a four-digit field. As information and data containing or related to the century date are introduced to computer hardware, software and other systems, date sensitive systems may recognize the year 2000 as 1900, or not at all, which may result in computer systems processing information incorrectly. This, in turn, may significantly and adversely affect the integrity and reliability of information databases and may result in a wide variety of adverse consequences to a company. In addition, Year 2000 problems that occur with third parties with which a company does business, such as suppliers, computer vendors and others, may also adversely affect any given company.
Beginning in 1990, Hartford Life began working on making its computer systems Year 2000 ready, either by installing new programs or by replacing systems. In January 1998, Hartford Life commenced a company-wide program to further identify, assess and remediate the impact of Year 2000 problems in all of Hartford Life's business segments. Hartford Life currently anticipates that this internal program will be substantially completed by the end of 1998, and testing of computer systems will continue through 1999. The costs of addressing the Year 2000 issue that have been incurred by Hartford Life through the year ended December 31, 1997 have not been material to Hartford Life's financial condition or results of operations. Hartford Life will continue to incur costs related to its Year 2000 efforts and is in the process of attempting to determine the approximate total costs to be incurred in the future, which are not currently anticipated to be material to the Company's results of operations or financial condition.