(1)On November 10, 1998, the Company recaptured an in force block of corporate owned life insurance (COLI) business from MBL Life Assurance Co. of New Jersey (MBL Life). For additional information, see the COLI section as well as the MBL Recapture discussion under "Purchases of Affiliates and Other" within the Capital Resources and Liquidity section of the Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A).
(5)1996 includes realized losses of $225 primarily resulting from actions taken in the third quarter of 1996 related to the Company's guaranteed investment contract business.
(6)Pro forma effect on basic and diluted earnings per share has been given for the 1997 and 1996 periods presented for the conversion of 1,000 shares of common stock into 114 million shares of Class B Common Stock, which occurred on April 3, 1997, prior to the Company's initial public offering (IPO). For information regarding the IPO and earnings per share data, see Notes 3 and 10 of Notes to Consolidated Financial Statements, respectively.
(7)Dividends per common share represent amounts declared subsequent to the Company's IPO on May 22, 1997. (For information regarding the IPO, see Note 3 of Notes to Consolidated Financial Statements.) The table does not include dividends paid to the parent in periods prior to the IPO.
The Company derives its revenues principally from: (a) asset management fees on separate account and mutual fund assets and mortality and expense fees; (b) fully insured premiums; (c) cost of insurance charges; (d) net investment income on general account assets; and (e) certain other fees earned by the Company. Asset management fees and mortality and expense fees are primarily generated from separate account assets, which are deposited with the Company through the sale of variable annuity products and variable life products, and mutual funds. Premium revenues are derived primarily from the sale of group life and group disability insurance products. Cost of insurance charges are assessed on the net amount at risk for investment oriented life insurance products.
Hartford Life's profitability depends largely on the amount of assets under management, the level of fully insured premiums, the adequacy of product pricing and underwriting discipline, and its ability to earn target spreads between earned investment rates on general account assets and credited rates to customers.
1999 COMPARED TO 1998 - Revenues decreased $252, or 4%, due primarily to the declining block of leveraged COLI business. Excluding the COLI segment, revenues increased $484, or 11%, driven mostly by the Investment Products and Employee Benefits segments, where revenues increased $257, or 14%, and $215, or 12%, respectively. The revenue growth in the Investment Products segment was, for the most part, due to higher fee income in the individual annuity and mutual fund operations. Combined fee income for these products increased $301, or 33%, to $1,215 due to significant growth in related assets under management resulting from strong sales, favorable persistency and equity market appreciation. The growth in Employee Benefits revenues was fundamentally due to higher premium revenue generated by persistency of the in force block of business, coupled with strong sales to new customers.
1998 COMPARED TO 1997 - Revenues increased $1.1 billion, or 23%, essentially due to the continued growth of revenues in the Investment Products and Individual Life segments of $274 and $57, respectively. Investment Products and Individual Life revenues increased as a result of higher assets under management associated with strong net cash flow and equity market appreciation. Additionally, Employee Benefits revenues increased $109, or 6%, due to strong sales and favorable persistency. COLI revenues increased $587 primarily due to the recapture in the fourth quarter of 1998 of an in force block of COLI business previously ceded to MBL Life Assurance Co. of New Jersey. (For a discussion of the MBL Recapture, see the Capital Resources and Liquidity section.)
The Investment Products segment focuses on the savings and retirement needs of the growing number of individuals who are preparing for retirement or have already retired through the sale of individual fixed and variable annuities, mutual funds, retirement plan services and other investment products. The Company was ranked the number one writer of individual variable annuities in the United States for 1999 according to Variable Annuity and Research Data Service (VARDS) and the number one seller of individual variable annuities through banks, according to Kenneth Kehrer and Associates. In addition, The Hartford Mutual Funds became the first retail mutual fund family to surpass $6.0 billion in assets in less than three and a half years of existence. Also, seven of the twelve mutual funds received Morningstar ratings and, as of December 31, 1999, all seven have three-, four- or five-star ratings.
1999 COMPARED TO 1998 - Revenues increased $257, or 14%, primarily due to higher fee income in the individual annuity and retail mutual fund operations. Fees generated by individual annuities increased $248, or 29%, as related account values increased $18.2 billion, or 26%. The growth in individual annuity account values was mostly due to significant net cash flow, resulting from strong sales of $10.9 billion and favorable persistency, as well as equity market appreciation. In addition, fee income from other investment products increased $68, or 59%, primarily due to the Company's continued growth in its retail mutual fund operation, where assets under management grew $3.9 billion, or 154%. This tremendous growth was driven by phenomenal sales of $3.3 billion, favorable persistency and equity market appreciation.
Associated with continued growth in this segment, total benefits, claims and expenses increased $165, or 12%. This increase was primarily driven by amortization of deferred policy acquisition costs, which grew $104, or 32%, and operating expenses, which increased $32, or 13%, as a result of growth in the individual annuity and mutual fund operations described above.
Net income increased $64, or 24%, for the most part due to the growth in revenues discussed above. Also contributing to the higher net income were operating efficiencies that the segment continues to achieve, particularly in its individual variable annuity operation, where operating expenses as a percentage of average individual annuity account values decreased from 23 basis points to 21 basis points.
1998 COMPARED TO 1997 - Revenues increased $274, or 18%, driven primarily by higher fee income in the individual annuity operation. Individual variable annuity fee income increased $236, or 38%, as related account values grew $15.3 billion, or 33%. The growth in individual variable annuity account values was due to significant net cash flow, the result of strong sales of $9.9 billion and favorable persistency, as well as equity market appreciation. In addition, fee income from other investment products increased $60, or 107%, most notably the result of growth in the Company's mutual fund operations, where related assets under management increased $1.5 billion, or 158%.
Total benefits, claims and expenses increased $177, or 15%, as a result of the continued growth in this segment. Amortization of deferred policy acquisition costs grew $76, or 30%, and other expenses increased $107, or 40%, essentially due to growth in the individual annuity and mutual fund operations discussed above. The increased revenues associated with the 33% growth in individual variable annuity account values, coupled with a reduction in individual annuity operating expenses as a percentage of average individual annuity account values to 23 basis points from 25 basis points, contributed to the increase in net income of $64, or 32%.
1999 COMPARED TO 1998 - Revenues increased $17, or 3%, resulting primarily from higher fee income associated with the growing block of variable life insurance. Fee income increased $59, or 18%, as variable life account values increased $868, or 50%, and variable life insurance in force increased $7.5 billion, or 46%. The higher fee income was partially offset by a decrease in premium revenue resulting from the sale of the Company's Canadian life insurance operation in 1999. Total benefits, claims and expenses increased slightly, principally due to a $21 increase in amortization of deferred policy acquisition costs associated with the growth in this segment's revenues, partially offset by a decrease of $11 in benefits, claims and claim adjustment expenses due to the sale of the Canadian life insurance operation and lower mortality costs. Net income increased $6, or 9%, essentially due to the higher fee income and favorable mortality described above.
1999 COMPARED TO 1998 - Revenues increased $215, or 12%, driven by growth in fully insured premiums, excluding buyouts, which increased $172, or 11%. This increase was fundamentally due to group life and group disability, where ongoing premiums increased $49, or 9%, and $63, or 11%, respectively, due to strong persistency of the in force block of business, coupled with an increase in sales to new customers.
1998 COMPARED TO 1997 - Revenues increased $109, or 6%, driven by growth in fully insured premiums, excluding buyouts, which increased $181, or 13%. This increase was primarily due to group life and group disability, where ongoing premiums increased $69 and $55, respectively, due to strong sales and good persistency. Sales of fully insured business, excluding buyouts, increased $68, or 21%, of which group life and group disability business increased $26 and $23, respectively.
to growth in the variable COLI business, where related account values increased $1.2 billion, or 10%. Additionally, leveraged COLI net income increased due to earnings associated with the MBL business recaptured in November 1998 (as discussed earlier), which was partially offset by decreases associated with the downsizing of the overall leveraged COLI business.
1998 COMPARED TO 1997 - Revenues increased $587, or 60%, primarily related to the recaptured MBL business of $541, comprised of $163 of premiums and other considerations and $378 of net investment income. In addition, revenues increased due to fee income on growing variable COLI account values, partially offset by declines in revenues associated with the downsizing of the overall leveraged COLI business. Benefits, claims and expenses increased $593, or 63%, primarily due to the recaptured MBL business. The MBL recapture resulted in an increase in benefits, claims and expenses of $541 and was comprised of $452 of benefits, claims and other expenses and $89 of dividends to policyholders. Net income declined $3, or 11%, as the growth in the Company's variable COLI business was offset by the declining block of leveraged COLI the Company had prior to passage of the HIPA Act of 1996. The recaptured MBL business had no impact on net income in 1998.
The following table sets forth by type the fixed maturity securities held in the Company's general account as of December 31, 1999 and 1998.
1999 COMPARED TO 1998 - Total net investment income, before-tax, decreased $393, or 20%, most notably due to a decrease in policy loan income of $398 associated with the downsizing of the leveraged COLI business. Yield on average invested assets declined to 6.7% as a result of a decline in the policy loan weighted average interest rate to 7.5% in 1999 from 9.9% in 1998. Net realized capital losses included a $5 loss from the sale of Hartford Life Insurance Company Canada Holdings, Inc. Additionally, net realized capital gains on the sale of equity securities and fixed maturities offset a $32, after-tax, other than temporary impairment charge related to asset backed securities securitized and serviced by Commercial Financial Services, Inc. (CFS) securities, which were sold in August of 1999.
Hartford Life has established investment credit policies that focus on the credit quality of obligors and counterparties, limit credit concentrations, encourage diversification and require frequent creditworthiness reviews. Investment activity, including setting of policy and defining acceptable risk levels, is subject to regular review and approval by senior management.
The Company also maintains credit policies regarding the financial stability and credit standing of its major derivatives' counterparties and typically requires credit enhancement provisions to further reduce its credit risk. Credit risk for derivatives contracts is limited to the amounts calculated to be due to the Company on such contracts based on current market conditions and potential payment obligations between the Company and its counterparties. Credit exposures are quantified weekly and netted. Collateral is pledged to or held by the Company to the extent the current value of derivatives exceeds exposure policy thresholds.
Changes in interest rates can potentially impact the Company's profitability. Under certain circumstances of interest rate volatility, the Company could be exposed to disintermediation risk and reduction in net interest rate spread or profit margins. For non-guaranteed separate accounts, the Company's exposure is not significant since the policyholder assumes substantially all the investment risk.
The Company's general account and guaranteed separate account investment portfolios primarily consist of investment grade, fixed maturity securities, including corporate bonds, asset backed securities, collateralized mortgage obligations and mortgage backed securities. The fair value of these and the Company's other invested assets fluctuates depending on the interest rate environment and other general economic conditions. During periods of declining interest rates, paydowns on mortgage backed securities and collateralized mortgage obligations increase as the underlying mortgages are prepaid. In addition, during such periods, the Company generally will not be able to reinvest the proceeds of any such prepayments at comparable yields. Conversely, during periods of rising interest rates, the rate of prepayments generally declines, exposing the Company to the possibility of asset/liability cash flow and yield mismatch. For a discussion of the Company's risk management techniques to manage this market risk, see "Asset/Liability Management Strategies Used to Manage Market Risk" below.
As described above, the Company holds a significant fixed maturity portfolio, which includes both fixed and variable rate features. The following table reflects the principal amounts of the fixed and variable rate fixed maturity portfolio, along with the respective weighted average coupons by estimated maturity year as of December 31, 1999. Comparative totals are included for December 31, 1998. Expected maturities differ from contractual maturities due to call or prepayment provisions. The weighted average coupon on variable rate securities is based on spot rates as of December 31, 1999 and 1998, and is primarily based on the London Interbank Offered Rate (LIBOR). Callable bonds and notes are distributed to either call dates or maturity, depending on which date produces the most conservative yield. Asset backed securities, collateralized mortgage obligations and mortgage backed securities are distributed to maturity year based on estimates of the rate of future prepayments of principal over the remaining life of the securities. These estimates are developed using prepayment speeds provided in broker consensus data. Such estimates are derived from prepayment speeds previously experienced at the interest rate levels projected for the underlying collateral. Actual prepayment experience may vary from these estimates. Financial instruments with certain leverage features have been included in each of the fixed maturity categories. These instruments have not been separately displayed because they were immaterial to the Company's investment portfolio.
The table below provides information as of December 31, 1999 and 1998 on debt obligations and reflects principal cash flows and related weighted average effective interest rate by maturity year.
Derivatives play an important role in facilitating the management of interest rate risk, creating opportunities to efficiently fund obligations, hedge against risks that affect the value of certain liabilities and adjust broad investment risk characteristics as a result of any significant changes in market risks. The Company uses a variety of derivatives, including swaps, caps, floors, forwards and exchange traded financial futures and options, in order to hedge exposure primarily to interest rate risk on anticipated investment purchases or existing assets and liabilities. The Company does not make a market or trade derivatives for the express purpose of earning trading profits. The Company's derivative program is monitored by an internal compliance unit and is reviewed frequently by senior management. The notional amounts of derivative contracts, which represent the basis upon which pay or receive amounts are calculated and are not reflective of credit risk, totaled $9.6 billion as of December 31, 1999 ($6.3 billion related to insurance investments and $3.3 billion related to life insurance liabilities). As of December 31, 1998, the notional amounts pertaining to derivatives totaled $11.2 billion ($6.0 billion related to insurance investments and $5.2 billion related to life insurance liabilities).
Anticipatory Hedging -- For certain liabilities, the Company commits to the price of the product prior to receipt of the associated premium or deposit. Anticipatory hedges are routinely executed to offset the impact of changes in asset prices arising from interest rate changes pending the receipt of premium or deposit and the subsequent purchase of an asset. These hedges involve taking a long position in interest rate futures or entering into an interest rate swap with duration characteristics equivalent to the associated liabilities or anticipated investments. The notional amount of anticipatory hedges as of December 31, 1999 and 1998 was $314 and $712, respectively.
Asset Hedging -- To meet the various policyholder obligations and to provide cost effective prudent investment risk diversification, the Company may combine two or more financial instruments to achieve the investment characteristics of a fixed maturity security or that match an associated liability. The use of derivative instruments in this regard effectively transfers unwanted investment risks or attributes to others. The selection of the appropriate derivative instruments depends on the investment risk, the liquidity and efficiency
Interest Credited -- Products in this category credit interest to policyholders, subject to market conditions and minimum guarantees. Policyholders may surrender at book value but are subject to surrender charges for an initial period. Product examples include universal life contracts and the general account portion of the Company's variable annuity products. Liability duration is short to intermediate term.
In 1999, a total of $50 in dividends was declared to holders of Class A and Class B Common Stock.
On February 17, 2000, Hartford Life's Board of Directors approved an 11% increase in the quarterly dividend to $0.10 per share, payable on April 3, 2000 to stockholders of record on March 1, 2000. Future dividend decisions are based on, and affected by, a number of factors, including the operating results and financial requirements of Hartford Life on a stand-alone basis and the impact of the regulatory restrictions discussed in Liquidity Requirements below.
The following table summarizes Hartford Life's significant U.S. member companies' financial ratings from the major independent rating organizations as of February 29, 2000:
The primary uses of funds are to pay claims, policy benefits, operating expenses and commissions, and to purchase new investments. Hartford Life carries a significant short-term investment position and accordingly does not anticipate selling intermediate- and long-term fixed maturity investments to meet any liquidity needs. For a discussion of the Company's investment objectives and strategies, see the Investments section.
In 1998, the change in cash provided by operating activities was primarily the result of timing in the settlement of receivables and payables. The change in cash provided by (used for) investing activities primarily reflects a decrease in policy loans resulting from the reduction of COLI account values in conjunction with the decline of the block of leveraged COLI offset by the investment of cash from operating and financing activities. The change in cash used for financing activities was primarily due to declines in GIC and COLI account values as well as proceeds from the IPO in May 1997, partially offset by changes in debt, dividends paid and proceeds from the TruPS offering.
PLANCO -- On August 26, 1998, the Company completed the purchase of all outstanding shares of PLANCO Financial Services, Inc. and its affiliate, PLANCO, Incorporated (collectively, "PLANCO"). PLANCO, a primary distributor of the Company's annuities and mutual funds, is the nation's largest wholesaler of individual annuities and has played a significant role in Hartford Life's growth over the past decade. As a wholesaler, PLANCO distributes Hartford Life's fixed and variable annuities, mutual funds and single premium variable life insurance, as well as providing sales support to registered representatives, financial planners and broker-dealers at brokerage firms and banks across the United States. The acquisition has been accounted for as a purchase and accordingly, the results of PLANCO's operations have been included in the Company's consolidated financial statements from the closing date of the transaction.
MBL Recapture -- On November 10, 1998, the Company recaptured an in force block of COLI business (referred to as "MBL Recapture") previously ceded to MBL Life Assurance Co. of New Jersey (MBL Life). The transaction was consummated through the assignment of a reinsurance arrangement between Hartford Life and MBL Life to a Hartford Life subsidiary. Hartford Life originally assumed the life insurance block in 1992 from Mutual Benefit Life, which was placed in court-supervised rehabilitation in 1991, and reinsured a portion of those policies back to MBL Life. MBL Life, previously a Mutual Benefit Life subsidiary, operated under the Rehabilitation Plan for Mutual Benefit Life. The MBL Recapture has been recorded retroactive to January 1, 1998 with respect to results of operations. The transaction resulted in a decrease in reinsurance recoverables of $4.8 billion with an offset primarily in policy loans and other investments.
The NAIC has been developing several model laws and regulations, including a Model Investment Law and amendments to the Model Holding Company System Regulatory Act (the "Holding Act Amendments"). The Model Investment Law defines the investments which are permissible for life insurers to hold, and the Holding Act Amendments address the types of activities in which subsidiaries and affiliates may engage. The NAIC adopted these models in 1997 and 1996, but the laws have not been enacted for insurance companies domiciled in the State of Connecticut, such as Hartford Life. Even if enacted in Connecticut or other states in which Hartford Life's insurance subsidiaries are domiciled, it is expected that these laws will neither significantly change Hartford Life's investment strategies nor have any material adverse effect on Hartford Life's liquidity or financial position.
The NAIC adopted the Codification of Statutory Accounting Principles (SAP) in March 1998. The proposed effective date for the statutory accounting guidance is January 1, 2001. It is expected that each of Hartford Life's domiciliary states will adopt the SAP and the Company will make the necessary changes required for implementation. The Company has not yet determined the impact that the SAP will have on the statutory financial statements of the insurance subsidiaries of Hartford Life.
The Year 2000 issue relates to the ability or inability of computer hardware, software and other information technology (IT) systems, as well as non-IT systems, such as equipment and machinery with imbedded chips and microprocessors, to properly process information and data containing or related to dates beginning with the Year 2000 and beyond. The Year 2000 issue exists because, historically, many IT and non-IT systems that are in use today were developed years ago when a year was identified using a two-digit date field rather than a four-digit date field. As information and data containing or related to the century date are introduced to date sensitive systems, these systems may recognize the Year 2000 as "1900," or not at all, which may result in systems processing information incorrectly. This, in turn, may significantly and adversely affect the integrity and reliability of information databases of IT systems, may cause the malfunctioning of certain non-IT systems, and may result in a wide variety of adverse consequences to a company. In addition, Year 2000 problems that occur with third parties with which a company does business, such as suppliers, computer vendors, distributors and others, may also adversely affect any given company.
The integrity and reliability of Hartford Life's IT systems, as well as the reliability of its non-IT systems, are integral aspects of Hartford Life's business. Hartford Life issues insurance policies, annuities, mutual funds and other financial products to individual and business customers, nearly all of which contain date sensitive payment dates. In addition, various IT systems support communications and other systems that integrate Hartford Life's various business segments and field offices, including Hartford Life's foreign operations. Hartford Life also has business relationships with numerous third parties that affect virtually all aspects of Hartford Life's business, including, without limitation, suppliers, computer hardware and software vendors, insurance agents and brokers, securities broker-dealers, banks and other distributors and servicers of financial products, many of which provide date sensitive data to Hartford Life and whose operations are important to Hartford Life's business.
The after-tax costs of Hartford Life's Year 2000 efforts that were incurred prior to January 1, 1998 were not material to Hartford Life's financial condition or results of operations. For the years ended December 31, 1999 and 1998, the after-tax costs were approximately $3 and $4, respectively. These costs were expensed as incurred. Hartford Life does not expect to incur significant costs in the year 2000 related to its Year 2000 efforts.
The rate of inflation as measured by the change in the average consumer price index has not had a material effect on the revenues or operating results of Hartford Life during the three most recent fiscal years.