In the commercial liability lines, the Company performs the frequency / severity technique only on claims over a certain size
Auto Liability - Personal Lines. 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, including paid and reported development methods, frequency/severity approaches, and Berquist-Sherman techniques. The Company generally uses the reported development method for older accident years and the frequency/severity and Berquist-Sherman methods for more recent accident years. Recent periods are heavily 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 changes in case reserve adequacy and claim disposal rates.
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 various information that has been accumulated. Numerous factors are considered in this determination process including, but not limited to, the assessed reliability of key loss trends and assumptions that may be significantly influencing the current actuarial indications, the maturity of the accident year, 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. In general, changes are made more quickly to more mature accident years and less volatile lines of business. At year-end 2007, total recorded net reserves excluding asbestos and environmental and excluding the allowance for uncollectible reinsurance were 2.7% higher than the actuarial indication of the reserves. Annually, as part of the statutory reporting requirements, IBNR is allocated to accident year by statutory line of business. This work forms the basis for the loss development table and reserve re-estimates table shown in the “Business” section.
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, 2007 of $2.26 billion ($2.00 billion and $257 for asbestos and environmental, respectively) is within an estimated range, unadjusted for covariance, of $1.88 billion to $2.60 billion. The process of estimating asbestos and environmental reserves remains subject to a wide variety of uncertainties, which are detailed in Note 12 of Notes to Consolidated Financial Statements. The Company believes that its current asbestos and environmental reserves are reasonable and appropriate. However, analyses of further 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, financial condition and liquidity. If there are significant developments that affect particular exposures, reinsurance arrangements or the financial condition of particular reinsurers, the Company will make adjustments to its reserves or to the amounts recoverable from its reinsurers.
The overall actual return generated by the Japan variable annuity separate accounts is influenced by the variable annuity products offered in Japan as well as the wide variety of funds offered within the sub-accounts of those products. The actual return is also dependent upon the relative mix of the underlying sub-accounts among the funds. Unlike in the U.S., there is no global index or market that reasonably correlates with the overall Japan actual separate account fund performance.
separate account assets could fall, through a combination of negative market returns, lapses and mortality, by at least 54% and 69%, respectively, before portions of its DAC and sales inducement assets would be unrecoverable.
Each quarter, during this analysis, the Company asserts its intent and ability to retain until recovery those securities judged to be temporarily impaired. Once identified, these securities are systematically restricted from trading unless approved by the committee. The committee will only authorize the sale of these securities based on predefined criteria that relate to events that could not have been foreseen. Examples of the criteria include, but are not limited to, the deterioration in the issuer’s creditworthiness, a change in regulatory requirements or a major business combination or major disposition.
Life includes in an Other category its leveraged PPLI product line of business; corporate items not directly allocated to any of its reporting segments; inter-segment eliminations and the mark-to-market adjustment for the International variable annuity assets that are classified as equity securities held for trading reported in net investment income and the related change in interest credited reported as a component of benefits, losses and loss adjustment expenses since these items are not considered by the Company’s chief operating decision maker in evaluating the International results of operations.
The increase in Retail U.S. individual variable annuity account values can be attributed primarily to market growth during 2006.
Retail individual annuity, Retirement Plans, Institutional and Individual Life net investment spreads increased primarily due to a higher allocation of investments in higher yield/higher risk investment classes, including limited partnerships and alternative investments and relative strong performance of this asset class in 2007.
The decrease in Retirement Plan’s ROA, excluding realized gains (losses) and DAC unlock, was primarily due to a shift in product mix resulting in lower fees as a percent of assets.
Net realized capital losses were larger in the year ended December 31, 2006 compared to 2005 primarily due to rising interest rates. Components of the increased realized losses included increased other than temporary impairments (see the Other-Than-Temporary Impairments discussion within Investment Results for more information on the increase in impairments), losses on non-qualifying derivatives and net losses on sales of investments.
Net realized gains (losses) for the year ended December 31, 2007
Retail losses decreased $20 on GMWB derivatives, primarily driven by a more significant impact from liability model refinements and assumption updates in 2005 as compared to 2006. For further discussion of the GMWB rider valuation assumption, see the Capital Markets Risk Management section of the MD&A under “Market Risk-Life”.
International losses on periodic net coupons from currency swaps increased $29 primarily due to increased fixed annuity assets.
Other net losses were primarily driven from the change in value of non-qualifying derivatives due to fluctuations in interest rates and foreign currency exchange rates. These losses were partially offset by a pre-tax benefit of $25 received from the WorldCom security settlement.
Net income in Retail increased for the year ended December 31, 2007, primarily driven by lower amortization of DAC resulting from the unlock benefit in the third quarter of 2007, fee income growth in the variable annuity and mutual fund businesses, partially offset by increased non-deferrable individual annuity asset based commissions and mutual fund commissions In addition, realized capital losses increased $294 for the year ended December 31, 2007 as compared to the prior year period. For further discussion, see Realized Capital Gains and Losses by Segment table under Life’s Operating Section of the MD&A. A more expanded discussion of income growth is presented below:
Institutional primarily offers customized wealth creation and financial protection for institutions, corporate and high net worth individuals through its two business units: IIP and PPLI.
Net investment income increased for the year ended December 31, 2007 substantially consistent with growth in general account account values. Individual Life earned additional net investment income throughout 2007 associated with higher returns from partnership investments.
Management’s current full year life insurance in-force projection for 2008 is an increase of 8% to 9%.
Also contributing to the higher fee income was increased surrender activity as some customers surrendered policies in order to lock in favorable market appreciation in their account balances. Surrender fees increased by $19, or 53% from the prior year.
During 2005, the Company recorded a charge of $18, after-tax, related to the settlement of certain annuity contracts.
The prior year loss and loss adjustment expense ratio represents the increase (decrease) in the estimated cost of settling catastrophe and non-catastrophe claims incurred in prior accident years as recorded in the current calendar year divided by earned premiums.
The expense ratio is the ratio of underwriting expenses, excluding bad debt expense, to earned premiums. Underwriting expenses include the amortization of deferred policy acquisition costs and insurance operating costs and expenses. Deferred policy acquisition costs include commissions, taxes, licenses and fees and other underwriting expenses and are amortized over the policy term.
When fixed maturity or equity investments are sold, any gain or loss is reported in net realized capital gains (losses). Individual securities may be sold for a variety of reasons, including a decision to change the Company’s asset allocation in response to market conditions and the need to liquidate funds to meet large claim settlements. Accordingly, net realized capital gains (losses) for any particular period are not predictable and can vary significantly. In addition, net realized capital gains (losses) include other-than-temporary impairments in the fair value of investments, changes in the fair value of non-qualifying derivatives and hedge ineffectiveness on qualifying derivative instruments. Refer to the Investment section of MD&A for further discussion of net investment income and net realized capital gains (losses).
Strengthened Middle Market general liability loss and loss adjustment expense reserves by $20 for accident years 1998 to 2005, primarily as a result of increasing allocated loss adjustment expenses associated with closing older claims. The $20 of reserve strengthening represented 2% of the Company’s net reserves for general liability claims as of December 31, 2005.
The principal property catastrophe reinsurance program and other reinsurance programs include a provision to reinstate limits in the event that a catastrophe loss exhausts limits on one or more layers under the treaties.
For terrorism, private sector catastrophe reinsurance capacity is limited and generally unavailable for terrorism losses caused by nuclear, biological, chemical or radiological weapons attacks. As such, the Company’s principal reinsurance protection against large-scale terrorist attacks is the coverage currently provided through the Terrorism Risk Insurance Program Reauthorization Act (TRIPRA). On December 26, 2007, the President signed TRIPRA extending the Terrorism Risk Insurance Act of 2002 (“TRIA”) through the end of 2014. TRIPRA provides a backstop for insurance-related losses resulting from any “act of terrorism” certified by the Secretary of the Treasury, in concurrence with the Secretary of State and Attorney General, that result in industry losses in excess of $100. In addition, TRIPRA revised the TRIA definition of a certified “act of terrorism” by removing the requirement that an act be committed “on behalf of any foreign person or foreign interest.” As a result, domestic acts of terrorism can now be certified as “acts of terrorism” under the program, subject to the other requirements of TRIPRA. Under the program, in any one calendar year, the federal government would pay 85% of covered losses from a certified act of terrorism after an insurer’s losses exceed 20% of the company’s eligible direct commercial earned premiums of the prior calendar year, up to a combined annual aggregate limit for the federal government and all insurers of $100 billion. If an act of terrorism or acts of terrorism result in covered losses exceeding the $100 billion annual industry aggregate limit, a future Congress would be responsible for determining how additional losses in excess of $100 billion will be paid.
The following table shows the components of the gross and net reinsurance recoverable as of December 31, 2007 and 2006:
Net favorable prior accident year reserve development increased from $64, or 0.6 points, in 2006 to $145, or 1.4 points, in 2007. Net favorable reserve development of $145 in 2007 included several changes in reserves, including a $151 release of workers’ compensation loss and loss adjustment expense reserves, primarily for accident years 2002 to 2006. Refer to the “Reserves” section of the MD&A for further discussion of the prior accident year reserve development in 2007.
Net realized capital losses increased from $17 in 2006 to $160 in 2007, primarily due to an increase in credit-related impairments and decreases in the fair value of non-qualifying derivatives attributable to changes in value associated with credit derivatives due to credit spreads widening. Credit-related impairments in 2007 primarily consisted of impairments of asset-backed securities backed by sub-prime residential mortgage loans and impairments of corporate securities in the financial services and homebuilders sectors. (See the Other-Than-Temporary Impairments discussion within Investment Results for more information on the impairments recorded in 2007).
Ongoing Operations’ current accident year loss and loss adjustment expenses before catastrophes increased by $143 in 2006, to $6,507, due largely to the increase in earned premium. Excluding the effect of catastrophe treaty reinstatement premium, the current accident year loss and loss adjustment expense ratio before catastrophes increased by 0.2 points, to 62.4, due to an increase in the current accident year loss and loss adjustment expense ratio before catastrophes of 0.9 points in Personal Lines, 2.1 points in Middle Market and 0.3 points in Specialty Commercial, largely offset by a decrease in the current accident year loss and loss adjustment expense ratio before catastrophes of 1.8 points in Small Commercial.
Auto earned premium grew slightly, by $30, or 1%, for the year ended December 31, 2007, primarily due to new business outpacing non-renewals in AARP and Agency over the last six months of 2006 and the first six months of 2007, partially offset by the effect of the sale of Omni. Before considering the effect of the sale of Omni, auto earned premium grew $152, or 6%, for the year ended December 31, 2007. Homeowners’ earned premium grew $99, or 10%, primarily due to earned pricing increases and due to new business outpacing non-renewals in AARP business over the last six months of 2006 and the first six months of 2007 and new business outpacing non-renewals in Agency over the last three months of 2006 and the first six months of 2007. Consistent with the growth in earned premium, the number of policies in-force has increased in auto and homeowners. The growth in policies in-force does not correspond directly with the growth in earned premiums due to the effect of earned pricing changes and because policy in-force counts are as of a point in time rather than over a period of time.
Underwriting results decreased by $107, from $429 to $322, with a corresponding 3.1 point increase in the combined ratio, from 88.6 to 91.7, due to:
For homeowners, written pricing increased 5% in 2007, primarily reflecting an increase in insurance to value and an increase in the value of insured properties. Non-catastrophe loss costs of homeowners claims increased in 2007 due to higher claim severity and management expects this trend to continue in 2008.
Earned premiums for the Small Commercial segment increased $231, or 10%. The increase was primarily due to new business growth outpacing non-renewals over the last six months of 2005 and the full year of 2006, partially offset by the effect of higher property catastrophe treaty reinsurance costs.
Consistent with the increase in earned premium the number of policies in-force has increased. The growth in policies in-force does not correspond directly with the change in earned premiums due to the effect of changes in earned pricing, changes in the average premium per policy and because policy in-force counts are as of a point in time rather than over a period of time.
The one year and average three year net paid amounts for asbestos claims, including Ongoing Operations, were $291 and $291, respectively, resulting in a one year net survival ratio of 6.9 and a three year net survival ratio of 6.9. Net survival ratio is the quotient of the net carried reserves divided by the average annual payment amount and is an indication of the number of years that the net carried reserve would last (i.e. survive) if the future annual claim payments were consistent with the calculated historical average.
The Company includes its allowance for uncollectible reinsurance in the “All Other” category of reserves. When the Company commutes a ceded reinsurance contract or settles a ceded reinsurance dispute, the portion of the allowance for uncollectible reinsurance attributable to that commutation or settlement, if any, is reclassified to the appropriate cause of loss.
Primarily consists of changes in fair value on non-qualifying derivatives, hedge ineffectiveness on qualifying derivative instruments and other investment gains.
The other-than-temporary impairments reported in Other were recorded on securities that had declined in value for which the Company was uncertain of its intent to retain the investments for a period of time sufficient to for allow recovery to amortized cost. Prior to the other-than-temporary impairments, these securities had an average market value as a percentage of amortized cost of 83%.
long-term interest rates rise dramatically within a six to twelve month time period, certain Life 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 Life’s fixed income product offerings have market value adjustment provisions at contract surrender.
At December 31, 2007 and 2006, notional amounts pertaining to derivatives utilized to manage interest rate risk totaled $16.8 billion and $15.6 billion, respectively ($13.1 billion and $11.4 billion, respectively, related to investments and $3.7 billion and $4.2 billion, respectively, related to life liabilities). The fair value of these derivatives was $45 and $(42) as of December 31, 2007 and 2006, respectively.
The fixed liabilities included above represented approximately 45% and 46% of Life’s general account liabilities as of December 31, 2007 and 2006, respectively. The assets supporting the fixed liabilities are monitored and managed within rigorous duration guidelines using scenario simulation techniques, and are evaluated on an annual basis, in compliance with regulatory requirements.
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
In April 2006, the Company entered into an indemnity reinsurance agreement with an unrelated party. Under this agreement, the reinsurer will reimburse the Company for death benefit claims, up to an annual cap, incurred for certain death benefit guarantees associated with an in-force block of variable annuity products offered in Japan with an account value of $2.3 billion as of December 31, 2007.
The following table provides an analysis showing the estimated after-tax change in the fair value of Property & Casualty’s fixed maturity investments and related derivatives, assuming 100 basis point upward and downward parallel shifts in the yield curve as of December 31, 2007 and 2006. Certain financial instruments, such as limited partnerships, 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 Hartford’s Board of Directors has authorized the Company to repurchase up to $2 billion of its securities. For the year ended December 31, 2007, The Hartford repurchased $1.2 billion of its common stock (12.9 million shares) under this program. The Company’s repurchase authorization permits purchases of common stock, which may be in the open market or through privately negotiated transactions. The Company also may enter into derivative transactions to facilitate future repurchases of common stock. The timing of any future repurchases will be dependent upon several factors, including the market price of the Company’s securities, the Company’s capital position, consideration of the effect of any repurchases on the Company’s financial strength or credit ratings, and other corporate considerations. The repurchase program may be modified, extended or terminated by the Board of Directors at any time.
The Hartford declared $643 and paid $636 in dividends to shareholders in 2007 and declared $531 and paid $460 in dividends to shareholders in 2006.