As of December 31, 2014, The Hartford owned building space of approximately 2.4 million square feet which comprised its Hartford, Connecticut location and other properties within the greater Hartford, Connecticut area. In addition, as of December 31, 2014, The Hartford leased approximately 1.8 million square feet, throughout the United States of America, and approximately 37 thousand square feet, in other countries. All of the properties owned or leased are used by one or more of all six reporting segments, depending on the location. For more information on reporting segments, see Part I, Item 1, Business - Reporting Segments. The Company believes its properties and facilities are suitable and adequate for current operations.
The Hartford provides projections and other forward-looking information in the following discussions, which contain many forward-looking statements, particularly relating to the Company’s future financial performance. These forward-looking statements are estimates based on information currently available to the Company, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and are subject to the cautionary statements set forth on pages 3 and 4 of this Form 10-K. Actual results are likely to differ, and in the past have differed, materially from those forecast by the Company, depending on the outcome of various factors, including, but not limited to, those set forth in each discussion below and in Part I, Item 1A, Risk Factors. The Hartford undertakes no obligation to publicly update any forward-looking statements, whether as a result of new information, future developments or otherwise.
Certain reclassifications have been made to prior year financial information presented in Management’s Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") to conform to the current year presentation. In 2014, the Company refined the definition of underwriting expenses by including certain centralized services and bad debt expenses in the determination of underwriting results for the Commercial Lines, Personal Lines and Property & Casualty Other Operations reporting segments. The reclassification of certain centralized services and bad debt expenses from other income (expenses) did not impact previously reported net income.
On June 30, 2014, the Company completed the sale of all of the issued and outstanding equity of HLIKK to ORIX Life Insurance Corporation, a subsidiary of ORIX Corporation, a Japanese company. HLIKK sold variable and fixed annuity policies in Japan from 2001 to 2009 and had been in runoff since 2009.
The financial results in the Company’s mutual fund and variable annuity businesses depend largely on the amount of the contract holder or shareholder account value or assets under management on which it earns fees and the level of fees charged. Changes in account value or assets under management are driven by two main factors: net flows, and the market return of the funds, which is heavily influenced by the return realized in the equity markets. Net flows are comprised of deposits less surrenders, death benefits, policy charges and annuitizations of investment type contracts, such as variable annuity contracts. In the mutual fund business, net flows are known as net sales. Net sales are comprised of new sales less redemptions by mutual fund customers. The Company uses the average daily value of the S&P 500 Index as an indicator for evaluating market returns of the underlying account portfolios in the United States. Financial results of variable products are highly correlated to the growth in account values or assets under management since these products generally earn fee income on a daily basis. Equity market movements could also result in benefits for or charges against deferred acquisition costs.
Net income of $798, or $1.73 per diluted share, compared with net income of $176, or $0.36 per diluted share, for the prior year.
Amounts paid for share repurchases totaled approximately $1.8 billion for the year.
Net investment income decreased 3.4% to $3,154 compared to the prior year primarily due to a decrease in income from fixed maturities as a result of a decline in asset levels, primarily in Talcott Resolution, lower income from repurchase agreements, and the impact of reinvesting at lower interest rates.
While the annualized investment yield after-tax of 3.0% decreased 10 basis points compared to the prior year, new money yields decreased from 3.8% to 3.6% driven by lower interest rates, tighter credit spreads and the effect of reinvesting Japan sales proceeds into short-duration assets pending use for share repurchases.
Group Benefits after-tax core earnings margin, excluding buyouts, increased to 5.2% from 4.3% in the prior year.
Talcott Resolution after-tax income from continuing operations was $370, down from $414 in the prior year.
A decrease in the loss from discontinued operations to $551, net of tax, compared to $1,049, net of tax, in 2013. The loss from discontinued operations in 2014 includes the results of operations of the Japan business and the realized capital loss on the sale of HLIKK. The loss from discontinued operations in 2013 includes the results of operations of the Japan and U.K. annuity businesses and the realized capital loss on the sale of HLIL. The results of operations for the Japan annuity business in 2013 include the write-off of DAC and higher hedging losses. For further discussion of the sale of these businesses, see Note 2 - Business Dispositions and Note 19 - Discontinued Operations of Notes to Consolidated Financial Statements.
A loss on extinguishment of debt of $213, before tax, in 2013 related to the repurchase of approximately $800 of senior notes at a premium to the face amount of the then outstanding debt. The resulting loss on extinguishment of debt consists of the repurchase premium, the write-off of the unamortized discount and debt issuance and other costs related to the repurchase transaction.
Prior accident year reserve strengthening in Property & Casualty of $228, before tax, in 2014, compared to reserve strengthening of $192, before tax, in 2013. Reserve strengthenings in 2014 were primarily related to an increase in reserves for asbestos and environmental claims, primarily due to a higher than previously estimated number of mesothelioma claim filings and an increase in costs associated with asbestos litigation. Reserve strengthenings in 2013 were primarily related to increased net asbestos reserves due to higher claim frequency and severity as well as costs and expenses associated with litigating asbestos coverage matters.
An increase in the loss from discontinued operations to $1,049, net of tax, compared to $258, net of tax, in 2013. The loss from discontinued operations in 2013 includes the results of operations of the Japan and U.K. annuity businesses and the realized capital loss on the sale of HLIL. The loss from discontinued operations in 2012 includes the results of operations of the Japan and U.K. annuity businesses.
Reinsurance loss on disposition of $533, before tax, in 2012 consisting of an impairment of goodwill and a loss accrual for premium deficiency related to the disposition of the Individual Life business, and losses in 2012 from the operations of the Retirement Plans and Individual Life businesses sold in 2013.
Current accident year losses and loss adjustment expenses before catastrophes in Property & Casualty of $6.3 billion, before tax, in 2013 decreased from $6.6 billion, before tax, in 2012. The decrease was primarily driven by lower loss and loss adjustment expenses in Commercial Lines workers’ compensation business due to favorable severity and frequency.
Net investment income of $3,264, before tax, in 2013 decreased from $4,127, before tax, in 2012. The decrease in net investment income is primarily due to lower asset levels as a result of the sale of the Retirement Plans and Individual Life businesses in 2013, and a decline in yield.
Differences between the Company's effective income tax rate and the U.S. statutory rate of 35% are due primarily to tax-exempt interest earned on invested assets and the dividends received deduction ("DRD"). The $555 increase in income tax expense in 2013 compared to an income tax benefit in 2012 was primarily due to the $1.0 billion increase in income from continuing operations, before tax. Income tax expense of $246 in 2013 and income tax benefit of $309 in 2012, includes separate account DRD benefits of $139 and $145, respectively.
As of December 31, 2013, approximately $19.7 billion of equity securities, trading, supported Japan variable annuities. Those equity securities, trading, were invested in mutual funds, which, in turn, invested in the following asset classes as of December 31, 2013: Japan equity 22%, Japan fixed income (primarily government securities) 15%, global equity 22%, global government bonds 40%, and cash and other 1%.
Gross gains on sales for the year ended December 31, 2014 were primarily due to gains on the sale of corporate securities, CMBS, RMBS, and municipal securities. Gross losses on sales for the year ended December 31, 2014 were primarily the result of losses on the sale of corporate and foreign government and government agency securities, which included sales resulting from a reduction in our exposure to the emerging market and energy sector securities as well as other portfolio management activities. The sales were primarily a result of duration, liquidity and credit management, as well as tactical changes to the portfolio as a result of changing market conditions.
Other, net loss for the year ended December 31, 2014 was primarily related to a loss of $172 on interest rate derivatives used to manage the risk of a rise in interest rates and manage duration, driven by a decline in U.S. interest rates.
Other, net gain for the year ended December 31, 2013 was primarily related to gains of $71 on interest rate derivatives primarily associated with fixed rate bonds sold as part of the Individual Life and Retirement Plan business dispositions. For further information on the business dispositions, see Note 2 of Notes to the Consolidated Financial Statements. Additional gains included $69 on interest rate derivatives primarily due to an increase in U.S. interest rates and $42 of gains on credit derivatives due to credit spreads tightening.
Other, net gain for the year ended December 31, 2012 was primarily related to gains of $313 on credit derivatives due to credit spreads tightening, and gains of $96 on interest derivatives largely driven by the de-designation of the cash flow hedges associated with bonds included in the sale of Individual Life and Retirement Plans businesses. For further information on the business dispositions, see Note 2 of Notes to the Consolidated Financial Statements. These gains were partially offset by losses of $111 related to Japan fixed payout annuity hedges primarily driven by the strengthening of the currency basis swap spread between the U.S. dollar and Japanese yen and the decline in U.S. interest rates.
Loss and loss adjustment expense reserves by line of business as of December 31, 2014, net of reinsurance are as follows:
(See Reserving for Asbestos and Environmental Claims within Property & Casualty Other Operations for a discussion of how A&E reserves are set)
Personal Auto Liability. For auto liability, and bodily injury in particular, the Company performs a greater number of techniques than it does for property and auto physical damage. In addition to traditional paid and reported development methods, the Company relies on frequency/severity techniques and Berquist-Sherman techniques. Because the paid development technique is affected by changes in claim closure patterns and the reported development method is affected by changes in case reserving practices, the Company uses Berquist-Sherman techniques which adjust these patterns to reflect current settlement rates and case reserving techniques. The Company generally uses the reported development method for older accident years as a higher percentage of ultimate losses are reflected in reported losses than in cumulative paid losses and a combination of reported development, frequency/severity and Berquist-Sherman methods for more recent accident years. Recent periods can be influenced by changes in case reserve practices and changing disposal rates; the frequency/severity techniques are not affected as much by these changes and the Berquist-Sherman techniques specifically adjust for these changes.
Long-Tailed General Liability, Bond and Large Deductible Workers’ Compensation. For these long-tailed lines of business, the Company generally relies on the expected loss ratio and reported development techniques. The Company generally weights these techniques together, relying more heavily on the expected loss ratio method at early ages of development and more on the reported development method as an accident year matures.
Workers’ Compensation. Workers’ compensation is the Company’s single largest reserve line of business so a wide range of methods are reviewed in the reserve analysis. Methods performed include paid and reported development, variations on expected loss ratio methods, and an in-depth analysis on the largest states. Historically, paid development patterns in the Company’s workers’ compensation business have been stable, so paid techniques are preferred. Although paid techniques may be less predictive of the ultimate liability when a low percentage of ultimate losses are paid as in early periods of development, given changes in the frequency of workers’ compensation claims over time, the Company places greater reliance on paid methods with continued consideration of the state-by-state analysis and the expected loss ratio approach.
Assumed Reinsurance and All Other. For these lines, the Company tends to rely on the reported development techniques. In assumed reinsurance, assumptions are influenced by information gained from claim and underwriting audits.
The final step in the reserve review process involves a comprehensive review by senior reserving actuaries who apply their judgment and, in concert with senior management, determine the appropriate level of reserves based on the information that has been accumulated. Numerous factors are considered in this process including, but not limited to, the assessed reliability of key loss trends and assumptions that may be significantly influencing the current actuarial indications, pertinent trends observed over the recent past, the level of volatility within a particular line of business, and the improvement or deterioration of actuarial indications in the current period as compared to the prior periods. Total recorded net reserves, excluding asbestos and environmental, were 3.5% higher than the actuarial indication of the reserves as of December 31, 2014.
For a discussion of changes to reserve estimates recorded in 2014, see Reserve Roll-forwards and Development included below in this section.
The Hartford is a multi-line company in the property and casualty insurance business. The Hartford is therefore subject to reserve uncertainty stemming from a number of conditions, including but not limited to those noted above, any of which could be material at any point in time. Certain issues may become more or less important over time as conditions change. As various market conditions develop, management must assess whether those conditions constitute a long-term trend that should result in a reserving action (i.e., increasing or decreasing the reserve).
For both asbestos and environmental reserves, the Company also compares its historical direct net loss and expense paid and reported experience, and net loss and expense paid and reported experience year by year, to assess any emerging trends, fluctuations or characteristics suggested by the aggregate paid and reported activity.
A number of factors affect the variability of estimates for asbestos and environmental reserves including assumptions with respect to the frequency of claims, the average severity of those claims settled with payment, the dismissal rate of claims with no payment and the expense to indemnity ratio. The uncertainty with respect to the underlying reserve assumptions for asbestos and environmental adds a greater degree of variability to these reserve estimates than reserve estimates for more traditional exposures. While this variability is reflected in part in the size of the range of reserves developed by the Company, that range may still not be indicative of the potential variance between the ultimate outcome and the recorded reserves. The recorded net reserves as of December 31, 2014 of approximately$2.0 billion ($1.7 billion and $0.3 billion for asbestos and environmental, respectively) are within an estimated range, unadjusted for covariance, of $1.6 billion to $2.3 billion. The process of estimating asbestos and environmental reserves remains subject to a wide variety of uncertainties, which are detailed in Note 14 - Commitments and Contingencies of Notes to Consolidated Financial Statements. The Company believes that its current asbestos and environmental reserves are appropriate. However, analyses of future developments could cause the Company to change its estimates and ranges of its asbestos and environmental reserves, and the effect of these changes could be material to the Company's consolidated operating results or cash flows. Consistent with the Company's long-standing reserve practices, the Company will continue to review and monitor its reserves in Property & Casualty Other Operations regularly, including its annual reviews of asbestos liabilities, reinsurance recoverables and the allowance for uncollectible reinsurance, and environmental liabilities, and where future developments indicate, make appropriate adjustments to the reserves.
Released reserves in professional liability for accident years 2008 through 2012 due to lower than expected claim severity, primarily for large-sized accounts.
Reserve strengthening related to the closing of the New York Section 25A Fund for Reopened Cases (the "Fund"). These claims were previously funded through assessments and paid by the Fund. The claims will become payable by the Company effective January 1, 2014.
Refer to the Property & Casualty Other Operations Claims section for further discussion of the increase to net asbestos and net environmental reserves.
The following table presents reserve activity, inclusive of estimates for both reported and incurred but not reported claims, net of reinsurance, for Property & Casualty Other Operations, categorized by asbestos, environmental and all other claims, for the years ended December 31, 2014, 2013 and 2012.
Excludes asbestos and environmental paid and incurred loss and LAE reported in Ongoing Operations. Total gross losses and LAE incurred in Ongoing Operations for the years ended December 31, 2014, 2013 and 2012 includes $19, $15 and $13, respectively, related to asbestos and environmental claims. Total gross losses and LAE paid in Ongoing Operations for the years ended December 31, 2014, 2013 and 2012 includes $21, $14 and $15, respectively, related to asbestos and environmental claims.
In the fourth quarters of 2014, 2013 and 2012, the Company completed evaluations of certain of its non-asbestos and non-environmental reserves in Property & Casualty Other Operations, including its assumed reinsurance liabilities. In 2014, the Company's prior year development was impacted by unfavorable frequency of international workers' compensation claims. The Company's prior year development on these reserves was immaterial in 2013 and 2012.
During the second quarters of 2014, 2013 and 2012, the Company completed its annual ground-up asbestos reserve evaluations. As part of these evaluations, the Company reviewed all of its open direct domestic insurance accounts exposed to asbestos liability, as well as assumed reinsurance accounts and its London Market exposures for both direct insurance and assumed reinsurance. During 2014, the Company found estimates for certain direct accounts increased, principally due to a higher than previously estimated number of mesothelioma claim filings and an increase in costs associated with asbestos litigation. The Company also experienced unfavorable development on certain of its assumed reinsurance accounts driven by a variety of account-specific factors, including those experienced by the direct policyholders. Based on this evaluation, the Company strengthened its net asbestos reserves by $212 in second quarter 2014. During 2013, the Company found estimates for individual cases changed based upon the particular circumstances in such accounts. These cases were case specific and not as a result of any underlying change in current environment. The Company experienced moderate increases in claim frequency and severity as well as expense and costs associated with litigating asbestos coverage matters, particularly against certain smaller, more peripheral insureds. The Company also experienced unfavorable development on certain of its assumed reinsurance accounts driven largely by the same factors experience by the direct policyholders. Based on this evaluation, the Company strengthened its net asbestos reserves by $130 in second quarter 2013. During 2012, the Company found estimates for individual cases changed based upon the particular circumstances of such accounts. These changes were case specific and not as a result of any underlying change in the current environment. The Company experienced moderate increases in claim severity, expense and costs associated with litigating asbestos coverage matters, particularly against certain smaller, more peripheral insureds. The Company also experienced unfavorable development on certain of its assumed reinsurance accounts driven largely by the same factors experienced by direct policy holders. Based on this evaluation, the Company strengthened its net asbestos reserves by $48 in second quarter 2012. The Company currently expects to continue to perform an evaluation of its asbestos liabilities annually.
During the second quarters of 2014, 2013 and 2012, the Company completed its annual ground-up environmental reserve evaluations. In each of these evaluations, the Company reviewed all of its open direct domestic insurance accounts exposed to environmental liability, as well as assumed reinsurance accounts and its London Market exposures for both direct and assumed reinsurance. The Company found estimates for certain individual account exposures increased based upon unfavorable litigation results and increased clean-up and expense costs. The net effect of these account-specific changes as well as quarterly actuarial evaluations of new account emergence and historical loss and expense paid experience resulted in increases of $30, $12 and $10 in net environmental reserves in 2014, 2013 and 2012, respectively. The Company currently expects to continue to perform a ground-up evaluation of its environmental liabilities annually and to regularly evaluate the Company's historical direct net loss and expense paid and reported experience by calendar and/or report year, to assess any emerging trends, fluctuations or characteristics suggested by the aggregate paid and reported activity.
Non-Major Accounts are all other open direct asbestos accounts and largely represent smaller and more peripheral defendants. These exposures represented 1,115 accounts and contained approximately 49% of the Company's total Direct gross asbestos reserves as of June 30, 2014.
The following table displays gross asbestos and environmental reserves by category as of December 31, 2014:
The Company provides an allowance for uncollectible reinsurance, reflecting management’s best estimate of reinsurance cessions that may be uncollectible in the future due to reinsurers’ unwillingness or inability to pay. During the second quarters of 2014, 2013 and 2012, the Company completed its annual evaluations of the collectability of the reinsurance recoverables and the adequacy of the allowance for uncollectible reinsurance associated with older, long-term casualty liabilities reported in the Property & Casualty Other Operations. In conducting this evaluation, the Company used its most recent detailed evaluations of ceded liabilities reported in the segment. The Company analyzed the overall credit quality of the Company’s reinsurers, recent trends in arbitration and litigation outcomes in disputes between cedants and reinsurers, and recent developments in commutation activity between reinsurers and cedants. The evaluation in the second quarters of 2014, 2013, and 2012 resulted in no adjustments to the allowance for uncollectible reinsurance. As of December 31, 2014, 2013, and 2012, the allowance for uncollectible reinsurance for Property & Casualty Other Operations totaled $225, $202, and $203. The Company currently expects to perform its regular comprehensive review of Property & Casualty Other Operations reinsurance recoverables annually. Due to the inherent uncertainties as to collection and the length of time before reinsurance recoverables become due, particularly for older, long-term casualty liabilities, it is possible that future adjustments to the Company’s reinsurance recoverables, net of the allowance, could be required.
The largest impacts of net reserve re-estimates are shown in the “2004 & Prior” accident years. The reserve deterioration is driven, in part, by deterioration of reserves for asbestos, environmental, assumed casualty reinsurance, workers’ compensation, and general liability claims. Numerous actuarial assumptions on assumed casualty reinsurance turned out to be low, including loss cost trends, particularly on excess of loss business, and the impact of deteriorating terms and conditions.
During calendar year 2006, favorable re-estimates occurred in both loss and allocated loss adjustment expenses for the 2005 accident year. In addition, catastrophe reserves related to the 2005 hurricanes developed favorably in 2006. During calendar years 2006 through 2008 for the 2005 through 2007 accident years, the Company recognized favorable re-estimates of both loss and allocated loss adjustment expenses on workers’ compensation claims, driven, in part, by state regulatory reforms in California and Florida, underwriting actions, and expense reduction initiatives that had a greater impact in controlling costs than originally estimated. Even after considering the reclassification of IBNR reserves, accident years 2005 through 2007 show favorable development in calendar years 2006 through 2011. A portion of the release comes from short-tail lines of business, where results emerge quickly. In 2007, the Company released reserves for package business claims as reported losses emerged favorably to previous expectations. In 2007 through 2009, the Company released reserves for general liability claims due to the favorable emergence of losses for high hazard and umbrella general liability claims. Reserves for professional liability claims were released in 2008 and 2009 related to the 2005 through 2007 accident years due to a lower estimate of claim severity on both directors’ and officers’ insurance claims and errors and omissions insurance claims. Reserves of auto liability claims, within Personal Lines, were released in 2008 due largely to an improvement in emerged claim severity for the 2005 to 2007 accident years.
Accident year 2009 remains reasonably close to original estimates. Modest favorable reserve re-estimates during calendar periods 2009 through 2014 are primarily related to liability lines of business.
Estimated gross profits are used in the amortization of the deferred policy acquisition costs ("DAC") asset, sales inducement assets (“SIA”) and unearned revenue reserves (“URR”). Portions of EGPs are also used in the valuation of reserves for death and other insurance benefit features on variable annuity and other universal life type contracts.
For additional information on death and other insurance benefit reserves, see Note 10 - Separate Accounts, Death Benefits and Other Insurance Benefit Features of Notes to Consolidated Financial Statements.
For most annuity contracts, the Company estimates gross profits over 20 years as EGPs emerging subsequent to that time frame are immaterial. Products sold in a particular year are aggregated into cohorts. Future gross profits for each cohort are projected over the estimated lives of the underlying contracts, based on future account value projections for variable annuity. The projection of future account values requires the use of certain assumptions including: separate account returns; separate account fund mix; fees assessed against the contract holder’s account balance; surrender and lapse rates; interest margin; mortality; and the extent and duration of hedging activities and hedging costs. Changes in these assumptions and, in addition, changes to other policyholder behavior assumptions such as resets, partial surrenders, reaction to price increases, and asset allocations causes EGPs to fluctuate which impacts earnings.
All assumption changes that affect the estimate of future EGPs including the update of current account values, the use of the RTM estimation technique and policyholder behavior assumptions are considered an Unlock in the period of revision. An Unlock adjusts DAC, SIA, URR and death and other insurance benefit reserve balances in the Consolidated Balance Sheets with an offsetting benefit or charge in the Consolidated Statements of Operations in the period of the revision. An Unlock that results in an after-tax benefit generally occurs as a result of actual experience or future expectations of product profitability being favorable compared to previous estimates. An Unlock that results in an after-tax charge generally occurs as a result of actual experience or future expectations of product profitability being unfavorable compared to previous estimates.
The Company has a monitoring process that is overseen by a committee of investment and accounting professionals which identifies investments that are subject to an enhanced evaluation on a quarterly basis to determine if an other-than-temporary impairment (“impairment”) is present for AFS securities or a valuation allowance is required for mortgage loans. This evaluation is a quantitative and qualitative process, which is subject to risks and uncertainties. For further discussion of the accounting policies, see the Significant Investment Accounting Policies Section in Note 1 - Basis of Presentation and Significant Accounting Policies of Notes to Consolidated Financial Statements. For a discussion of impairments recorded, see the Other-Than-Temporary Impairments within the Investment Portfolio Risks and Risk Management section of the MD&A.
For further discussion on the impact of fair value changes from living benefits see Note 5 - Fair Value Measurements of Notes to Consolidated Financial Statements, and for a discussion on the sensitivities of certain living benefits due to capital market factors see Variable Product Guarantee Risks and Risk Management section of the MD&A.
A reporting unit is defined as an operating segment or one level below an operating segment. The Company’s reporting units, for which goodwill has been allocated, are equivalent to the Company’s operating segments of Group Benefits, Personal Lines and Mutual Funds.
The carrying value of goodwill is $498 as of December 31, 2014 and is comprised of $138 for Group Benefits, $119 for Personal Lines, and $241 for Mutual Funds.
The Company has analyzed the third-party pricing services' valuation methodologies and related inputs, and has also evaluated the various types of securities in its investment portfolio to determine an appropriate fair value hierarchy level based upon trading activity and the observability of market inputs. For further discussion of fair value measurement, see Note 5 of Notes to Consolidated Financial Statements.
Deferred tax assets represent the tax benefit of future deductible temporary differences and operating loss and tax credit carryovers. Deferred tax assets are measured using the enacted tax rates expected to be in effect when such benefits are realized if there is no change in tax law. Under U.S. GAAP, we test the value of deferred tax assets for impairment on a quarterly basis at the entity level within each tax jurisdiction, consistent with our filed tax returns. Deferred tax assets are reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some portion, or all, of the deferred tax assets will not be realized. The determination of the valuation allowance for our deferred tax assets requires management to make certain judgments and assumptions. In evaluating the ability to recover deferred tax assets, we have considered all available evidence as of December 31, 2014, including past operating results, the existence of cumulative losses in the most recent years, forecasted earnings, future taxable income, and prudent and feasible tax planning strategies. In the event we determine it is not more likely than not that we will not be able to realize all or part of our deferred tax assets in the future, an increase to the valuation allowance would be charged to earnings in the period such determination is made. Likewise, if it is later determined that it is more likely than not that those deferred tax assets would be realized, the previously provided valuation allowance would be reversed. Our judgments and assumptions are subject to change given the inherent uncertainty in predicting future performance and specific industry and investment market conditions.
The Company has recorded a deferred tax asset valuation allowance that is adequate to reduce the total deferred tax asset to an amount that will be more likely than not realized. The deferred tax asset valuation allowance was $181, relating mostly to the U.S. capital loss carryover, as of December 31, 2014 and $4, relating mostly to U.S. net operating losses, as of December 31, 2013. In assessing the need for a valuation allowance, management considered future taxable temporary difference reversals, future taxable income exclusive of reversing temporary differences and carryovers, taxable income in open carry back years, as well as other tax planning strategies. These tax planning strategies include holding a portion of debt securities with market value losses until recovery, altering the level of tax exempt securities held, making investments that allow utilization of foreign tax credits, business considerations such as asset-liability matching, and making investments which have specific tax characteristics. Management views such tax planning strategies as prudent and feasible, and would implement them, if necessary, to realize the deferred tax asset.
The Company considers the measures and ratios discussed below to be key performance indicators for its businesses. Management believes that these ratios and measures are useful in understanding the underlying trends in The Hartford’s businesses. However, these key performance indicators should only be used in conjunction with, and not in lieu of, the results presented in the segment discussions that follow in this MD&A. These ratios and measures may not be comparable to other performance measures used by the Company’s competitors.
After-tax core earnings margin, excluding buyouts, is a non-GAAP financial measure that the Company uses to evaluate, and believes is an important measure of, the Group Benefits segment’s operating performance. After-tax margin is the most directly comparable U.S. GAAP measure. The Company believes that after-tax core earnings margin, excluding buyouts, provides investors with a valuable measure of the performance of Group Benefits because it reveals trends in the business that may be obscured by the effect of buyouts. After-tax core earnings margin, excluding buyouts, should not be considered as a substitute for after-tax margin and does not reflect the overall profitability of Group Benefits. Therefore, the Company believes it is important for investors to evaluate both after-tax core earnings margin, excluding buyouts, and after-tax margin when reviewing performance. After-tax core earnings margin, excluding buyouts is calculated by dividing core earnings excluding buyouts by revenues excluding buyouts and realized gains (losses). A reconciliation of after-tax margin to after-tax core earnings margin, excluding buyouts for the years ended December 31, 2014, 2013 and 2012 is set forth in the After-tax margin section within MD&A - Group Benefits.
The combined ratio is the sum of the loss and loss adjustment expense ratio, the expense ratio and the policyholder dividend ratio. This ratio is a relative measurement that describes the related cost of losses and expenses for every $100 of earned premiums. A combined ratio below 100 demonstrates underwriting profit; a combined ratio above 100 demonstrates underwriting losses.
The combined ratio before catastrophes and prior accident year development, a non-GAAP financial measure, represents the combined ratio for the current accident year, excluding the impact of catastrophes. Combined ratio is the most directly comparable U.S. GAAP measure. A reconciliation of combined ratio to combined ratio before prior accident year reserve development for the years ended December 31, 2014, 2013 and 2012 is set forth in MD&A - Commercial Lines and Personal Lines.
Core earnings, a non-GAAP measure, is an important measure of the Company’s operating performance. The Company believes that core earnings provides investors with a valuable measure of the performance of the Company’s ongoing businesses because it reveals trends in our insurance and financial services businesses that may be obscured by including the net effect of certain realized capital gains and losses, discontinued operations, pension settlements, loss on extinguishment of debt, gains and losses on business disposition transactions, certain restructuring and other costs and the impact of Unlocks to DAC, SIA, URR and death and other insurance benefit reserve balances. Some realized capital gains and losses are primarily driven by investment decisions and external economic developments, the nature and timing of which are unrelated to the insurance and underwriting aspects of our business. Accordingly, core earnings excludes the effect of all realized gains and losses (net of tax and the effects of DAC) that tend to be highly variable from period to period based on capital market conditions. The Company believes, however, that some realized capital gains and losses are integrally related to our insurance operations, so core earnings includes net realized gains and losses such as net periodic settlements on credit derivatives. These net realized gains and losses are directly related to an offsetting item included in the income statement such as net investment income. Net income (loss) is the most directly comparable U.S. GAAP measure. Core earnings should not be considered as a substitute for net income (loss) and does not reflect the overall profitability of the Company’s business. Therefore, the Company believes that it is useful for investors to evaluate both net income (loss) and core earnings when reviewing the Company’s performance.
A reconciliation of net income to core earnings is set forth below:
Written premiums are earned over the policy term, which is six months for certain personal lines auto business and twelve months for substantially all of the remainder of the Company’s property and casualty business. Because the Company earns premiums over the six to twelve month term of the policies, renewal earned price increases (decreases) lag renewal written price increases (decreases) by six to twelve months.
ROA, core earnings, is a non-GAAP financial measure that the Company uses to evaluate, and believes is an important measure of, certain of the segment’s operating performance. ROA is the most directly comparable U.S. GAAP measure. The Company believes that ROA, core earnings, provides investors with a valuable measure of the performance of certain of the Company’s on-going businesses because it reveals trends in our businesses that may be obscured by the effect of realized gains (losses). ROA, core earnings, should not be considered as a substitute for ROA and does not reflect the overall profitability of our businesses. Therefore, the Company believes it is important for investors to evaluate both ROA, core earnings, and ROA when reviewing the Company’s performance. ROA is calculated by dividing core earnings by a two-point average AUM. A reconciliation of ROA to ROA, core earnings for the years ended December 31, 2014, 2013 and 2012 is set forth in the ROA section within MD&A - Mutual Funds.
The Company expects economic conditions to continue to improve slowly driving a modest increase in exposures, while pricing is anticipated to moderate. As such, the Company expects low-to-mid single-digit written premiums growth in 2015 driven by small commercial and middle market where the Company continues to develop comprehensive product solutions, deeper relationships with distribution partners, differentiating customer experiences and enhanced ease of doing business processes and technologies. In specialty lines, the Company expects modest written premium growth in professional liability. The Company expects the combined ratio before catastrophes and prior accident year development will be between approximately 89.5 and 91.5 for 2015, compared to 91.5 in 2014, due to stable to slightly improving margins as earned pricing increases are expected to be slightly ahead of long-term loss costs trends.
The combined ratio, before catastrophes and prior year development, improved 3.6 points to 91.5 in 2014 from 95.1 in 2013. The improvement primarily reflects a decrease in the current accident year loss and loss adjustment expense ratio before catastrophes, as well as a decrease in the expense ratio (including a 0.8 point favorable impact on the expense ratio related to a reduction in NY State Workers' Compensation Board assessments).
Net income, as compared to the prior year period, increased in 2013 primarily due to improvements in underwriting results, driven by lower current accident year losses and loss adjustment expenses before catastrophes and lower current accident year catastrophe losses.
Earned premiums decreased in 2013, reflecting the impact of lower written premiums primarily in middle market and specialty lines, partially offset by written premium growth in small commercial.
Losses and loss adjustment expenses reflect favorable current accident year losses before catastrophes in all three businesses and a significant decline in current accident year catastrophes partially offset by unfavorable prior accident years development.
Current accident year catastrophe losses of $105, before tax, in 2013, compared to $325, before tax, in 2012. Losses in 2013 were primarily due to multiple thunderstorm, hail and tornado events across various U.S. geographic regions. Losses in 2012 were primarily driven by $207 related to Storm Sandy and multiple thunderstorm, hail and tornado events across various U.S. geographic regions. For additional information, see MD&A - Critical Accounting Estimates, Property and Casualty Insurance Product Reserves, Net of Reinsurance.
Prior accident years reserve strengthening of $83, before tax, in 2013, compared to $72, before tax, in 2012. Development in 2013 was primarily due to strengthening related to commercial auto liability and the closing of the New York Section 25A Fund for Reopened Cases partially offset by a release of general liability reserves. Development in 2012 was primarily due to strengthening related to commercial auto liability claims, professional liability directors and officers claims and workers compensation partially offset by a release of general liability and catastrophe reserves. For additional information, see MD&A - Critical Accounting Estimates, Reserve Roll-forwards and Development.
The combined ratio, before catastrophes and prior year development, improved 3.2 points to 95.1 in 2013 from 98.3 in 2012. The improvement primarily reflects a decrease in the current accident year before catastrophes loss and loss adjustment expense ratio.
Includes servicing revenues of $163 and $155 for years ended December 31, 2013 and 2012, respectively.
Losses and loss adjustment expenses reflect an increase in current accident year loss and loss adjustment expenses before catastrophes and higher current accident year catastrophes, partially offset by higher favorable prior accident years development.
The combined ratio, before current accident year catastrophes and prior year development, improved to 90.6 in 2014 from 92.3 in 2013.
Earned and written premiums increased in 2013, reflecting new business written premium growth in auto and home, primarily from the AARP Direct and AARP through agents distribution channels and improved policy count retention in auto and home due to initiatives implemented over the last two years.
Losses and loss adjustment expenses reflect a decline in current accident year catastrophes partially offset by lower favorable prior accident years development.
The combined ratio, before current accident year catastrophes and prior year development, stayed consistent at 92.3 for 2012 and 2013.
Investment income increased in 2014, as compared to the prior year period. For discussion of consolidated investment results, see MD&A - Investment Results, Net Investment Income (Loss) and Net Realized Capital Gains (Losses).
The effective tax rates in 2013 and 2012 differ from the U.S. Federal statutory rate of 35% primarily due to permanent differences related to investments in tax exempt securities. For further discussion of income taxes, see Note 13 - Income Taxes of Notes to Consolidated Financial Statements.
Net loss, as compared to the prior year period, increased in 2014 primarily due to an increase in net asbestos and environmental reserve strengthening. As part of its annual ground-up asbestos and environmental reserve evaluations in 2014, the Company strengthened its associated reserves by $212 and $27, before tax, respectively. In 2013, the Company strengthened its net asbestos and environmental reserves by $130 and $10, before tax, respectively.
Net income, as compared to the prior year period, decreased in 2013 primarily due to net asbestos and environmental reserve strengthening. As part of its annual ground-up asbestos and environmental reserve evaluations in 2013, the Company strengthened its associated reserves by $130 and $10, before tax, respectively. In 2012, the Company strengthened its net asbestos and environmental reserves by $48 and $3, before tax, respectively.
The effective tax rates in 2014, 2013 and 2012 differ from the U.S. Federal statutory rate of 35% primarily due to permanent differences related to investments in tax exempt securities. For further discussion of income taxes, see the Income Taxes section within Note 1 - Basis of Presentation and Significant Accounting Policies of Notes to Consolidated Financial Statements.
For information on net asbestos and environmental reserves, see Property & Casualty Other Operations Claims within the Property and Casualty Insurance Product Reserves, Net of Reinsurance section in Critical Accounting Estimates.
The Company expects premiums to increase for 2015 due primarily to higher expected sales than prior year and continued strong book persistency. The Company expects Group Benefits' disability results to improve as a result of continued pricing actions, and lower incidence partially offset by lower life results due to less favorable life mortality compared to 2014. The Company expects Group Benefits' after-tax core earnings margin (excluding buyouts) will be between approximately 5.0% and 5.5% for 2015 as compared to 5.2% in 2014.
The total loss ratio increased by 0.6 points in 2014, as compared to the prior year period. Excluding the Association - Financial Institutions block of business, the loss ratio improved 1.9 points in 2014 due to improvements in both the life and disability loss ratios. The life loss ratio improvement reflects favorable mortality experience, improved pricing, and the impact of changes in reserve assumptions. The disability loss ratio improvement reflects improved accident year incidence and pricing partially offset by higher new claim severity and less favorable development on prior accident year recoveries.
The after-tax core earnings margin, excluding buyouts, improved 0.9 points in 2014, compared to the prior year period. The improvement was primarily due to the improved loss ratio excluding the Association - Financial Institutions block of business.
Net income, as compared to the prior year period, increased in 2013 driven primarily by an improvement in the loss ratio and lower insurance operating costs and other expenses, partially offset by a decrease in premiums and other considerations.
The improvement in the loss ratio in 2013 was primarily attributable to the long-term disability product driven by favorable claim recoveries from claims incurred in 2013 and prior years, lower incidence trends and improved renewal pricing. Additionally, the 2012 loss ratio reflected unfavorable long-term disability severity. The increase in after-tax core earnings margin, excluding buyouts, was primarily due to an improved loss ratio.
The year ended December 31, 2014 includes a planned asset transfer of $0.7 billion to the HIMCO Variable Insurance Trust (“HVIT”) which supports legacy retirement mutual funds and runoff mutual funds (see footnote [3]). HVIT's invested assets are managed by Hartford Investment Management Company, a wholly-owned subsidiary of the Company.
Talcott AUM (formerly Annuity Mutual Fund Assets) consist of Company-sponsored mutual fund assets held in separate accounts supporting variable insurance and investment products. The year ended December 31, 2014 includes a planned asset transfer of $2.0 billion to HVIT.
Net income, as compared to the prior year period, increased in 2013 primarily due to higher fee revenue driven by higher Mutual Fund average AUM and partially offset by increased sales related expenses. AUM increased reflecting positive market performance of the Mutual Fund assets throughout the year offset by expected runoff of Talcott assets. Redemptions in 2013 included a portfolio rebalance at a key distributor and an institutional redemption, together totaling $2.5 billion.
Included in the balance is approximately $(1.0) billion and $(1.2) billion for the years ended December 31, 2013 and 2012, respectively, related to a Talcott Resolution intra-segment funding agreement which eliminates in consolidation.
As the Company's annuity book continues to run off, earnings will continue to decline. A key driver to the decline in earnings will be the pace at which customers surrender their contracts. In 2014, the Company continued to experience double digit variable annuities surrender rates driven by market appreciation, continued aging of the block and in-force management initiatives. Contract counts decreased 13% for variable annuities in 2014. Looking forward, the Company expects variable annuity surrender rates to decline in 2015, as 2014 included the effect of in-force management initiatives. The decline in policy counts will likely result in unit cost increases and margin compression because expenses will not reduce at the same pace as the annuity block, further contributing to a decline in earnings over time.
The net loss for the year ended December 31, 2014 decreased compared to the net loss for the year ended December 31, 2013 primarily due to the decrease in the loss from discontinued operations, net of tax, related to the sale of HLIKK. Also contributing to the decrease in net loss were lower amortization of DAC, and lower insurance operating costs and other expenses, including lower costs associated with the enhanced surrender value program, and higher income from limited partnerships and other alternative investments, partially offset by a decline in earned fee income attributable to the continued run off of the business, and a decline in net investment income excluding that from limited partnerships and other alternative investments.
Account values for Talcott Resolution decreased to approximately $185 billion at year ended December 31, 2014 from approximately $219 billion at year ended December 31, 2013 due primarily to the sale of HLIKK, and net outflows partially offset by market value appreciation in variable annuities. For the year ended December 31, 2014 variable annuity net outflows decreased by approximately $2.9 billion as compared to the prior year period due to lower outflows from in-force management initiatives.
Contract counts decreased 13% for variable annuities at year ended December 31, 2014 compared to year ended December 31, 2013 primarily due to market appreciation, in-force management initiatives and the continued aging of the block.
The 2013 and 2012 effective tax rates differ from the U.S. Federal statutory rate of 35% primarily due to permanent differences related to investments in separate account DRD. For further discussion of income taxes, see Note 13 - Income Taxes of Notes to Consolidated Financial Statements.
In 2014, $200 of the Company's senior notes matured. For additional information regarding debt, see Note 12 - Debt of Notes to Consolidated Financial Statements.
For a reconciliation of the tax provision at the U.S. Federal statutory rate to the provision (benefit) for income taxes, see Note 13 - Income Taxes of Notes to Consolidated Financial Statements.
In 2013, the Company repurchased approximately $800 of senior notes at a premium to the face amount of the then outstanding debt. In 2012, the Company repurchased all outstanding 10% fixed-to-floating rate junior subordinated debentures due 2068 with a $1.75 billion aggregate principal amount held by Allianz. Loss on extinguishment of debt consists of the premium associated with repurchasing the debentures at an amount greater than the face amount, the write-off of the unamortized discount and debt issuance and other costs related to the repurchase transactions. For additional information regarding debt, see Note 12 - Debt of Notes to Consolidated Financial Statements.
The Company has an enterprise risk management function (“ERM”) that is charged with providing analysis of the Company’s risks on an individual and aggregated basis and with ensuring that the Company’s risks remain within its risk appetite and tolerances. The Company has established the Enterprise Risk and Capital Committee (“ERCC”) that includes the Company’s CEO, President, Chief Financial Officer, Chief Investment Officer, Chief Risk Officer, General Counsel and others as deemed necessary by the committee chair. The ERCC is responsible for managing the Company’s risks and overseeing the enterprise risk management program.
Morbidity: Risk of loss to an insured from illness incurred during the course of employment or illness from other covered perils.
While Enterprise Risk Management has a process to track and manage these limits, from time to time, the estimated loss to natural catastrophes from a single 250-year event prior to reinsurance may fluctuate above or below these limits due to changes in modeled loss estimates, exposures, or statutory surplus. Currently, the Company's estimated pre-tax loss to a single 250-year natural catastrophe event prior to reinsurance is less than 30% of the statutory surplus of the property and casualty insurance subsidiaries and the Company's estimated pre-tax loss net of reinsurance is less than 15% of statutory surplus of the property and casualty operations. The estimated 250 year pre-tax probable maximum losses from hurricane events are estimated to be $1.5 billion and $570, before and after reinsurance, respectively. The estimated 250 year pre-tax probable maximum loss from earthquake events is estimated to be $736 before reinsurance and $471 net of reinsurance. The loss estimates represent total property losses for hurricane events and property and workers compensation losses for earthquake events resulting from a single event. The estimates provided are based on 250-year return period loss estimates that have a 0.4% likelihood of being exceeded in any single year.
Pandemic risk is the exposure to loss arising from widespread influenza or other pathogens or bacterial infections that create an aggregation of loss across the Company's insurance or asset portfolios. Consistent with industry practice, the Company assesses exposure to pandemics by analyzing the potential impact from a variety of pandemic scenarios based on conditions consistent with historical outbreaks of flu-like viruses such as the “Severe” 1918 Spanish Flu, the Asian flu of 1957, the Hong Kong flu of 1968, and the 2009 outbreak of the swine flu. For pandemic risk, the Company generally limits its estimated pre-tax loss from a single 250 year event to less than 10% of total available capital resources. In evaluating these scenarios, the Company assesses the impact on group life policies, short-term and long term disability, annuities, COLI, property & casualty claims, and losses in the investment portfolio associated with market declines in the event of a widespread pandemic. While ERM has a process to track and manage these limits, from time to time, the estimated loss for pandemics may fluctuate above or below these limits due to changes in modeled loss estimates, exposures, or statutory surplus. Currently, the Company's estimated pre-tax loss for pandemic is less than 10% of enterprise statutory surplus.
The Company has several catastrophe reinsurance programs, including reinsurance treaties that cover property and workers’ compensation losses aggregating from single catastrophe events. The following table summarizes the primary catastrophe treaty reinsurance coverages that the Company has in place as of January 1, 2015:
In addition to the limit shown above, the workers compensation reinsurance includes a non-catastrophe, industrial accident layer, 80% placement of a $30 per event limit in excess of a $20 retention.
Life insurance product reinsurance recoverables represent future policy benefits and unpaid loss and loss adjustment expenses and other policyholder funds and benefits payable that are recoverable from a number of reinsurers.
As of December 31, 2014, the Company has reinsurance recoverables from MassMutual and Prudential of $8.6 billion and $10.4 billion, respectively. As of December 31, 2013 the Company has reinsurance recoverables from MassMutual and Prudential of $9.5 billion and $9.9 billion, respectively. These reinsurance recoverables are secured by invested assets held in trust for the benefit of the Company in the event of a default by the reinsurers. As of December 31, 2014, the fair value of assets held in trust securing the reinsurance recoverables from MassMutual and Prudential is $9.0 billion for each of these parties. As of December 31, 2014, the Company has no reinsurance-related concentrations of credit risk greater than 10% of the Company’s consolidated stockholders’ equity.
As part of its risk management strategy, the Company regularly monitors the financial wherewithal of other insurers and, in particular, activity by insurance regulators and various state guaranty associations relating to troubled insurers. In all states, insurers licensed to transact certain classes of insurance are required to become members of a guaranty fund. In most states, in the event of the insolvency of an insurer writing any such class of insurance in the state, members of the funds 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 was engaged. Assessments are generally limited for any year to one or two percent of the premiums written per year depending on the state. The amount and timing of assessments related to past insolvencies is unpredictable.
Citizens Property Insurance Corporation in Florida (“Citizens”), a non-affiliate insurer, provides property insurance to Florida homeowners and businesses that are unable to obtain insurance from other carriers, including for properties deemed to be “high risk.” Citizens maintains a Personal Lines account, a Commercial Lines account and a High Risk account. If Citizens incurs a deficit in any of these accounts, Citizens may impose a “regular assessment” on other insurance carriers in the state, such as the Company, to fund the deficits, subject to certain restrictions and subject to approval by the Florida Office of Insurance Regulation. Carriers are then permitted to surcharge policyholders to recover the assessments over the next few years. Citizens may also opt to finance a portion of the deficits through issuing bonds and may impose “emergency assessments” on other insurance carriers to fund the bond repayments. Unlike with regular assessments, however, insurance carriers only serve as a collection agent for emergency assessments and are not required to remit surcharges for emergency assessments to Citizens until they collect surcharges from policyholders. Under U.S. GAAP, the Company is required to accrue for regular assessments in the period the assessments become probable and estimable and the obligating event has occurred. Surcharges to recover the amount of regular assessments may not be recorded as an asset until the related premium is written. Emergency assessments that may be levied by Citizens are not recorded in the income statement.
Liquidity risk is the risk to current or prospective earnings or capital arising from the Company's inability or perceived inability to meet its contractual cash obligations at the legal entity level when they come due over given horizons without incurring unacceptable costs and without relying on uncommitted funding sources. Liquidity risk includes the inability to manage unplanned increases or accelerations in cash outflows, decreases or changes in funding sources, and changes in market conditions that affect the ability to liquidate assets quickly to meet obligations with minimal loss in value. Components of liquidity risk include funding risk, transaction risk and market liquidity risk. Funding risk is the gap between sources and uses of cash under normal and stressed conditions taking into consideration structural, regulatory and legal entity constraints. Changes in institution-specific conditions that affect the Company's ability to sell assets or otherwise transact business without incurring a significant loss in value is transaction risk. Changes in general market conditions that affect the institution's ability to sell assets or otherwise transact business without incurring a significant loss in value is market liquidity risk.
An increase in interest rates from current levels is generally a favorable development for the Company. Interest rate increases are expected to provide additional net investment income, reduce the cost of the variable annuity hedging program, limit the potential risk of margin erosion due to minimum guaranteed crediting rates in certain Talcott Resolution products. Conversely, if long-term interest rates rise dramatically within a six to twelve month time period, certain Talcott Resolution businesses may be exposed to disintermediation risk. Disintermediation risk refers to the risk that policyholders will surrender their contracts in a rising interest rate environment requiring the Company to liquidate assets in an unrealized loss position. In conjunction with the interest rate risk measurement and management techniques, certain of Talcott Resolution's fixed income product offerings have market value adjustment provisions at contract surrender. An increase in interest rates may also impact the Company’s tax planning strategies and in particular its ability to utilize tax benefits of previously recognized realized capital losses.
The Company’s investment portfolios primarily consist of investment grade fixed maturity securities. The fair value of fixed maturity investments was $59.9 billion and $63.2 billion at December 31, 2014 and 2013, respectively. The fair value of these and other invested assets fluctuates depending on the interest rate environment and other general economic conditions. The weighted average duration of the portfolio, including fixed maturities, commercial mortgage loans, certain derivatives, and cash equivalents, was approximately 5.3 years as of both December 31, 2014 and 2013. As of December 31, 2013, the weighted average duration of the portfolio, excluding the Japan variable and fixed annuity business, was approximately 5.2 years.
The Company utilizes a variety of derivative instruments to mitigate interest rate risk associated with its investment portfolio or hedge liabilities. Interest rate swaps are primarily used to convert interest receipts or payments to a fixed or variable rate. The use of such swaps enable the Company to customize contract terms and conditions to desired objectives and manage the duration profile within established tolerances. Interest rate swaps are also used to hedge the variability in the cash flow of a forecasted purchase or sale of fixed rate securities due to changes in interest rates. Interest rate caps, floors, swaps, swaptions, and futures may be used to manage portfolio duration.
The following table provides an analysis showing the estimated before-tax change in the fair value of the Company’s investments and related derivatives, excluding assets supporting fixed liabilities which are included in the table above, assuming 100 basis point upward and downward parallel shifts in the yield curve as of December 31, 2014 and 2013. Certain financial instruments, such as limited partnerships and other alternative investments, have been omitted from the analysis due to the fact that the investments are accounted for under the equity method and generally lack sensitivity to interest rate changes.
The table above excludes all assets associated with the Company's former Japan variable and fixed annuity business.
The carrying value of fixed maturities, commercial mortgage loans and short-term investments related to the businesses included in the table above was $43.1 billion and $40.7 billion, as of December 31, 2014 and 2013, respectively. The selection of the 100 basis point parallel shift in the yield curve was made only as an illustration of the potential hypothetical impact of such an event and should not be construed as a prediction of future market events. Actual results could differ materially from those illustrated above due to the nature of the estimates and assumptions used in the above analysis. The Company’s sensitivity analysis calculation assumes that the composition of invested assets and liabilities remain materially consistent throughout the year and that the current relationship between short-term and long-term interest rates will remain constant over time. As a result, these calculations may not fully capture the impact of portfolio re-allocations, significant product sales or non-parallel changes in interest rates.
The Company’s variable products are significantly influenced by the U.S. and other equity markets. Increases or declines in equity markets impact certain assets and liabilities related to the Company’s variable products and the Company’s earnings derived from those products. The Company’s variable products currently include U.S. variable annuity contracts and mutual funds.
The NAR is generally defined as the guaranteed minimum benefit amount in excess of the contract holder’s current account value. Variable annuity account values with guarantee features were $52.9 billion and $81.9 billion (including HLIKK) as of December 31, 2014 and December 31, 2013, respectively.
The following tables summarize the account values of the Company’s variable annuities with guarantee features and the NAR split between various guarantee features (retained net amount at risk does not take into consideration the effects of the variable annuity hedge programs in place as of each balance sheet date):
On June 30, 2014, the Company completed the sale of the Japan variable annuity business of HLIKK. For further information of the sale of Japan variable annuity business, HLIKK in 2014, see Note 2 - Business Dispositions of Notes to the Consolidated Financial Statements.
Many policyholders with a GMDB also have a GMWB. Policyholders that have a product that offer both guarantees can only receive the GMDB or GMWB. The GMDB NAR disclosed in the tables above is a point in time measurement and assumes that all participants utilize the GMDB benefit on that measurement date. For additional information on the Company's GMDB liability, see Note 10 - Separate Accounts, Death Benefits and Other Insurance Benefit Features of Notes to Consolidated Financial Statements.
The Company expects to incur GMDB payments in the future only if the policyholder has an “in the money” GMDB at their death. If the account value is reduced to a specified level, the contract holder will receive an annuity equal to the guaranteed remaining balance ("GRB"). For the Company’s “life-time” GMWB products, this annuity can exceed the GRB. As the account value fluctuates with equity market returns on a daily basis and the “life-time” GMWB payments may exceed the GRB, the ultimate amount to be paid by the Company, if any, is uncertain and could be significantly more or less than the Company’s current carried liability. For additional information on the Company’s GMWB liability, see Note 5 - Fair Value Measurements of Notes to Consolidated Financial Statements.
The Company uses reinsurance for a portion of contracts with GMWB riders issued prior to the third quarter of 2003 and GMWB risks associated with a block of business sold between the third quarter of 2003 and the second quarter of 2006. The Company also uses reinsurance for a majority of the GMDB issued.
The underlying guaranteed living benefit liabilities and the related hedge assets within the GMWB (excluding the life-contingent GMWB benefits) and Macro hedge programs are carried at fair value, with the exception of liabilities within the Macro hedge program.
The above sensitivity analysis is an estimate and should not be used to predict the future financial performance of the Company's variable annuity hedge programs. The actual net changes in the fair value liability and the hedging assets illustrated in the above table may vary materially depending on a variety of factors which include but are not limited to:
Foreign currency exchange risk is defined as the risk of financial loss due to changes in the relative value between currencies. The Company’s foreign currency exchange risk is related to non-U.S. dollar denominated investments, which primarily consist of fixed maturity investments, and a yen denominated fixed payout annuity that is reinsured from HLIKK, a former, indirect wholly-owned subsidiary that was sold on June 30, 2014. For further discussion of the sale, see Note 2 - Business Dispositions of Notes to Consolidated Financial Statements. In addition, the Company’s Talcott Resolution operations formerly issued non-U.S. dollar denominated funding agreement liability contracts. A significant portion of the Company’s foreign currency exposure is mitigated through the use of derivatives.
As the value of certain derivative instruments that do not qualify for hedge accounting decreases, statutory surplus and RBC ratios may decrease.
With respect to our fixed annuity business, sustained low interest rates may result in a reduction in statutory surplus and an increase in NAIC required capital.
The Company has reinsured approximately 26% of its risk associated with GMWB and 79% of its risk associated with the aggregate GMDB exposure. These reinsurance agreements serve to reduce the Company’s exposure to changes in the statutory reserves and the related capital and RBC ratios associated with changes in the capital markets. The Company also continues to explore other solutions for mitigating the capital market risk effect on surplus, such as external reinsurance solutions, modifications to our hedging program, changes in product design, increasing pricing and expense management.
Credit risk is defined as the risk to earnings or capital due to uncertainty of an obligor’s or counterparty’s ability or willingness to meet its obligations in accordance with contractually agreed upon terms. The majority of the Company’s credit risk is concentrated in its investment holdings but is also present in reinsurance and insurance portfolios. Credit risk is comprised of three major factors: the risk of change in credit quality, or credit migration risk; the risk of default; and the risk of a change in value of a financial instrument due to changes in credit spread that are unrelated to changes in obligor credit quality. A decline in creditworthiness is typically associated with an increase in an investment’s credit spread, potentially resulting in an increase in other-than-temporary impairments and an increased probability of a realized loss upon sale.
The Company manages credit risk exposure from its inception to its maturity or sale. Both the investment and reinsurance areas have formulated procedures for counterparty approvals and authorizations. Although approval processes may vary by area and type of credit risk, approval processes establish minimum levels of creditworthiness and financial stability. Credits considered for investment are subjected to prudent and conservative underwriting reviews. Within the investment portfolio, private securities, such as commercial mortgages, and private placements, must be presented to their respective review committees for approval.
Credit risks are managed on an on-going basis through the use of various processes and analyses. At the investment, reinsurance, and insurance product levels, fundamental credit analyses are performed at the issuer/counterparty level on a regular basis. To provide a holistic review within the investment portfolio, fundamental analyses are supported by credit ratings, assigned by nationally recognized rating agencies or internally assigned, and by quantitative credit analyses. The Company utilizes a credit value at risk ("VaR") to measure default and migration risk on a monthly basis. Issuer and security level risk measures are also utilized. In the event of deterioration in credit quality, the Company maintains watch lists of problem counterparties within the investment and reinsurance portfolios. The watch lists are updated based on regular credit examinations and management reviews. The Company also performs quarterly assessments of probable expected losses in the investment portfolio. The process is conducted on a sector basis and is intended to promptly assess and identify potential problems in the portfolio and to recognize necessary impairments.
As of December 31, 2014, the Company had no exposure to any credit concentration risk of a single issuer or counterparty greater than 10% of the Company's stockholders' equity, other than the U.S. government and certain U.S. government securities. As of December 31, 2013, the Company's only exposure to any credit concentration risk of a single issuer or counterparty greater than 10% of the Company's stockholders' equity, other than the U.S. government and certain U.S. government securities, were the Government of Japan. The Government of Japan securities represented $2.6 billion, or 14% of stockholders' equity, and 3% of total invested assets. For further discussion of concentration of credit risk in the investment portfolio, see the Concentration of Credit Risk section in Note 6 - Investments and Derivative Instruments of Notes to Consolidated Financial Statements.
The Company utilizes a variety of OTC, OTC-cleared and exchange-traded derivative instruments as a part of its overall risk management strategy, as well as to enter into replication transactions. Derivative instruments are used to manage risk associated with interest rate, equity market, credit spread, issuer default, price, and currency exchange rate risk or volatility. Replication transactions are used as an economical means to synthetically replicate the characteristics and performance of assets that are permissible investments under the Company’s investment policies. For further information on the Company’s use of derivatives, see Note 6 of Notes to Consolidated Financial Statements.
Derivative activities are monitored and evaluated by the Company’s compliance and risk management teams and reviewed by senior management. In addition, the Company monitors counterparty credit exposure on a monthly basis to ensure compliance with Company policies and statutory limitations. The notional amounts of derivative contracts represent the basis upon which pay or receive amounts are calculated and are not reflective of credit risk. Downgrades to the credit ratings of The Hartford’s insurance operating companies may have adverse implications for its use of derivatives including those used to hedge benefit guarantees of variable annuities. In some cases, downgrades may give derivative counterparties for OTC derivatives and clearing brokers for OTC-cleared derivatives the right to cancel and settle outstanding derivative trades or require additional collateral to be posted. In addition, downgrades may result in counterparties and clearing brokers becoming unwilling to engage in or clear additional derivatives or may require collateralization before entering into any new trades. This will restrict the supply of derivative instruments commonly used to hedge variable annuity guarantees, particularly long-dated equity derivatives and interest rate swaps.
The following table presents the Company’s fixed maturities, AFS, by credit quality. The average credit ratings referenced below and throughout this section are based on availability, and are the midpoint of the applicable ratings among Moody’s, S&P, Fitch and Morningstar. If no rating is available from a rating agency, then an internally developed rating is used.
Securities with an amortized cost and fair value of $1.0 billion and $1.1 billion, respectively, as of December 31, 2013, were reclassified in 2014 from utilities to energy as a result of an update to the Barclays bond index which is the primary component used in determining the classification in the above table. The balances as of December 31, 2013 have been reclassified to reflect the categorization as of December 31, 2014.
The decline in the fair value of AFS and FVO securities as compared to December 31, 2013 is primarily attributable to the sale of the Japan variable and fixed annuity buisness. In addition assets declined due to the effect of net outflows as a result of the continued runoff of Talcott Resolution, partially offset by higher valuations as a result of a decrease in long term interest rates and tighter credit spreads.
Market values of securities in the energy sector have experienced volatility in the second half of 2014 largely because prices for crude oil have declined significantly. West Texas Intermediate (WTI) crude oil is the benchmark for oil prices in the United States. Prices for WTI futures contracts for one month forward delivery have declined more than 51% from the June 2014 high of $108 a barrel, to $53 a barrel as of December 31, 2014. The drop in oil prices is primarily due to an increase in supply, lower than expected growth in global demand, and a stronger U.S. dollar. The speed and severity of the decline in oil prices has caused credit spreads to widen in the second half of 2014 for corporate and sovereign issuers that generate a large portion of their revenues from oil. The impact was more pronounced on issuers with below investment grade credit. Ultimately, the impact on these issuers will be determined by the severity and duration of the decline in oil prices and the ability of the issuers to adjust their cost structure or find other sources of revenue.
Included in fixed maturities, AFS and FVO, equity, AFS and short-term investments on the Consolidated Balance Sheets. Excludes equity securities, FVO with cost and fair value of $45 and $45, respectively, that are hedged with total return swaps.
Early in 2014, emerging market securities were negatively impacted by lower European interest rates, increased political tension in eastern Europe, softer-than-expected economic growth, as well as trade and budget deficits, raising the potential for destabilizing capital outflows and rapid currency depreciation, causing bondholders to demand a higher yield which caused the fair value of securities held to decline. The decline in oil prices during the second half of 2014 has put added strain on certain emerging markets that rely on revenues derived from the energy sector. As a result of these factors, credit spreads for emerging market securities have been volatile and we expect continued sensitivity to geopolitical events, the ongoing evolution of Fed policy and other economic factors, including contagion risk.
The Company manages the credit risk associated with emerging market securities within the investment portfolio on an on-going basis using macroeconomic analysis and issuer credit analysis subject to diversification and individual credit risk management limits. For additional details regarding the Company’s management of credit risk, see the Credit Risk section of this MD&A. Due to increased political tensions in Argentina, Ukraine, and Venezuela, the Company selectively reduced its exposure to these economies during the first quarter of 2014.
In addition, the Company has limited exposure to the Russian Federation, with a total amortized cost and fair value of $23 and $20, respectively, as of December 31, 2014. The exposure is primarily comprised of government and government agency bonds, but also includes corporate bonds.
Certain economies in the European region have experienced adverse economic conditions, specifically in Europe’s peripheral region (Greece, Ireland, Italy, Portugal and Spain), that were precipitated in part by elevated unemployment rates weighing on inflation rates, government debt levels and the slowing growth of the region. However, austerity measures aimed at reducing sovereign debt levels and the European Central Bank’s plan to institute a bond buying program to provide liquidity and credit support, has reduced the risk of default on the sovereign debt of the countries within the region. As a result, economic conditions in the region have shown signs of improvement in the current period through stabilized credit ratings in Ireland, Portugal and Spain. Though economic conditions in the region have improved, continued slow GDP growth and elevated unemployment levels may continue to put pressure on sovereign debt.
The Company has limited direct European exposure, totaling only 6% of total invested assets as of December 31, 2014. The following tables present the Company’s European securities included in the Securities by Type table above. The Company identifies exposures with the issuers’ ultimate parent country of domicile, which may not be the country of the security issuer. The European countries within Europe’s peripheral region are separately listed below because of the current significant economic strains persisting in these countries.
Includes amortized cost and fair value of $4 as of December 31, 2014 and $34 as of December 31, 2013 related to limited partnerships and other alternative investments.
Includes a notional amount and fair value of $44 and $0, respectively, as of December 31, 2014 and $190 and $(1), respectively, as of December 31, 2013 related to credit default swap protection. This includes a notional amount of $3 and $55 as of December 31, 2014 and December 31, 2013, respectively, related to single name corporate issuers in the financial services sector.
The Company’s European investment exposure largely relates to corporate entities which are domiciled in or generated a significant portion of its revenue within the United Kingdom, Germany, the Netherlands and Switzerland. Entities domiciled in the United Kingdom comprise the Company's largest exposure; as of December 31, 2014 and 2013, the exposure totals less than 3% of total invested assets. The majority of the European investments are U.S. dollar-denominated, and those securities that are pound and euro-denominated are hedged to U.S. dollars or support foreign-denominated liabilities. For a discussion of foreign currency risks, see the Foreign Currency Exchange Risk section of this MD&A. The Company does not hold any sovereign exposure to the peripheral region and does not hold any exposure to issuers in Greece. As of December 31, 2014 and 2013, the Company’s unfunded commitments associated with its investment portfolio was immaterial, and the weighted average credit quality of European investments was A- and A-, respectively.
As of December 31, 2014 and 2013, the Company’s credit default swaps that provide credit protection on European issuers had a notional amount of $44 and $190, respectively, and a fair value of $0 and $(1), respectively. As of December 31, 2014 and 2013 these credit default swaps that reference single name corporate and financial European issuers, of which a notional value of $3 and $23, respectively, related to the peripheral region. The maturity dates of credit defaults swaps are primarily consistent with the hedged bonds. For further information on the use of the Company’s credit derivatives and counterparty credit quality, see Derivative Instruments within the Credit Risk section of this MD&A.
In addition to the credit risk associated with the investment portfolio, the Company has $231 of reinsurance recoverables due from legal entity counterparties domiciled within Europe. For a more detail discussion of the Company's reinsurance arrangements, see Note 7 - Reinsurance of Notes to Consolidated Financial Statements.
The Company’s exposure to the financial services sector is predominantly through investment grade banking and insurance institutions. The following table presents the Company’s fixed maturity, AFS and equity, AFS securities in the financial services sector that are included in the Securities by Type table above.
In addition to CMBS bonds and CRE CDOs, the Company has exposure to commercial mortgage loans as presented in the following table. These loans are collateralized by a variety of commercial properties and are diversified both geographically throughout the United States and by property type. These loans are primarily in the form of whole loans, where the Company is the sole lender, or may include participations. Loan participations are loans where the Company has purchased or retained a portion of an outstanding loan or package of loans and participates on a pro-rata basis in collecting interest and principal pursuant to the terms of the participation agreement. In general, A-Note participations have senior payment priority, followed by B-Note participations and then mezzanine loan participations. As of December 31, 2014, loans within the Company’s mortgage loan portfolio that have had extensions or restructurings other than what is allowable under the original terms of the contract are immaterial.
The overall decrease in mortgage loans is attributed to an increase in loan payoffs in the agricultural loan and loan participations portfolios, partially offset by loan originations in the whole loan portfolio. Since December 31, 2013, the Company funded $604 of commercial whole loans with a weighted average loan-to-value (“LTV”) ratio of 61% and a weighted average yield of 4.0%. The Company continues to originate commercial whole loans within primary markets, such as office, industrial and multi-family, focusing on loans with strong LTV ratios and high quality property collateral. Included in the table above are mortgage loans held-for-sale with a carrying value and valuation allowance of $61 and $3, respectively, as of December 31, 2013. There were no mortgage loans held for sale a of December 31, 2014.
Leasing revenue bonds are generally the obligations of a financing authority established by the municipality that leases municipal facilities to a municipality. The notes are typically secured by lease payments made by the municipality that is leasing the facilities financed by the issue. Lease payments may be subject to annual appropriation by the municipality or the municipality may be obligated to appropriate general tax revenues to make lease payments.
The overall increase in the fair value of municipal bonds is primarily due to the decline in interest rates and tighter credit spreads. As of December 31, 2014 and December 31, 2013, the largest issuer concentrations were the states of Illinois, California and Massachusetts, which each comprised less than 3% of the municipal bond portfolio and were primarily comprised of general obligation and taxable bonds.
For the year ended December 31, 2014, impairments recognized in earnings were comprised of credit impairments of $37, securities that the Company intends to sell of $17, impairments on equity securities of $2, and other impairments of $3.
For the year ended December 31, 2014, the change in valuation allowances on mortgage loan additions of $4 was largely driven by individual property performance. Continued improvement in commercial real estate property valuations will positively impact future loss development, with future impairments driven by idiosyncratic loan-specific performance, as well as the necessity of risk reduction in the portfolio, rather than overall deteriorating market fundamentals.
As of December 31, 2014, HFSG Holding Company held fixed maturities, short-term investments and cash of $2.1 billion. Expected liquidity requirements of the HFSG Holding Company for the next twelve months include interest on debt of approximately $360 and common stockholder dividends, subject to discretion of the Board of Directors, of approximately $300.
In December 2014 the Company completed an ASR program, repurchasing a total of 13.9 million common shares under the ASR program for $525 million, including the initial delivery of 11.2 million common shares in July 2014 and 2.7 million common shares delivered in December 2014.
During the year ended December 31, 2014, the Company repurchased 49.5 million common shares for $1,796. During the period January 1, 2015 to February 24, 2015, the Company repurchased 4.1 million common shares, for $165.
This arrangement provided the Company with a vehicle to provide more efficient financing of the risk associated with this business with internal funds. The reinsurance arrangement between HLAI and WRR did not impact the Company's reserving methodology or the amount of required regulatory capital associated with the reinsured business. The effects of this intercompany arrangement were eliminated in consolidation.
On January 29, 2015 Hartford Insurance Company of the Midwest, an indirect wholly-owned subsidiary of the Company, issued a Revolving Note (the "Note") in the principal amount of $58 to Hartford Fire Insurance Company, a subsidiary of the Company, under the intercompany liquidity agreement. The Note bears interest at 0.20% and matures on March 31, 2015.
In September 2014, the Company extended a limited time voluntary lump sum offer to vested participants in the U.S. qualified defined benefit pension plan who had separated from service, but who had not yet commenced annuity benefits. These participants had until November 2014 to elect to receive their benefit in a lump-sum payment, rather than as an annuity. The Company made benefit payments in December 2014 using assets from the U.S. qualified defined benefit pension plan. The Company recognized a pre-tax settlement charge of $128 in 2014. The pension settlement charge was offset by a corresponding increase in accumulated other comprehensive income and therefore did not impact consolidated stockholders’ equity. For further discussion of the settlement, see Note 17 - Employee Benefit Plans of Notes to Consolidated Financial Statements.
On August 9, 2013, The Hartford filed with the Securities and Exchange Commission (the “SEC”) an automatic shelf registration statement (Registration No. 333-190506) for the potential offering and sale of debt and equity securities. The registration statement allows for the following types of securities to be offered: debt securities, junior subordinated debt securities, preferred stock, common stock, depositary shares, warrants, stock purchase contracts, and stock purchase units. In that The Hartford is a well-known seasoned issuer, as defined in Rule 405 under the Securities Act of 1933, the registration statement went effective immediately upon filing and The Hartford may offer and sell an unlimited amount of securities under the registration statement during the three-year life of the registration statement.
The Hartford is party to a put option agreement that provides The Hartford with the right to require the Glen Meadow ABC Trust, a Delaware statutory trust, at any time and from time to time, to purchase The Hartford’s junior subordinated notes in a maximum aggregate principal amount not to exceed $500. Under the Put Option Agreement, The Hartford will pay the Glen Meadow ABC Trust premiums on a periodic basis, calculated with respect to the aggregate principal amount of notes that The Hartford had the right to put to the Glen Meadow ABC Trust for such period. The Hartford has agreed to reimburse the Glen Meadow ABC Trust for certain fees and ordinary expenses. The Company holds a variable interest in the Glen Meadow ABC Trust where the Company is not the primary beneficiary. As a result, the Company did not consolidate the Glen Meadow ABC Trust. As of December 31, 2014, The Hartford has not exercised its right to require Glen Meadow ABC Trust to purchase the Notes. As a result, the notes remain a source of capital for the HFSG Holding Company.
On October 31, 2014, the Company entered into a senior unsecured five-year revolving credit facility (the “Credit Facility”) that provides for up to $1.0 billion of unsecured credit through October 31, 2019, available in U.S. dollars, Euro, Sterling, Canadian dollars, and Japanese Yen, and terminated its $1.75 billion credit facility expiring January 6, 2016. As of December 31, 2014, there were no borrowings outstanding under the Credit Facility. The Credit Facility is available for general corporate purposes. Of the total availability under the Credit Facility, up to $250 is available to support letters of credit issued on behalf of the Company or subsidiaries of the Company. Under the Credit Facility, the Company must maintain a minimum level of consolidated net worth of $13.5 billion. The definition of consolidated net worth under the terms of the Credit Facility excludes AOCI and includes the Company’s outstanding junior subordinated debentures and perpetual preferred securities, net of discount. In addition, the Company’s maximum ratio of consolidated total debt to consolidated total capitalization permitted under the Credit Facility is 35%, and the maximum ratio of subsidiary debt to consolidated total capitalization is 10%. As of December 31, 2014, the Company was in compliance with all financial covenants under the Credit Facility.
Life Operations’ total general account contractholder obligations are supported by $44 billion of cash and total general account invested assets, which includes a significant short-term investment position to meet liquidity needs.
As of December 31, 2014, Life Operations’ fixed maturities, short-term investments, and cash are summarized as follows:
Relates to annuities that are recorded in the general account (under U.S. GAAP), as the contractholders are subject to the Company's credit risk, although these annuities are held in a statutory separate account. In the statutory separate account, Life Operations is required to maintain invested assets with a fair value equal to the MVA surrender value of the Fixed MVA contract. In the event assets decline in value at a greater rate than the MVA surrender value of the Fixed MVA contract, Life Operations is required to contribute additional capital to the statutory separate account. Life Operations will fund these required contributions with operating cash flows or short-term investments. In the event that operating cash flows or short-term investments are not sufficient to fund required contributions, the Company may have to sell other invested assets at a loss, potentially resulting in a decrease in statutory surplus. As the fair value of invested assets in the statutory separate account are generally equal to the MVA surrender value of the Fixed MVA contract, surrender of Fixed MVA annuities will have an insignificant impact on the liquidity requirements of Life Operations.
The following table summarizes the Company’s aggregate contractual obligations as of December 31, 2014:
Includes contractual principal and interest payments. See Note 12 of Notes to Consolidated Financial Statements for additional discussion of long-term debt obligations.
Includes cash collateral of $327 which the Company has accepted in connection with the Company’s derivative instruments. Since the timing of the return of the collateral is uncertain, the return of the collateral has been included in the payments due in less than 1 year. Also included in other long-term liabilities are net unrecognized tax benefits of $48, retained Japan fixed payout annuity liabilities of $886, and consumer notes of $74. Consumer notes include principal payments and contractual interest for fixed rate notes and interest based on current rates for floating rate notes.
Total debt of the Company excludes $71 and $84 of consumer notes as of December 31, 2014 and December 31, 2013, respectively.
The Hartford’s total capitalization decreased $620 million, or 2%, from December 31, 2014 to December 31, 2013 primarily due to decreases in total debt. Total stockholders' equity, remained flat from December 31, 2013 to December 31, 2014 due to share repurchases during the period, offset by an increase in AOCI, primarily due to an increase in net unrealized capital gains from securities.
Cash provided by operating activities in 2014 reflect an increase in premiums collected and a decrease in loss and loss adjustment expenses paid, partially offset by an increase in payments for payables and accruals. Operating cash flows for the years ended December 31, 2014, and 2013 have been adequate to meet liquidity requirements. On June 30, 2014, the Company completed the sale of its Japan annuity business. The operations of this business are reported as discontinued operations and are primarily in Net cash provided by operating activities. For further information regarding these transactions, see Note 2 - Business Dispositions of Notes to Consolidated Financial Statements.
Cash used for investing activities in 2014 primarily relates to net proceeds from available-for-sale securities of $2.8 billion, and proceeds from the business sold of $963, partially offset by net payments for short-term investments of $1.8 billion. Cash used for investing activities in 2013 primarily relates to net proceeds from the sale of available-for-sale securities of $4.9 billion, and proceeds from the business sold of $815, partially offset by net payments on derivatives of $2.2 billion.
Cash used for financing activities in 2014 primarily relates to $2.2 billion related to net activity for investment and universal life products, and acquisition of treasury stock of $1.8 billion. Cash used for financing activities in 2013 primarily consists of net outflows on investment and universal life-type contracts of $2.1 billion, decrease in securities loaned or sold under agreements to repurchase of $1.9 billion, repayment of long term debt of $ 1.3 billion and treasury stock acquired of $600.
On April 3, 2014, A.M. Best revised the outlook to positive from stable and affirmed the issuer credit ratings and debt ratings of The Hartford Financial Services Group, Inc. and the financial strength ratings and issuer credit ratings of the property and casualty subsidiaries. A.M. Best upgraded the financial strength rating of Hartford Life and Accident Insurance Company to A from A- and affirmed the ratings of Hartford Life Insurance Company and Hartford Life and Annuity Insurance Company. A.M. Best's outlook for Hartford Life and Accident Insurance Company, Hartford Life Insurance Company and Hartford Life and Annuity Insurance Company is stable.
On April 15, 2014 Standard & Poor’s (“S&P”) raised its long-term financial strength rating and counterparty credit ratings on Hartford Life and Accident Insurance Company to A from A-. At the same time S&P raised the rating on Hartford Life Inc. to BBB from BBB-. The outlook for Hartford Life and Accident Insurance Company and Hartford Life, Inc. is stable.
The following table summarizes The Hartford’s significant member companies’ financial ratings from the major independent rating organizations as of February 24, 2015:
Statutory capital and surplus for the property and casualty insurance increased by $47, primarily due to statutory net income of $1.1 billion, and unrealized gains on investments of $1.4 billion, largely offset by dividends to the HFSG Holding Company of $2.5 billion.
The Company’s stockholders’ equity, as prepared using U.S. generally accepted accounting principles (“U.S. GAAP”) was $18.7 billion as of December 31, 2014. The Company’s estimated aggregate statutory capital and surplus, as prepared in conformity with statutory accounting practices prescribed or permitted by the applicable state insurance department (“U.S. STAT”) was $15.2 billion as of December 31, 2014. Significant differences between U.S. GAAP stockholders’ equity and aggregate statutory capital and surplus prepared in accordance with U.S. STAT include the following:
In any particular year, statutory surplus amounts and RBC ratios may increase or decrease depending upon a variety of factors. The amount of change in the statutory surplus or RBC ratios can vary based on individual factors and may be compounded in extreme scenarios or if multiple factors occur at the same time. At times the impact of changes in certain market factors or a combination of multiple factors on RBC ratios can be counterintuitive. For further discussion on these factors and the potential impacts to the life insurance subsidiaries, see the Financial Risk on Statutory Capital section within Enterprise Risk Management.
Statutory capital at the property and casualty subsidiaries has historically been maintained at or above the capital level required to meet “AA level” ratings from rating agencies. Statutory capital generated by the property and casualty subsidiaries in excess of the capital level required to meet “AA level” ratings is available for use by the enterprise or for corporate purposes. The amount of statutory capital can increase or decrease depending on a number of factors affecting property and casualty results including, among other factors, the level of catastrophe claims incurred, the amount of reserve development, the effect of changes in interest rates on investment income and the discounting of loss reserves, and the effect of realized gains and losses on investments.
The Dodd-Frank Act vests the Financial Stability Oversight Council (“FSOC”) with the power to designate “systemically important” institutions, which will be subject to special regulatory supervision and other provisions intended to prevent, or mitigate the impact of, future disruptions in the U.S. financial system. Based on its most current financial data, The Hartford is below the quantitative thresholds used by the FSOC to determine which nonbank companies merit consideration. However, the FSOC has indicted it will review on a quarterly basis whether nonbank financial institutions meet the metrics for further review. If we were to be designated as a systemically important institution, we could be subject to heightened regulation under the Federal Reserve, which could impact requirements regarding our required level of capital, liquidity and leverage as well as our business and investment conduct. In addition, we could be subject to assessments to pay for the orderly liquidation of other systemically important financial institutions that have become insolvent.
On March 23, 2010, the President signed the Affordable Care Act. The impact to The Hartford as an employer is consistent with other large employers. It is too early to tell how the Affordable Care Act will impact The Hartford's businesses. The Hartford’s core business does not involve the issuance of health insurance and we do not issue any products that insure customers under the Affordable Care Act’s individual mandate. There may be, nevertheless, impacts to The Hartford's businesses that are too early to identify as key aspects of the law are still not fully implemented. For example, private exchanges may provide The Hartford additional opportunities to market our group benefit products and services. Conversely, access to medical care and medical costs are a substantial component of both disability and workers compensation products offered by The Hartford. We are monitoring the impact of the Affordable Care Act on consumer, broker and medical provider behavior for leading indicators of changes in medical costs or loss payments primarily on the Company's workers' compensation and disability liabilities.
On January 12, 2015, the President signed TRIPRA, extending a backstop for insurance-related losses resulting from “acts of terrorism” through the end of 2020. For additional information, see Part II, Item 7, MD&A - Enterprise Risk Management, Reinsurance as a Risk Management Strategy, Reinsurance for Terrorism.
For a discussion regarding Guaranty Fund and Other Insurance-related Assessments, see Note 14 of Notes to Consolidated Financial Statements.