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Proc-Type: 2001,MIC-CLEAR
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<SEC-DOCUMENT>0000948572-03-000012.txt : 20030303
<SEC-HEADER>0000948572-03-000012.hdr.sgml : 20030303
<ACCEPTANCE-DATETIME>20030303162916
ACCESSION NUMBER: 0000948572-03-000012
CONFORMED SUBMISSION TYPE: 10-K
PUBLIC DOCUMENT COUNT: 14
CONFORMED PERIOD OF REPORT: 20021231
FILED AS OF DATE: 20030303
FILER:
COMPANY DATA:
COMPANY CONFORMED NAME: HARTFORD FINANCIAL SERVICES GROUP INC/DE
CENTRAL INDEX KEY: 0000874766
STANDARD INDUSTRIAL CLASSIFICATION: INSURANCE AGENTS BROKERS & SERVICES [6411]
IRS NUMBER: 133317783
STATE OF INCORPORATION: DE
FISCAL YEAR END: 1231
FILING VALUES:
FORM TYPE: 10-K
SEC ACT: 1934 Act
SEC FILE NUMBER: 001-13958
FILM NUMBER: 03589664
BUSINESS ADDRESS:
STREET 1: HARTFORD PLZ
CITY: HARTFORD
STATE: CT
ZIP: 06115
BUSINESS PHONE: 8605475000
MAIL ADDRESS:
STREET 1: HARTFORD PLAZA T-15
CITY: HARTFORD
STATE: CT
ZIP: 06115
FORMER COMPANY:
FORMER CONFORMED NAME: ITT HARTFORD GROUP INC /DE
DATE OF NAME CHANGE: 19930328
</SEC-HEADER>
<DOCUMENT>
<TYPE>10-K
<SEQUENCE>1
<FILENAME>b10k12312002.txt
<DESCRIPTION>THE HARTFORD FINANCIAL SERVICES GROUP
<TEXT>
NOTICE
This document is a copy of the Annual Report filed by The Hartford Financial
Services Group, Inc. with the Securities and Exchange Commission. It has not
been approved or disapproved by the Commission nor has the Commission passed
upon its accuracy or adequacy.
<PAGE>
================================================================================
FORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ____________ to ______________
Commission file number 0-19277
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 13-3317783
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation Or Organization) Identification No.)
HARTFORD PLAZA, HARTFORD, CONNECTICUT 06115-1900
(Address of Principal Executive Offices)
(860) 547-5000
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act: the following, all
of which are registered on the New York Stock Exchange, Inc.:
Common Stock, par value $0.01 per share
7.75% Notes due June 15, 2005
4.7% Notes due September 1, 2007
6.375% Notes due November 1, 2008
4.1% Equity Unit Notes due November 16, 2008
7.90% Notes due June 15, 2010
7.30% Debentures due November 1, 2015
7.70% Cumulative Quarterly Income Preferred Securities, Series A, issued
by Hartford Capital I
7.45% Trust Originated Preferred Securities, Series C, issued by Hartford
Capital III
Securities registered pursuant to Section 12 (g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained to the best
of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
As of February 27, 2003, there were outstanding 255,399,358 shares of Common
Stock, $0.01 par value per share, of the registrant. Indicate by check mark
whether the registrant is an accelerated filer (as defined in Exchange Act Rule
12b-2) Yes [X] No [ ].
The aggregate market value of the shares of Common Stock held by non-affiliates
of the registrant as of June 28, 2002, was $14,673,000,000 based on the closing
price of $59.47 per share of the Common Stock on the New York Stock Exchange on
June 28, 2002.
Documents Incorporated by Reference:
Portions of the Registrant's definitive proxy statement for its 2003 annual
meeting of shareholders are incorporated by reference in Part III of this Form
10-K.
<PAGE>
CONTENTS
ITEM DESCRIPTION PAGE
PART I 1 Business of The Hartford 2
2 Properties 13
3 Legal Proceedings 13
4 Submission of Matters to a Vote of Security Holders 15
PART II 5 Market for The Hartford's Common Stock and Related
Stockholder Matters 15
6 Selected Financial Data 16
7 Management's Discussion and Analysis of Financial
Condition and Results of Operations 17
7A Quantitative and Qualitative Disclosures About Market Risk 72
8 Financial Statements and Supplementary Data 72
9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 72
PART III 10 Directors and Executive Officers of The Hartford 72
11 Executive Compensation 73
12 Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters 73
13 Certain Relationships and Related Transactions 74
14 Controls and Procedures 74
PART IV 15 Exhibits, Financial Statements Schedules, and
Reports on Form 8-K 74
Signatures II-1
Certifications II-2
Exhibits Index II-4
<PAGE>
PART I
ITEM 1. BUSINESS OF THE HARTFORD
(DOLLAR AMOUNTS IN MILLIONS, EXCEPT FOR PER SHARE DATA, UNLESS OTHERWISE STATED)
GENERAL
The Hartford Financial Services Group, Inc. (together with its subsidiaries,
"The Hartford" or the "Company") is a diversified insurance and financial
services company. The Hartford, headquartered in Connecticut, is among the
largest providers of investment products, individual life, group life and group
disability insurance products, and property and casualty insurance products in
the United States. Hartford Fire Insurance Company, founded in 1810, is the
oldest of The Hartford's subsidiaries. The Hartford writes insurance and
reinsurance in the United States and internationally. At December 31, 2002,
total assets and total stockholders' equity of The Hartford were $182.0 billion
and $10.7 billion, respectively.
ORGANIZATION
The Hartford strives to maintain and enhance its position as a market leader
within the financial services industry and to maximize shareholder value. The
Company pursues a strategy of developing and selling diverse and innovative
products through multiple distribution channels, continuously developing and
expanding those distribution channels, achieving cost efficiencies through
economies of scale and improved technology, maintaining effective risk
management and prudent underwriting techniques and capitalizing on its brand
name and customer recognition of The Hartford Stag Logo, one of the most
recognized symbols in the financial services industry.
As a holding company that is separate and distinct from its subsidiaries, The
Hartford Financial Services Group, Inc. has no significant business operations
of its own. Therefore, it relies on the dividends from its insurance company and
other subsidiaries as the principal source of cash flow to meet its obligations.
Additional information regarding the cash flow and liquidity needs of The
Hartford Financial Services Group, Inc. may be found in the Capital Resources
and Liquidity section of Management's Discussion and Analysis of Financial
Condition and Results of Operations ("MD&A").
The Company maintains a retail mutual fund operation, whereby the Company,
through wholly-owned subsidiaries, provides investment management and
administrative services to The Hartford Mutual Funds, Inc., a family of 33
mutual funds. Investors can purchase "shares" in the mutual funds, all of which
are registered with the Securities and Exchange Commission in accordance with
the Investment Company Act of 1940. The mutual funds are owned by the
shareholders of those funds and not by the Company.
Pursuant to its initial public offering of Class A common stock on May 22, 1997
(the "Offering"), Hartford Life, Inc. ("HLI"), the holding company parent of The
Hartford's significant life insurance subsidiaries, sold to the public 26
million shares at $28.25 per share and received proceeds, net of offering
expenses, of $687. The 26 million shares sold in the Offering represented
approximately 19% of the equity ownership in HLI. On June 27, 2000, The Hartford
acquired all of the outstanding shares of HLI that it did not already own ("The
HLI Repurchase"). As a result, HLI again became a wholly-owned subsidiary of The
Hartford. Additional information on The HLI Repurchase may be found in the
Capital Resources and Liquidity section of the MD&A and Note 18(a) of Notes to
Consolidated Financial Statements.
On April 2, 2001, The Hartford acquired the United States individual life
insurance, annuity and mutual fund businesses of Fortis, Inc. (operating as
"Fortis Financial Group", or "Fortis") for $1.12 billion in cash. The Company
effected the acquisition through several reinsurance agreements with
subsidiaries of Fortis and the purchase of 100% of the stock of Fortis Advisors,
Inc. and Fortis Investors, Inc., wholly-owned subsidiaries of Fortis. (For
additional information, see the Capital Resources and Liquidity section of the
MD&A and Note 18(a) of Notes to Consolidated Financial Statements.)
The Company has exited its international property and casualty businesses by
means of a number of dispositions. In September 2001, The Hartford entered into
an agreement to sell Hartford Insurance Company (Singapore), Ltd. (formerly
People's Insurance Company, Ltd. ("Singapore Insurance")). The sale was
completed in January 2002. On February 8, 2001, The Hartford completed the sale
of its Spain-based subsidiary, Hartford Seguros. On December 22, 2000, The
Hartford completed the sale of its Netherlands-based Zwolsche Algemeene N.V.
("Zwolsche") subsidiary. On November 16, 1998, The Hartford completed the sale
of its United Kingdom-based London & Edinburgh Insurance Group, Ltd. ("London &
Edinburgh") subsidiary.
REPORTING SEGMENTS
The Hartford is organized into two major operations: Life and Property &
Casualty. Within these operations, The Hartford conducts business principally in
nine operating segments. Additionally, the capital raising and purchase
accounting adjustment activities related to The HLI Repurchase, capital raised
in 2002 that was not contributed to the Company's insurance subsidiaries, and
the minority interest in HLI for pre-acquisition periods are included in
Corporate.
Life, headquartered in Simsbury, Connecticut, is organized into four reportable
operating segments: Investment Products, Individual Life, Group Benefits and
Corporate Owned Life Insurance ("COLI"). Life also includes in an Other category
its international operations, which are primarily located in Japan and Latin
America; realized capital gains and losses; as well as corporate items not
directly allocated to any of its reportable operating segments, principally
interest expense; and intersegment eliminations.
In January 2002, Property & Casualty integrated its Affinity Personal Lines and
Personal Insurance segments, now reported as Personal Lines. As a result,
Property & Casualty is now organized into five reportable operating segments:
the North American underwriting segments of the Business Insurance, Personal
Lines, Specialty Commercial and Reinsurance; and the Other Operations segment,
which includes substantially all of the Company's asbestos and environmental
exposures. "North American" includes the combined underwriting results of
Business Insurance, Personal Lines, Specialty Commercial and Reinsurance
underwriting segments along with income and expense items not directly allocated
to these segments, such as
- 2 -
<PAGE>
net investment income, net realized capital gains and losses, other expenses
including interest, and income taxes.
The following is a description of Life and Property & Casualty along with each
of their segments, including a discussion of principal products, marketing and
distribution and competitive environments. Additional information on The
Hartford's reporting segments may be found in the MD&A and Note 17 of Notes to
Consolidated Financial Statements.
LIFE
Life's business is conducted by HLI, a leading financial services and insurance
organization. Through Life, The Hartford provides (i) investment products,
including variable annuities, fixed market value adjusted ("MVA") annuities,
mutual funds and retirement plan services for the savings and retirement needs
of over 1.5 million customers, (ii) life insurance for wealth protection,
accumulation and transfer needs for approximately 740,000 customers, (iii) group
benefits products such as group life and group disability insurance for the
benefit of millions of individuals and (iv) corporate owned life insurance,
which includes life insurance policies purchased by a company on the lives of
its employees. The Company is one of the largest sellers of individual variable
annuities, variable life insurance and group disability insurance in the United
States. In addition, in 2001 The Hartford Mutual Funds, Inc. reached $12 billion
in assets faster than any other retail-oriented mutual fund family in history,
according to Strategic Insight. As of December 31, 2002, retail mutual fund
assets were $14.2 billion. The Company's strong position in each of its core
businesses provides an opportunity to increase the sale of The Hartford's
products and services as individuals increasingly save and plan for retirement,
protect themselves and their families against disability or death and engage in
estate planning. In an effort to advance the Company's strategy of growing its
life and asset accumulation businesses, The Hartford acquired the individual
life insurance, annuity and mutual fund businesses of Fortis on April 2, 2001.
(For additional information, see the Capital Resources and Liquidity section of
the MD&A and Note 18(a) of Notes to Consolidated Financial Statements.) In
addition, The Hartford's Japanese operation achieved $1.4 billion in variable
annuity sales for the year ended December 31, 2002, bringing account values
related to Japan to more than $1.7 billion as of December 31, 2002.
HLI is among the largest consolidated life insurance groups in the United States
based on statutory assets as of December 31, 2001. In the past year, Life's
total assets under management, which include $15.3 billion of third-party assets
invested in the Company's mutual funds and 529 College Savings Plans, decreased
2% to $165.1 billion at December 31, 2002 from $168.4 billion at December 31,
2001. Life generated revenues of $6.4 billion, $6.5 billion and $6.0 billion in
2002, 2001 and 2000, respectively. Additionally, Life generated net income of
$557, $685 and $575 in 2002, 2001 and 2000, respectively.
CUSTOMER SERVICE, TECHNOLOGY AND ECONOMIES OF SCALE
Life maintains advantageous economies of scale and operating efficiencies due to
its growth, attention to expense and claims management and commitment to
customer service and technology. These advantages allow the Company to
competitively price its products for its distribution network and policyholders.
The Company continues to achieve operating efficiencies in its Investment
Products segment. Operating expenses associated with the Company's individual
annuity products as a percentage of total individual annuity account values have
been reduced since 1992, declining from 43 basis points to 25 basis points in
2002. In addition, the Company utilizes computer technology to enhance
communications within the Company and throughout its distribution network in
order to improve the Company's efficiency in marketing, selling and servicing
its products and, as a result, provides high-quality customer service. In
recognition of excellence in customer service for variable annuities, The
Hartford was awarded the 2002 Annuity Service Award by DALBAR Inc., a recognized
independent financial services research organization, for the seventh
consecutive year. The Hartford is the only company to receive this prestigious
award in every year of the award's existence. Also, in both 2002 and 2001, The
Hartford Mutual Funds, Inc. was named the leading mid-sized fund complex in the
industry for top service providers, according to a survey of broker-dealers
conducted by DALBAR Inc. Additionally, the Company's Individual Life Division
won its second consecutive DALBAR award for service of life insurance customers
and its first DALBAR Intermediary Service Award in 2002.
RISK MANAGEMENT
Life's product designs, prudent underwriting standards and risk management
techniques are structured to protect it against disintermediation risk and
greater than expected mortality and morbidity experience. As of December 31,
2002, the Company had limited exposure to disintermediation risk on
approximately 96% of its domestic life insurance and annuity liabilities through
the use of non-guaranteed separate accounts, MVA features, policy loans,
surrender charges and non-surrenderability provisions. The Company effectively
utilizes prudent underwriting to select and price insurance risks and regularly
monitors mortality and morbidity assumptions to determine if experience remains
consistent with these assumptions and to ensure that its product pricing remains
appropriate. The Company also enforces disciplined claims management to protect
itself against greater than expected morbidity experience.
INVESTMENT PRODUCTS
The Investment Products segment focuses, through the sale of individual variable
and fixed annuities, mutual funds, retirement plan services and other investment
products, on the savings and retirement needs of the growing number of
individuals who are preparing for retirement or who have already retired. From
December 31, 1997 to December 31, 2002, this segment's assets under management
grew to $110.2 billion from $71.3 billion, a five year compounded annual growth
rate of 9.4%. Investment Products generated revenues of $2.6 billion, $2.5
billion and $2.4 billion in 2002, 2001 and 2000, respectively, of which
individual annuities accounted for $1.5 billion in 2002, 2001 and 2000. Net
income in the Investment Products segment was $432, $463 and $424 in 2002, 2001
and 2000, respectively.
The Hartford sells both variable and fixed individual annuity products through a
wide distribution network of national and regional broker-dealer organizations,
banks and other financial institutions and independent financial advisors. The
Hartford is a market leader in the annuity industry with sales of $11.6 billion,
$10.0 billion and $10.7 billion in 2002, 2001 and 2000, respectively. The
Hartford was the largest seller of individual
- 3 -
<PAGE>
retail variable annuities in the United States with sales of $10.3 billion in
2002 and $9.0 billion in 2001 and 2000. In addition, the Company continues to be
the largest seller of individual retail variable annuities through banks in the
United States.
The Company's total account value related to individual annuity products was
$74.9 billion as of December 31, 2002. Of this total account value, $64.3
billion, or 86%, related to individual variable annuity products and $10.6
billion, or 14%, related primarily to fixed MVA annuity products. In 2001, the
Company's total account value related to individual annuity products was $84.2
billion. Of this total account value, $74.6 billion, or 89%, related to
individual variable annuity products and $9.6 billion, or 11%, related primarily
to fixed MVA annuity products.
In addition to its leading position in individual annuities, The Hartford
continues to emerge as a significant participant in the mutual fund business and
is among the top providers of retirement products and services, including asset
management and plan administration sold to small and medium size corporations
pursuant to Section 401 of the Internal Revenue Code of 1986, as amended
(referred to as "401(k)") and to municipalities pursuant to Section 457 and
403(b) of the Internal Revenue Code of 1986, as amended (referred to as "Section
457" and "403(b)", respectively). The Company also provides structured
settlement contracts, terminal funding products and other investment products
such as guaranteed investment contracts ("GICs"). In 2002, The Hartford began
selling a 529 college savings product.
As previously mentioned, The Hartford acquired the individual annuity and mutual
fund businesses of Fortis, Inc. in 2001. This acquisition increased assets under
management in the Company's fast growing mutual fund business by 20%, helped
solidify the Company's strong position in variable annuities and strengthened
the Company's 401(k) sales.
Principal Products
- ------------------
Individual Variable Annuities -- The Hartford earns fees, based on
policyholders' account values, for managing variable annuity assets and
maintaining policyholder accounts. The Company uses specified portions of the
periodic deposits paid by a customer to purchase units in one or more mutual
funds as directed by the customer, who then assumes the investment performance
risks and rewards. As a result, variable annuities permit policyholders to
choose aggressive or conservative investment strategies, as they deem
appropriate, without affecting the composition and quality of assets in the
Company's general account. These products offer the policyholder a variety of
equity and fixed income options, as well as the ability to earn a guaranteed
rate of interest in the general account of the Company. The Company offers an
enhanced guaranteed rate of interest for a specified period of time (no longer
than twelve months) if the policyholder elects to dollar-cost average funds from
the Company's general account into one or more non-guaranteed separate accounts.
Due to this enhanced rate and the volatility experienced in the overall equity
markets, this option continues to be popular with policyholders. Additionally,
the Investment Products segment sells variable annuity contracts that offer
various guaranteed death benefits. For certain guaranteed death benefits, The
Hartford pays the greater of (1) the account value at death; (2) the sum of all
premium payments less prior withdrawals; or (3) the maximum anniversary value of
the contract, plus any premium payments since the contract anniversary, minus
any withdrawals following the contract anniversary.
Policyholders may make deposits of varying amounts at regular or irregular
intervals and the value of these assets fluctuates in accordance with the
investment performance of the funds selected by the policyholder. To encourage
persistency, many of the Company's individual variable annuities are subject to
withdrawal restrictions and surrender charges. Surrender charges range up to 8%
of the contract's initial deposit less withdrawals, and reduce to zero on a
sliding scale, usually within seven policy years. Volatility experienced by the
equity markets over the past few years did not cause a significant increase in
variable annuity surrenders, demonstrating that policyholders are generally
aware of the long-term nature of these products. Individual variable annuity
account values of $64.3 billion as of December 31, 2002, have grown
significantly from $13.1 billion as of December 31, 1994, due to strong net cash
flow, resulting from high levels of sales, low levels of surrenders and equity
market appreciation. Approximately 88% and 94% of the individual variable
annuity account values were held in non-guaranteed separate accounts as of
December 31, 2002 and 2001, respectively.
The assets underlying the Company's variable annuities are managed both
internally and by outside money managers, while the Company provides all policy
administration services. The Company utilizes a select group of money managers,
such as Wellington Management Company, LLP ("Wellington"); Hartford Investment
Management Company ("HIMCO"), a wholly-owned subsidiary of The Hartford; Putnam
Financial Services, Inc. ("Putnam"); American Funds; MFS Investment Management
("MFS"); Franklin Templeton Group; and AIM Investments ("AIM"). All have an
interest in the continued growth in sales of the Company's products and greatly
enhance the marketability of the Company's annuities and the strength of its
product offerings. The Director variable annuity, which is managed in part by
Wellington, continues to be the industry leader in terms of retail sales. In
addition, Hartford Leaders, which is a multi-manager variable annuity that
combines the product manufacturing, wholesaling and service capabilities of The
Hartford with the investment management expertise of four of the nation's most
successful investment management organizations: American Funds, Franklin
Templeton Group, AIM and MFS, has quickly emerged as a strong selling product
for the Company and ranks in the top 5 in the industry.
Fixed MVA Annuities -- Fixed MVA annuities are fixed rate annuity contracts
which guarantee a specific sum of money to be paid in the future, either as a
lump sum or as monthly income. In the event that a policyholder surrenders a
policy prior to the end of the guarantee period, the MVA feature increases or
decreases the cash surrender value of the annuity in respect of any interest
rate decreases or increases, respectively, thereby protecting the Company from
losses due to higher interest rates at the time of surrender. The amount of
payment will not fluctuate due to adverse changes in the Company's investment
return, mortality experience or expenses. The Company's primary fixed MVA
annuities have terms varying from one to ten years with an average term of
approximately eight years. Account values of fixed MVA annuities were $10.6
billion and $9.6 billion as of December 31, 2002 and 2001, respectively.
- 4 -
<PAGE>
Mutual Funds -- In September 1996, The Hartford launched a family of retail
mutual funds for which the Company provides investment management and
administrative services. The fund family has grown significantly from 8 funds at
inception to the current offering of 33 funds, including the addition of five
new fixed income funds introduced in 2002. The Company's funds are managed by
Wellington and HIMCO. The Company has entered into agreements with over 960
financial services firms to distribute these mutual funds.
The Company charges fees to the shareholders of the mutual funds, which are
recorded as revenue by the Company. Investors can purchase shares in the mutual
funds, all of which are registered with the Securities and Exchange Commission
in accordance with the Investment Company Act of 1940. The mutual funds are
owned by the shareholders of those funds and not by the Company. As such, the
mutual fund assets and liabilities, as well as related investment returns, are
not reflected in the Company's consolidated financial statements. Total retail
mutual fund assets under management were $14.2 billion and $15.9 billion as of
December 31, 2002 and 2001, respectively.
Governmental -- The Company sells retirement plan products and services to
municipalities under Section 457 plans. The Company offers a number of different
investment products, including variable annuities and a fixed bucket, to the
employees in Section 457 plans. Generally, with the variable products, the
Company manages the fixed income funds and certain other outside money managers
act as advisors to the equity funds offered in Section 457 plans administered by
the Company. As of December 31, 2002, the Company administered over 3,000 plans
under Sections 457 and 403(b). Total governmental assets under management were
$7.9 billion and $8.6 billion as of December 31, 2002 and 2001, respectively.
Corporate -- The Company sells retirement plan products and services to
corporations under Section 401 plans targeting the small and medium case
markets. The Company believes these markets are under-penetrated in comparison
to the large case market. As of December 31, 2002, the Company administered over
4,100 Section 401(k) plans. Total corporate assets under management were $3.4
billion and $2.6 billion as of December 31, 2002 and 2001, respectively.
Institutional Investment Products -- The Company sells structured settlement
contracts which provide for periodic payments to an injured person or survivor
for a generally determinable number of years, typically in settlement of a claim
under a liability policy in lieu of a lump sum settlement. The Company's
structured settlements are sold through The Hartford's Property & Casualty
insurance operations as well as specialty brokers. The Company also markets
other annuity contracts for special purposes such as the funding of terminated
defined benefit pension plans. In addition, the Company offers GICs and
short-term funding agreements. Total institutional investment products assets
under management were $9.7 billion and $9.1 billion as of December 31, 2002 and
2001, respectively.
Section 529 Plans - The Hartford introduced a tax advantaged college savings
product ("529 plan") in March 2002 called SMART 529. SMART 529 is a
state-sponsored education savings program established by the State of West
Virginia which offers an easy way for both residents of West Virginia and
out-of-state participants to plan for a college education. In 1996, Congress
created a tax-advantaged college savings program as part of Section 529 of the
Internal Revenue Code (the "Code"). The 529 Plan is an investment plan operated
by a state and designed to help families save for future college costs. On
January 1, 2002, 529 Plans became federal tax-exempt for qualified withdrawals.
SMART 529 is designed to be flexible by allowing investors to choose from a wide
variety of investment portfolios to match their risk preference to help
investors accumulate savings for college. An individual can open a SMART 529
account for anyone, at any age. The SMART 529 product complements HLI's existing
offering of investment products (mutual funds, variable annuities, 401(k), 457
and 403(b) plans). It also leverages the Company's capabilities in distribution,
service and fund performance. Total 529 Plan assets under management were $87 as
of December 31, 2002.
Marketing and Distribution
- --------------------------
The Investment Products distribution network is based on management's strategy
of utilizing multiple and competing distribution channels to achieve the
broadest distribution to reach target customers. The success of the Company's
marketing and distribution system depends on its product offerings, fund
performance, successful utilization of wholesaling organizations, quality of
customer service, and relationships with national and regional broker-dealer
firms, banks and other financial institutions, and independent financial
advisors (through which the sale of the Company's retail investment products to
customers is consummated).
The Hartford maintains a distribution network of approximately 1,500
broker-dealers and approximately 500 banks. As of September 30, 2002, the
Company was selling products through 24 of the 25 largest retail banks in the
United States, including proprietary relationships with 12 of the top 25. The
Company periodically negotiates provisions and terms of its relationships with
unaffiliated parties, and there can be no assurance that such terms will remain
acceptable to the Company or such third parties. The Company's primary
wholesaler of its individual annuities and mutual funds is its wholly-owned
subsidiary, PLANCO Financial Services, Inc. and its affiliate, PLANCO,
Incorporated (collectively "PLANCO"). PLANCO is one of the nation's largest
wholesalers of individual annuities and has played a significant role in The
Hartford's growth over the past decade. As a wholesaler, PLANCO distributes The
Hartford's fixed and variable annuities, mutual funds, 401(k) plans and 529
Plans by providing sales support to registered representatives, financial
planners and broker-dealers at brokerage firms and banks across the United
States. Owning PLANCO secures an important distribution channel for the Company
and gives the Company a wholesale distribution platform which it can expand in
terms of both the number of individuals wholesaling its products and the
portfolio of products which they wholesale. In addition, the Company uses
internal personnel with extensive experience in the Section 457 market, as well
as access to the Section 401(k) market, to sell its products and services in the
retirement plan and institutional markets.
- 5 -
<PAGE>
Competition
- -----------
The Investment Products segment competes with numerous other insurance companies
as well as certain banks, securities brokerage firms, independent financial
advisors and other financial intermediaries marketing annuities, mutual funds
and other retirement-oriented products. Product sales are affected by
competitive factors such as investment performance ratings, product design,
visibility in the marketplace, financial strength ratings, distribution
capabilities, levels of charges and credited rates, reputation and customer
service.
INDIVIDUAL LIFE
- ---------------
The Individual Life segment provides life insurance solutions to a wide array of
partners to solve the wealth protection, accumulation and transfer needs of
their affluent, emerging affluent and business insurance clients. The individual
life business acquired from Fortis in 2001 added significant scale to the
Company's Individual Life segment, contributing to the significant increase in
life insurance in-force. As of December 31, 2002, life insurance in-force
increased 5% to $126.7 billion, from $120.3 billion as of December 31, 2001.
Account values decreased 4% to $7.6 billion as of December 31, 2002 from $7.9
billion as of December 31, 2001. Revenues were $958, $890 and $640 in 2002, 2001
and 2000, respectively. Net income in the Individual Life segment was $133, $121
and $79 in 2002, 2001 and 2000, respectively.
Principal Products
- ------------------
The Hartford holds a significant market share in the variable life product
market. In 2002, the Company's new sales of individual life insurance were 82%
variable life, 13% universal life and other, and 5% term life insurance.
Variable Life -- Variable life insurance provides a return linked to an
underlying investment portfolio and the Company allows policyholders to
determine their desired asset mix among a variety of underlying mutual funds. As
the return on the investment portfolio increases or decreases, the surrender
value of the variable life policy will increase or decrease, and, under certain
policyholder options or market conditions, the death benefit may also increase
or decrease. The Company's single premium variable life product provides a death
benefit to the policy beneficiary based on a single premium deposit. The
Company's second-to-die products are distinguished from other products in that
two lives are insured rather than one, and the policy proceeds are paid upon the
death of both insureds. Second-to-die policies are frequently used in estate
planning for a married couple. Variable life account values were $3.6 billion
and $4.0 billion as of December 31, 2002 and 2001, respectively.
Universal Life and Interest Sensitive Whole Life -- Universal life and interest
sensitive whole life insurance coverages provide life insurance with adjustable
rates of return based on current interest rates. The Company offers both
flexible and fixed premium policies and provides policyholders with flexibility
in the available coverage, the timing and amount of premium payments and the
amount of the death benefit, provided there are sufficient policy funds to cover
all policy charges for the coming period. The Company also sells universal life
insurance policies with a second-to-die feature similar to that of the variable
life insurance product offered. Universal life and interest sensitive whole life
account values were $3.1 billion as of December 31, 2002 and 2001.
Marketing and Distribution
- --------------------------
Consistent with the Company's strategy to access multiple distribution outlets,
the Individual Life distribution organization has been developed to penetrate a
multitude of retail sales channels. These include independent life insurance
sales professionals; agents of other companies; national, regional and
independent broker-dealers; banks; financial planners; certified public
accountants and property and casualty insurance organizations. The primary
organization used to wholesale The Hartford's products to these outlets is a
group of highly qualified life insurance professionals with specialized training
in sophisticated life insurance sales. These individuals are generally employees
of The Hartford who are managed through a regional sales office system.
Competition
- -----------
The Individual Life segment competes with approximately 1,800 life insurance
companies in the United States, as well as other financial intermediaries
marketing insurance products. Competitive factors related to this segment are
primarily the breadth and quality of life insurance products offered, pricing,
relationships with third-party distributors, effectiveness of wholesaling
support, pricing and availability of reinsurance, and the quality of
underwriting and customer service.
GROUP BENEFITS
The Group Benefits segment sells group life and group disability insurance, as
well as other products, including stop loss, accidental death and dismemberment,
travel accident and other special risk coverage to employers and associations.
The Company also offers disability underwriting, administration, claims
processing services and reinsurance to other insurers and self-funded employer
plans. Generally, policies sold in this segment are term insurance. Typically,
policies are sold with one, two or three year rate guarantees depending on the
product. This allows the Company to adjust the rates or terms of its policies in
order to minimize the adverse effect of various market trends, including
declining interest rates and other factors. In the disability market, the
Company focuses on strong underwriting and claims management to derive a
competitive advantage. The Group Benefits segment generated revenues of $2.6
billion, $2.5 billion and $2.2 billion in 2002, 2001 and 2000, respectively, of
which group disability insurance accounted for $1.2 billion, $1.1 billion and
$964 and group life insurance accounted for $1.0 billion, $902 and $810,
respectively. The Company held group disability reserves of $2.5 billion and
$2.4 billion and group life reserves of $765 and $706, as of December 31, 2002
and 2001, respectively. The Company's net income in the Group Benefits segment
was $128, $106 and $90 in 2002, 2001 and 2000, respectively.
Principal Products
- ------------------
Group Disability -- The Hartford is one of the largest participants in the
"large case" market of the group disability insurance business. The large case
market, as defined by the Company, generally consists of group disability
policies covering over 500 employees in a particular company. The Company is
continuing its focus on the growing "small case"
- 6 -
<PAGE>
and "medium case" group markets, emphasizing name recognition and reputation as
well as the Company's managed disability approach to claims and administration.
The Company's efforts in the group disability market focus on early
intervention, return-to-work programs and successful rehabilitation. Over the
last several years, the focus of new disability products introduced is to
provide incentives for employees to return to independence. The Company also
works with disability claimants to improve the receipt rate of Social Security
offsets (i.e., reducing payment of benefits by the amount of Social Security
payments received).
The Company's short-term disability benefit plans provide a weekly benefit
amount (typically 60% to 70% of the employee's earned income up to a specified
maximum benefit) to insured employees when they are unable to work due to an
accident or illness. Long-term disability insurance provides a monthly benefit
for those extended periods of time not covered by a short-term disability
benefit plan when insured employees are unable to work due to disability.
Employees may receive total or partial disability benefits. Most of these
policies begin providing benefits following a 90 or 180 day waiting period and
generally continue providing benefits until the employee reaches age 65.
Long-term disability benefits are paid monthly and are limited to a portion,
generally 50-70%, of the employee's earned income up to a specified maximum
benefit.
Group Life -- Group term life insurance provides term coverage to employees and
their dependents for a specified period and has no accumulation of cash values.
The Company offers options for its basic group life insurance coverage,
including portability of coverage and a living benefit option, whereby
terminally ill policyholders can receive death benefits prior to their deaths.
In addition, the Company offers premium waiver and accidental death and
dismemberment coverages to employee groups.
Other -- The Hartford provides excess of loss medical coverage (known as stop
loss insurance) to employers who self-fund their medical plans and pay claims
using the services of a third-party administrator. The Company also provides
travel accident, hospital indemnity and other coverages (including group life
and disability) primarily to individual members of various associations, as well
as employee groups. A significant Medicare supplement customer of the company
had been the members of the Retired Officers Association, an organization
consisting of retired military officers. Congress passed legislation, effective
in the fourth quarter of 2001, whereby retired military officers age 65 and
older will receive full medical insurance, eliminating the need for Medicare
supplement insurance. This legislation reduced the Company's premium revenue by
$131 in 2002, compared to 2001.
Marketing and Distribution
- --------------------------
The Hartford uses an experienced group of Company employees, managed through a
regional sales office system, to distribute its group insurance products and
services through a variety of distribution outlets, including brokers,
consultants, third-party administrators and trade associations. The Company
intends to continue to expand the system over the coming years in areas that
offer the highest growth potential.
Competition
- -----------
The Group Benefits business remains highly competitive. Competitive factors
primarily affecting Group Benefits are the variety and quality of products and
services offered, the price quoted for coverage and services, the Company's
relationships with its third-party distributors, and the quality of customer
service. Group Benefits competes with numerous other insurance companies and
other financial intermediaries marketing insurance products. However, many of
these businesses have relatively high barriers to entry and there have been very
few new entrants over the past few years.
CORPORATE OWNED LIFE INSURANCE ("COLI")
The Hartford is a leader in the COLI market, which includes life insurance
policies purchased by a company on the lives of its employees, with the company
or a trust sponsored by the company named as the beneficiary under the policy.
Until passage of the Health Insurance Portability and Accountability Act of 1996
("HIPAA"), the Company sold two principal types of COLI, leveraged and variable
products. Leveraged COLI is a fixed premium life insurance policy owned by a
company or a trust sponsored by a company. HIPAA phased out the deductibility of
interest on policy loans under leveraged COLI at the end of 1998, virtually
eliminating all future sales of leveraged COLI. Variable COLI continues to be a
product used by employers to fund non-qualified benefits or other postemployment
benefit liabilities.
Variable COLI account values were $19.7 billion and $18.0 billion as of December
31, 2002 and 2001, respectively. Leveraged COLI account values decreased to $3.3
billion as of December 31, 2002 from $4.3 billion as of December 31, 2001,
primarily due to the continuing effects of HIPAA. COLI generated revenues of
$592, $719 and $767 in 2002, 2001 and 2000, respectively, and net income of $32,
$37 and $34 in 2002, 2001 and 2000, respectively.
PROPERTY & CASUALTY
Property & Casualty provides (1) workers' compensation, property, automobile,
liability, umbrella, specialty casualty, marine, agricultural and bond coverages
to commercial accounts primarily throughout the United States; (2) professional
liability coverage and directors and officers liability coverage, as well as
excess and surplus lines business not normally written by standard commercial
lines insurers; (3) automobile, homeowners and home-based business coverage to
individuals throughout the United States; (4) assumed reinsurance, primarily
through professional reinsurance brokers covering various property, casualty,
catastrophe, alternative risk transfer and marine classes of business; and (5)
insurance related services.
The Hartford is the fourteenth largest property and casualty insurance operation
in the United States based on written premiums for the year ended December 31,
2001 according to A.M. Best Company, Inc. ("A.M. Best"). Property & Casualty
generated revenues of $9.5 billion, $8.6 billion and $8.7 billion, in 2002, 2001
and 2000, respectively. Written premiums for 2002, 2001 and 2000 were $8.6
billion, $7.6 billion and $7.3 billion, respectively. Additionally, net income
(loss) was $469, $(115) and $494 for 2002, 2001 and 2000, respectively. Total
- 7 -
<PAGE>
assets for Property & Casualty were $31.2 billion and $29.2 billion as of
December 31, 2002 and 2001, respectively.
BUSINESS INSURANCE
Business Insurance provides standard commercial insurance coverage to small and
middle market commercial businesses primarily throughout the United States. This
segment also provides commercial risk management products and services as well
as marine coverage. The segment had written premiums of $3.4 billion, $2.9
billion and $2.4 billion in 2002, 2001 and 2000, respectively, and underwriting
income (loss) of $44, $(242) (includes $245 of underwriting loss related to
September 11) and $(50) in 2002, 2001 and 2000, respectively.
Principal Products
- ------------------
The Business Insurance segment offers workers' compensation, property,
automobile, liability, umbrella and marine coverages. Commercial risk management
products and services are also provided.
Marketing and Distribution
- --------------------------
Business Insurance provides insurance products and services through its home
office located in Hartford, Connecticut, and multiple domestic regional office
locations and insurance centers. The segment markets its products nationwide
utilizing independent agents and involving trade associations and employee
groups. Independent agents, who often represent other companies as well, are
compensated on a commission basis and are not employees of The Hartford.
Competition
- -----------
The commercial insurance industry is a highly competitive environment regarding
product, price, service and technology. The Hartford competes with other stock
companies, mutual companies, alternative risk sharing groups and other
underwriting organizations. These companies sell through various distribution
channels and business models, across a broad array of product lines, and with a
high level of variation regarding geographic, marketing and customer
segmentation. The Hartford is the fourteenth largest commercial lines' insurer
in the United States based on 2001 written premiums according to A.M. Best. The
relatively large size and underwriting capacity of The Hartford provide
opportunities not available to smaller companies. In addition, the marketplace
is affected by available capacity of the insurance industry as measured by
policyholders' surplus. Surplus expands and contracts primarily in conjunction
with profit levels generated by the industry. The low interest rate environment
is impacting returns and making underwriting decisions even more critical.
Overall, in 2002, market conditions in the commercial industry have continued to
improve as a result of increased underwriting discipline and a firmer pricing
environment, but are still under stress from years of soft market conditions.
PERSONAL LINES
Personal Lines provides automobile, homeowners' and home-based business
coverages to the members of AARP through a direct marketing operation; to
individuals who prefer local agent involvement through a network of independent
agents in the standard personal lines market; and in the non-standard automobile
market through the Company's Omni Insurance Group, Inc. ("Omni") subsidiary.
Personal Lines also operates a member contact center for health insurance
products offered through AARP's Health Care Options. The Hartford's exclusive
licensing arrangement with AARP, which was renewed during the fourth quarter of
2001, continues through January 1, 2010 for automobile, homeowners and
home-based business. The Health Care Options agreement continues through 2007.
These agreements provide Personal Lines with an important competitive advantage.
Personal Lines had written premiums of $3.1 billion, $2.9 billion and $2.6
billion in 2002, 2001 and 2000, respectively. Underwriting income (loss) for
2002, 2001 and 2000 was $(46), $(87) (includes $9 of underwriting loss related
to September 11) and $2, respectively.
Principal Products
- ------------------
Personal Lines provides standard and non-standard automobile, homeowners and
home-based business coverages to individuals across the United States, including
a special program designed exclusively for members of AARP.
Marketing and Distribution
- --------------------------
Personal Lines reaches diverse markets through multiple distribution channels
including independent agents, direct mail, the Internet and advertising in
publications. This segment provides customized products and services to
customers through a network of independent agents in the standard personal lines
market, and in the non-standard automobile market through Omni. Independent
agents, who often represent other companies as well, are compensated on a
commission basis and are not employees of The Hartford. Personal Lines has an
important relationship with AARP and markets directly to its over 35 million
members.
Competition
- -----------
The personal lines automobile and homeowners businesses continue to remain
highly competitive. Personal lines insurance is written by insurance companies
of varying sizes that sell products through various distribution channels,
including independent agents, captive agents and directly to the consumer. The
personal lines market competes on the basis of price; product; service,
including claims handling; stability of the insurer and name recognition. For
2001, the industry net written premiums were $163 billion. The Hartford's share
of this market was approximately 2% and ranked twelfth in size. The personal
lines marketplace reported a combined ratio of 104.9 for the first nine months
of 2002. Industry data and The Hartford's market share and ranking in the
industry were derived directly from data reported by A.M. Best. A major
competitive advantage of The Hartford is the exclusive licensing arrangement
with AARP to provide personal automobile, homeowners and home-based business
insurance products to its members. This arrangement was renewed during the
fourth quarter of 2001 through January 1, 2010. Management expects favorable
"baby boom" demographics to increase AARP membership during this period. In
addition, The Hartford provides customer service for all health insurance
products offered through AARP's Health Care Options, with an agreement that
continues through 2007.
- 8 -
<PAGE>
SPECIALTY COMMERCIAL
Specialty Commercial provides a wide variety of property and casualty insurance
products and services through retailers and wholesalers to large commercial
clients and insureds requiring a variety of specialized coverages. Excess and
surplus lines coverages not normally written by standard line insurers are also
provided, primarily through wholesale brokers. Specialty Commercial had written
premiums of $1.4 billion, $989 (includes $7 of reinsurance cessions related to
September 11) and $1.1 billion in 2002, 2001 and 2000, respectively, and
underwriting losses of $23, $262 (includes $167 of underwriting loss related to
September 11) and $103 in 2002, 2001 and 2000, respectively.
Principal Products
- ------------------
Specialty Commercial offers a variety of customized insurance products and risk
management services. Specialty Commercial provides standard commercial insurance
products including workers' compensation, automobile and liability coverages to
large-sized companies. Specialty Commercial also provides bond, professional
liability, specialty casualty and agricultural coverages, as well as core
property and excess and surplus lines coverages not normally written by standard
lines insurers. Alternative markets, within Specialty Commercial, provides
insurance products and services primarily to captive insurance companies, pools
and self-insurance groups. In addition, Specialty Commercial provides
third-party administrator services for claims administration, integrated
benefits, loss control and performance measurement through Specialty Risk
Services.
Marketing and Distribution
- --------------------------
Specialty Commercial provides insurance products and services through its home
office located in Hartford, Connecticut and multiple domestic office locations.
The segment markets its products nationwide utilizing a variety of distribution
networks including independent agents and brokers as well as wholesalers.
Independent agents, who often represent other companies as well, are compensated
on a commission basis and are not employees of The Hartford.
Competition
- -----------
The commercial insurance industry is a highly competitive environment regarding
product, price, service and technology. Specialty Commercial is comprised of a
diverse group of businesses that are unique to commercial lines. Each line of
business operates independently with its own set of business objectives, and
focuses on the operational dynamics of their specific industry. These
businesses, while somewhat interrelated, each have a unique business model and
operating cycle. Specialty Commercial is considered a transactional business
and, therefore, competes with other companies for business primarily on an
account by account basis due to the complex nature of each transaction.
Specialty Commercial competes with other stock companies, mutual companies,
alternative risk sharing groups and other underwriting organizations. The
relatively large size and underwriting capacity of The Hartford provide
opportunities not available to smaller companies. September 11 has significantly
affected the Specialty Commercial business by demonstrating the importance of
risk aggregation, by driving property pricing increases and by influencing
capital decisions. Overall, in 2002, market conditions in the commercial
industry have continued to improve as a result of increased underwriting
discipline and a firmer pricing environment, but are still under stress from
years of soft market conditions.
REINSURANCE
The Reinsurance segment assumes reinsurance in North America and primarily
writes treaty reinsurance through professional reinsurance brokers covering
various property, casualty and specialty classes of business. The Reinsurance
segment also writes catastrophe, marine and alternative risk transfer business
outside of North America. The Reinsurance segment had written premiums of $703,
$849 (includes $69 of reinsurance cessions related to September 11) and $826 in
2002, 2001 and 2000, respectively, and underwriting losses of $59, $375
(includes $226 of underwriting loss related to September 11) and $73 in 2002,
2001 and 2000, respectively.
Principal Products
- ------------------
The Reinsurance segment offers a full range of treaty and facultative
reinsurance products including property, casualty, catastrophe, marine and
alternative risk transfer which includes non-traditional reinsurance products
such as multi-year property catastrophe treaties, aggregate of excess of loss
agreements and quota share treaties with event or aggregate loss ratio caps.
Marketing and Distribution
- --------------------------
The Reinsurance segment assumes insurance from other insurers, primarily through
reinsurance brokers, but also through direct channels and pools in the worldwide
reinsurance market.
Competition
- -----------
The property and casualty worldwide reinsurance market remains extremely
competitive, although the pricing environment continued to improve in 2002.
There are domestic and foreign reinsurers, which compete in this market, with
varying levels of financial resources and scope. Reinsurers compete on the basis
of financial strength and stability, price, service, capacity and terms and
conditions. The Hartford was the eleventh largest reinsurer in the United States
based on 2001 net written premiums, according to data published by Reinsurance
Associate of America. In the aftermath of the terrorist attack on September 11,
the reinsurance landscape has become very dynamic. Several new reinsurers were
formed in Bermuda, and existing reinsurers raised additional capital, while
several others have either exited the market, announced plans to do so, or are
considering other strategic options. In addition, poor underwriting results over
the past few years and the decline in equity markets have put pressure on
capital.
OTHER OPERATIONS
Property & Casualty's Other Operations currently consist of certain property and
casualty insurance operations of The Hartford which have ceased writing new
business. These operations primarily include First State Insurance Company,
located in Boston, Massachusetts; Heritage Reinsurance Company, Ltd.,
headquartered in Bermuda; and Excess Insurance Company Limited, located in the
United Kingdom. Also included in Other Operations are Property & Casualty's
international businesses up until their dates of sales, and for
- 9 -
<PAGE>
2002, the activity in the exited international lines of HartRe following its
restructuring in the fourth quarter of 2001.
Property & Casualty's international businesses have historically consisted
primarily of Western European companies offering a variety of insurance products
designed to meet the needs of local customers. The Company's strategic shift to
emphasize growth opportunities in asset accumulation businesses has resulted in
the sale of all of its international property and casualty businesses. London &
Edinburgh, located in the United Kingdom, was sold in November 1998. Zwolsche,
located in the Netherlands, Belgium and Luxembourg, was sold in December 2000.
Hartford Seguros, located in Spain, was sold in February 2001. The Hartford
Insurance Company (Singapore), Ltd. (formerly People's Insurance Company, Ltd.
("Singapore Insurance")), located in Singapore, was sold in January 2002.
The Hartford was a global reinsurer through its Hartford Reinsurance Company
("HartRe") operations in the United Kingdom, France, Italy, Germany, Spain, Hong
Kong and Taiwan, writing treaty and facultative assumed reinsurance including
property, casualty, fidelity, and specialty coverages. In October 2001, HartRe
announced that it was exiting most international lines and in January 2002 these
lines were moved to Other Operations.
The primary objectives of Other Operations are the proper disposition of claims,
the resolution of disputes, and the collection of reinsurance proceeds primarily
related to policies written and reinsured prior to 1985. As such, Other
Operations has no new product sales, distribution systems or competitive issues.
The Other Operations segment generated revenues of $189, $168 and $602 in 2002,
2001 and 2000, respectively. Net income (loss) for 2002, 2001 and 2000 was
$(13), $10 and $28, respectively.
LIFE RESERVES
In accordance with applicable insurance regulations under which Life operates,
life insurance subsidiaries of The Hartford establish and carry as liabilities
actuarially determined reserves which are calculated to meet The Hartford's
future obligations. Reserves for life insurance and disability contracts are
based on actuarially recognized methods using prescribed morbidity and mortality
tables in general use in the United States, which are modified to reflect The
Hartford's actual experience when appropriate. These reserves are computed at
amounts that, with additions from estimated premiums to be received and with
interest on such reserves compounded annually at certain assumed rates, are
expected to be sufficient to meet The Hartford's policy obligations at their
maturities or in the event of an insured's disability or death. Reserves also
include unearned premiums, premium deposits, claims incurred but not reported
and claims reported but not yet paid. Reserves for assumed reinsurance are
computed in a manner that is comparable to direct insurance reserves.
(Additional information on Life reserves may be found in the Critical Accounting
Estimates section of the MD&A under "Reserves".)
PROPERTY & CASUALTY RESERVES
The Hartford establishes property and casualty reserves to provide for the
estimated costs of paying claims under insurance policies written by The
Hartford. These reserves include estimates for both claims that have been
reported and those that have been incurred but not reported to The Hartford and
include estimates of all expenses associated with processing and settling these
claims. This estimation process is primarily based on historical experience and
involves a variety of actuarial techniques which analyze trends and other
relevant factors.
As a result of September 11, the Company established estimated gross and net
reserves of $1.1 billion and $556, respectively, related to property and
casualty operations. This loss estimate includes coverages related to property,
business interruption, workers' compensation and other liability exposures,
including those underwritten by the Company's assumed reinsurance operation. The
Company based the loss estimate upon a review of insured exposures using a
variety of assumptions and actuarial techniques, including estimated amounts for
incurred but not reported policyholder losses and costs incurred in settling
claims. The Company continues to carry the original incurred amount related to
September 11, less any paid losses. Reported losses to date have fallen within
the original reserved amounts. However, there is significant uncertainty around
September 11, particularly with regard to inhalation claims, stress claims and
other bodily injury, as well as the three year statute of limitations in New
York State. Included in net reserves was an estimate of amounts recoverable
under the Company's ceded reinsurance programs. Although management anticipates
certain claims for recovery to be challenged, the impact of these challenges is
not expected to be material. Risk of non-collection due to the financial
condition of The Hartford's reinsurers has been mitigated as a result of the
Company's process of selecting its reinsurers. The Hartford's property and
casualty reinsurance is placed with reinsurers that meet strict financial
criteria established by the Company's credit committee. As a result of the
uncertainties involved in the estimation process, final claim settlements may
vary from present estimates.
The Hartford continues to receive claims that assert damages from asbestos- and
environmental-related exposures. Asbestos claims relate primarily to bodily
injuries asserted by those who came in contact with asbestos or products
containing asbestos. Environmental claims relate primarily to pollution related
clean-up costs. Due to deviations from past experience and a variety of social,
economic and legal issues, the Company's ability to estimate the unpaid claims
and claim adjustment expenses is significantly impacted. Further discussion may
be found in the Critical Accounting Estimates and Other Operations sections of
the MD&A.
Most of the Company's reserves do not include discounts. However, certain
liabilities for unpaid claims where the amount and timing of payments are fixed
and reliably determinable, principally for permanently disabled claimants, and
certain structured settlement contracts that fund loss run-offs for unrelated
parties, have been discounted to present value. The amount of the discount was
approximately $424 and $429 as of December 31, 2002 and 2001, respectively, and
amortization of
- 10 -
<PAGE>
the discount had no material effect on net income during 2002, 2001 and 2000.
As of December 31, 2002, property and casualty reserves for claims and claim
adjustment expenses reported on a statutory basis exceeded those reported under
Generally Accepted Accounting Principles ("GAAP") by $27. The primary difference
resulted from the discounting of GAAP-basis workers' compensation reserves at
risk free interest rates, which exceeded the statutory discount rates set by
regulators, partially offset by the required exclusion from statutory reserves
of assumed retoactive reinsurance.
There were no significant changes in the mix of the Company's business that have
impacted property and casualty claims and claim adjustment expense reserves; nor
has the Company completed any significant loss portfolio transfers, structured
settlements or other transactions which would change claim payment patterns.
Further discussion on The Hartford's property and casualty reserves, including
asbestos and environmental claims reserves, may be found in the Reserves section
of the MD&A- Critical Accounting Estimates.
A reconciliation of liabilities for unpaid claims and claim adjustment expenses
is herein referenced from Note 7 of Notes to Consolidated Financial Statements.
A table depicting the historical development of the liabilities for unpaid
claims and claim adjustment expenses, net of reinsurance, follows.
<TABLE>
<CAPTION>
LOSS DEVELOPMENT TABLE
PROPERTY AND CASUALTY CLAIM AND CLAIM ADJUSTMENT EXPENSE LIABILITY DEVELOPMENT - NET OF REINSURANCE
FOR THE YEARS ENDED DECEMBER 31, [1]
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Liabilities for unpaid claims and
claim adjustment expenses, net of
reinsurance $10,498 $10,717 $10,776 $11,024 $12,202 $12,265 $12,401 $12,020 $11,857 $12,437 $12,688
CUMULATIVE PAID CLAIMS AND CLAIM EXPENSES
One year later 2,596 2,578 2,654 2,434 2,551 2,447 2,903 2,929 3,183 3,008
Two years later 4,282 4,207 4,179 4,004 4,078 4,223 4,626 4,873 4,851 --
Three years later 5,433 5,268 5,286 5,056 5,390 5,363 5,972 5,944 -- --
Four years later 6,229 6,112 6,040 6,077 6,211 6,303 6,617 -- -- --
Five years later 6,895 6,682 6,877 6,717 6,922 6,702 -- -- -- --
Six years later 7,354 7,391 7,406 7,303 7,178 -- -- -- -- --
Seven years later 7,987 7,861 7,924 7,478 -- -- -- -- -- --
Eight years later 8,411 8,332 8,052 -- -- -- -- -- -- --
Nine years later 8,851 8,426 -- -- -- -- -- -- -- --
Ten years later 8,917 -- -- -- -- -- -- -- -- --
LIABILITIES REESTIMATED
One year later 10,757 10,811 11,019 11,988 12,183 12,090 12,176 11,980 11,973 12,668
Two years later 10,970 11,009 12,142 11,992 12,065 11,808 12,048 11,975 12,218 --
Three years later 11,182 12,094 12,127 11,919 11,887 11,638 11,992 12,083 -- --
Four years later 12,304 12,157 12,113 11,789 11,772 11,511 12,008 -- -- --
Five years later 12,406 12,184 12,082 11,769 11,615 11,488 -- -- -- --
Six years later 12,462 12,165 12,088 11,640 11,556 -- -- -- -- --
Seven years later 12,414 12,218 11,981 11,568 -- -- -- -- -- --
Eight years later 12,500 12,154 11,902 -- -- -- -- -- -- --
Nine years later 12,472 12,076 -- -- -- -- -- -- -- --
Ten years later 12,414 -- -- -- -- -- -- -- -- --
DEFICIENCY (REDUNDANCY), NET OF
REINSURANCE $1,916 $1,359 $1,126 $544 $(646) $(777) $(393) $63 $361 $231
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The table above shows the cumulative deficiency (redundancy) of the Company's
reserves, net of reinsurance, as now estimated with the benefit of additional
information. Those amounts are comprised of changes in estimates of gross losses
and changes in estimates of related reinsurance recoveries. The table below, for
the periods presented, reconciles the net reserves to the gross reserves, as
initially estimated and recorded, and as currently estimated and recorded, and
computes the cumulative deficiency (redundancy) of the Company's reserves before
reinsurance.
<TABLE>
<CAPTION>
PROPERTY AND CASUALTY CLAIM AND CLAIM ADJUSTMENT EXPENSE LIABILITY DEVELOPMENT - GROSS
FOR THE YEARS ENDED DECEMBER 31, [1]
1994 1995 1996 1997 1998 1999 2000 2001 2002
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
NET RESERVE, AS INITIALLY ESTIMATED $10,776 $11,024 $12,202 $12,265 $12,401 $12,020 $11,857 $12,437 $12,688
Reinsurance and other recoverables, as initially
estimated 5,156 4,829 4,357 3,996 3,275 3,706 3,871 4,176 4,018
- ------------------------------------------------------------------------------------------------------------------------------------
GROSS RESERVE, AS INITIALLY ESTIMATED $15,932 $15,853 $16,559 $16,261 $15,676 $15,726 $15,728 $16,613 $16,706
- ------------------------------------------------------------------------------------------------------------------------------------
NET REESTIMATED RESERVE $11,902 $11,568 $11,556 $11,488 $12,008 $12,083 $12,218 $12,668
Reestimated and other reinsurance recoverables 5,337 4,572 3,896 3,606 3,080 3,858 3,866 4,049
- ------------------------------------------------------------------------------------------------------------------------------------
GROSS REESTIMATED RESERVE $17,239 $16,140 $15,452 $15,094 $15,088 $15,941 $16,084 $16,717
- ------------------------------------------------------------------------------------------------------------------------------------
GROSS DEFICIENCY (REDUNDANCY) $1,307 $287 $(1,107)$(1,167) $(588) $(215) $356 $104
- ------------------------------------------------------------------------------------------------------------------------------------
<FN>
[1] The above tables exclude Hartford Insurance, Singapore as a result of its
sale in September 2001, Hartford Seguros as a result of its sale in February
2001, Zwolsche as a result of its sale in December 2000 and London &
Edinburgh as a result of its sale in November 1998.
</FN>
</TABLE>
- 11 -
<PAGE>
The above tables exclude the liabilities and claim developments for certain
reinsurance coverages written for affiliated parties detailed in the table
below.
<TABLE>
<CAPTION>
1994 1995 1996 1997 1998 1999 2000 2001 2002
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Liabilities, net and gross of reinsurance for unpaid
claims and claim adjustment expenses excluded $495 $550 $500 $505 $501 $456 $459 $423 $453
====================================================================================================================================
</TABLE>
The following table reconciles the Loss Development Table to the Consolidated
Financial Statements:
2002 2001 2000
- ------------------------------------------------------------------
Loss Development Table:
Gross reserves $ 16,706 $ 16,613 $ 15,728
Exclusion of international
subsidiaries -- -- 106
Reinsurance - affiliated parties 453 423 459
==================================================================
Gross reserves per
Consolidated Financial
Statements (see Note 7) $ 17,159 $ 17,036 $ 16,293
==================================================================
The following table is derived from the Loss Reserve Development table and
summarizes the effect of reserve re-estimates, net of reinsurance, on calendar
year operations for the ten-year period ended December 31, 2002. The total of
each column details the amount of reserve re-estimates made in the indicated
calendar year and shows the accident years to which the re-estimates are
applicable. The amounts in the total accident year column on the far right
represent the cumulative reserve re-estimates during the ten year period ended
December 31, 2002 for the indicated accident year(s).
<TABLE>
<CAPTION>
EFFECT OF NET RESERVE RE-ESTIMATES ON CALENDAR YEAR OPERATIONS
CALENDAR YEAR
---------------------------------------------------------------------------------------------------------
1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
By Accident year
1992 & Prior $259 $213 $212 $1,122 $102 $56 $(48) $86 $(28) $(58) $1,916
1993 (119) (14) (37) (39) (29) 29 (33) (36) (20) (298)
1994 45 38 (78) (41) (12) (47) (43) (1) (139)
1995 (159) 19 (59) (99) (26) (22) 7 (339)
1996 (23) (45) (48) (95) (28) 13 (226)
1997 (57) (104) (55) 30 36 (150)
1998 57 42 71 39 209
1999 88 51 92 231
2000 121 137 258
2001 (14) (14)
- ------------------------------------------------------------------------------------------------------------------------------------
Total $259 $94 $243 $964 $(19) $(175) $(225) $(40) $116 $231 $1,448
====================================================================================================================================
</TABLE>
CEDED REINSURANCE
Consistent with industry practice, The Hartford cedes insurance risk to
reinsurance companies. For Property & Casualty operations, these reinsurance
arrangements are intended to provide greater diversification of business and
limit The Hartford's maximum net loss arising from large risks or catastrophes.
A major portion of The Hartford's property and casualty reinsurance is effected
under general reinsurance contracts known as treaties, or, in some instances, is
negotiated on an individual risk basis, known as facultative reinsurance. The
Hartford also has in-force excess of loss contracts with reinsurers that protect
it against a specified part or all of certain losses over stipulated amounts.
Reinsurance does not relieve The Hartford of its primary liability and, as such,
failure of reinsurers to honor their obligations could result in losses to The
Hartford. The Hartford evaluates the financial condition of its reinsurers and
monitors concentrations of credit risk. The Company's monitoring procedures
include careful initial selection of its reinsurers, structuring agreements to
provide collateral funds where possible, and regularly monitoring the financial
condition and ratings of its reinsurers.
In accordance with normal industry practice, Life is involved in both the
cession and assumption of insurance with other insurance and reinsurance
companies. As of December 31, 2002, the largest amount of life insurance
retained on any one life by any one of the life operations was approximately
$2.5. In addition, the Company reinsures the majority of the minimum death
benefit guarantee and the guaranteed withdrawal benefits offered in connection
with its variable annuity contracts.
INVESTMENT OPERATIONS
An important element of the financial results of The Hartford is return on
invested assets. The Hartford's investment activities are primarily divided
between Life and Property & Casualty and are managed based on the underlying
characteristics and nature of their respective liabilities.
The primary investment objective of Life's general account and guaranteed
separate accounts is to maximize after-tax returns consistent with acceptable
risk parameters, including the management of the interest rate sensitivity of
invested assets and the generation of sufficient liquidity, relative to that of
corporate and policyholder obligations.
The investment objective for the majority of Property & Casualty is to maximize
economic value while generating after-tax income and sufficient liquidity to
meet corporate
- 12 -
<PAGE>
and policyholder obligations. For Property & Casualty's Other Operations
segment, the investment objective is to ensure the full and timely payment of
all liabilities. Property & Casualty investment strategies are developed based
on a variety of factors including business needs, regulatory requirements and
tax considerations.
For a further discussion of The Hartford's approach to managing risks, including
derivative utilization, see the Capital Markets Risk Management section of the
MD&A, as well as Note 3 of Notes to Consolidated Financial Statements.
REGULATION AND PREMIUM RATES
Although there has been some deregulation with respect to large commercial
insureds in recent years, insurance companies, for the most part, are still
subject to comprehensive and detailed regulation and supervision throughout the
United States. The extent of such regulation varies, but generally has its
source in statutes which delegate regulatory, supervisory and administrative
powers to state insurance departments. Such powers relate to, among other
things, the standards of solvency that must be met and maintained; the licensing
of insurers and their agents; the nature of and limitations on investments;
establishing premium rates; claim handling and trade practices; restrictions on
the size of risks which may be insured under a single policy; deposits of
securities for the benefit of policyholders; approval of policy forms; periodic
examinations of the affairs of companies; annual and other reports required to
be filed on the financial condition of companies or for other purposes; fixing
maximum interest rates on life insurance policy loans and minimum rates for
accumulation of surrender values; and the adequacy of reserves and other
necessary provisions for unearned premiums, unpaid claims and claim adjustment
expenses and other liabilities, both reported and unreported.
Most states have enacted legislation that regulates insurance holding company
systems such as The Hartford. This legislation provides that each insurance
company in the system is required to register with the insurance department of
its state of domicile and furnish information concerning the operations of
companies within the holding company system which may materially affect the
operations, management or financial condition of the insurers within the system.
All transactions within a holding company system affecting insurers must be fair
and equitable. Notice to the insurance departments is required prior to the
consummation of transactions affecting the ownership or control of an insurer
and of certain material transactions between an insurer and any entity in its
holding company system. In addition, certain of such transactions cannot be
consummated without the applicable insurance department's prior approval.
The extent of insurance regulation on business outside the United States varies
significantly among the countries in which The Hartford operates. Some countries
have minimal regulatory requirements, while others regulate insurers
extensively. Foreign insurers in many countries are faced with greater
restrictions than domestic competitors domiciled in that particular
jurisdiction. The Hartford's international operations are comprised of insurers
licensed in their respective countries and, therefore, are subject to the
generally less restrictive domestic insurance regulations.
EMPLOYEES
The Hartford had approximately 29,000 employees as of December 31, 2002.
AVAILABLE INFORMATION
The Hartford files annual, quarterly and current reports, proxy statements and
other documents with the Securities and Exchange Commission (the "SEC") under
the Securities Exchange Act of 1934 (the "Exchange Act"). The public may read
and copy any materials that The Hartford files with the SEC at the SEC's Public
Reference Room at 450 Fifth Street, NW, Washington, DC 20549. The public may
obtain information on the operation of the Public Reference Room by calling the
SEC at 1-800-SEC-0330. Also, the SEC maintains an Internet website that contains
reports, proxy and information statements, and other information regarding
issuers, including The Hartford, that file electronically with the SEC. The
public can obtain any documents that The Hartford files with the SEC at
http://www.sec.gov.
The Hartford also makes available free of charge on or through its Internet
website (http://thehartford.com) The Hartford's Annual Report on Form 10-K,
Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to
those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Exchange Act as soon as reasonably practicable after The Hartford electronically
files such material with, or furnishes it to, the SEC.
ITEM 2. PROPERTIES
The Hartford owns the land and buildings comprising its Hartford location and
other properties within the greater Hartford, Connecticut area which total
approximately 1.8 million square feet. In addition, The Hartford leases
approximately 6.5 million square feet throughout the United States and 37
thousand square feet in other countries. All of the properties owned or leased
are used by one or more of all nine operating segments, depending on the
location. (For more information on operating segments see Part 1, Item 1,
Business of The Hartford - Reporting Segments.) The Company believes its
properties and facilities are suitable and adequate for current operations.
ITEM 3. LEGAL PROCEEDINGS
The Hartford is involved in claims litigation arising in the ordinary course of
business, both as a liability insurer defending third-party claims brought
against insureds and as an insurer defending coverage claims brought against it.
The Hartford accounts for such activity through the establishment of unpaid
claim and claim adjustment expense reserves. Subject to the discussion of the
litigation involving Mac Arthur Company and its subsidiary, Western MacArthur
Company, both former regional distributors of asbestos products (collectively or
individually, "MacArthur"), below and the uncertainties discussed in Note 16(b)
of Notes to Consolidated Financial Statements under the caption "Asbestos and
Environmental Claims," management expects that the ultimate liability, if any,
with respect to such ordinary-course claims litigation, after consideration of
provisions made for potential losses and costs of defense, will not be material
to the consolidated financial condition, results of operations or cash flows of
The Hartford.
- 13 -
<PAGE>
The Hartford is also involved in other kinds of legal actions, some of which
assert claims for substantial amounts. These actions include, among others,
putative state and federal class actions seeking certification of a state or
national class. Such putative class actions have alleged, for example,
underpayment of claims or improper underwriting practices in connection with
various kinds of insurance policies, such as personal and commercial automobile,
premises liability, and inland marine. The Hartford also is involved in
individual actions in which punitive damages are sought, such as claims alleging
bad faith in the handling of insurance claims. Management expects that the
ultimate liability, if any, with respect to such lawsuits, after consideration
of provisions made for potential losses and costs of defense, will not be
material to the consolidated financial condition of The Hartford. Nonetheless,
given the large or indeterminate amounts sought in certain of these actions, and
the inherent unpredictability of litigation, it is possible that an adverse
outcome in certain matters could, from time to time, have a material adverse
effect on the Company's consolidated results of operations or cash flows in
particular quarterly or annual periods.
As further discussed in the MD&A under the caption "Other Operations," The
Hartford continues to receive environmental and asbestos claims that involve
significant uncertainty regarding policy coverage issues. Regarding these
claims, The Hartford continually reviews its overall reserve levels,
methodologies and reinsurance coverages.
Hartford Accident and Indemnity Company ("Hartford A&I"), a subsidiary of the
Company, issued primary general liability policies to MacArthur during the
period 1967 to 1976. MacArthur sought coverage for asbestos-related claims from
Hartford A&I under these policies beginning in 1978. During the period between
1978 and 1987, Hartford A&I paid its full aggregate limits under these policies
plus defense costs. In 1987, Hartford A&I notified MacArthur that its available
limits under these policies had been exhausted, and MacArthur ceased submitting
claims to Hartford A&I under these policies.
On October 3, 2000, thirteen years after it had accepted Hartford A&I's notice
of exhaustion, MacArthur filed an action against Hartford A&I and another
insurer in the U.S. District Court for the Eastern District of New York, seeking
for the first time additional coverage for asbestos bodily injury claims under
The Hartford A&I primary policies. MacArthur seeks additional coverage on the
theory that Hartford A&I has exhausted only its products aggregate limit of
liability, not separate limits MacArthur alleges to be available for
non-products liability. The complaint seeks a declaration of coverage and
unquantified damages. Hartford A&I has moved for summary judgment dismissing
MacArthur's claims with prejudice. MacArthur has moved to dismiss the action
without prejudice. Both motions are pending.
On June 3, 2002, The St. Paul Companies, Inc. ("St. Paul") announced a
settlement of a coverage action brought by MacArthur against United States
Fidelity and Guaranty Company ("USF&G"), a subsidiary of St. Paul. Under the
settlement, St. Paul agreed to pay a total of $975 to resolve its asbestos
liability to MacArthur in conjunction with a proposed bankruptcy petition and
pre-packaged plan of reorganization to be filed by MacArthur. USF&G provided at
least 12 years of primary general liability coverage to MacArthur, but, unlike
Hartford A&I, had denied coverage and had refused to pay for defense or
indemnity.
On October 7, 2002, MacArthur filed an action in the Superior Court in Alameda
County, California, against Hartford A&I and two other insurers. As in the New
York action, MacArthur seeks a declaration of coverage and damages for asbestos
bodily injury claims. Five asbestos claimants who allegedly have obtained
default judgments against MacArthur also are joined as plaintiffs; they seek to
recover the amount of their default judgments and additional damages directly
from the defendant insurers and assert a right to an accelerated trial.
In its October 7, 2002 complaint, MacArthur alleges that it has approximately
$1.8 billion of unpaid asbestos liability judgments against it to date. The
ultimate amount of MacArthur's alleged non-products asbestos liability,
including any unresolved current claims and future demands, is currently
unknown. On Hartford A&I's motion, the court stayed the action until March 3,
2003, to allow the New York federal court time to rule first on the motions
pending there.
On November 22, 2002, MacArthur filed a bankruptcy petition and proposed plan of
reorganization, which seeks to implement the terms of its settlement with St.
Paul. MacArthur's bankruptcy filings indicate that it will seek to have the full
amount of its current and future asbestos liability estimated in conjunction
with plan confirmation. If such an estimation is made, MacArthur intends to ask
the Alameda County court to enter judgment against the insurers for the amount
of its total estimated liability, including unliquidated claims and future
demands, less the amount ultimately paid by St. Paul. Hartford A&I has filed an
adversary complaint in the MacArthur bankruptcy seeking a declaratory judgment
that any estimation made in the bankruptcy proceedings is not an adjudication of
MacArthur's asbestos liability for purposes of insurance coverage.
Hartford A&I intends to defend the MacArthur actions vigorously. Based on the
information currently available, management believes that Hartford A&I's
liability, if any, to MacArthur will not be finally resolved for at least a year
and most probably not for several years. In the opinion of management, the
ultimate outcome is highly uncertain for many reasons. It is not yet known, for
example, in which venue Hartford A&I's liability, if any, will be determined;
whether Hartford A&I's defenses based on MacArthur's long delay in asserting
claims for further coverage will be successful; how other significant coverage
defenses will be decided; or the extent to which the claims and default
judgments against MacArthur involve injury outside of the products and completed
operations hazard definitions of the policies. In the opinion of management, an
adverse outcome could have a material adverse effect on the Company's results of
operations, financial condition and liquidity.
In addition, on May 14, 2002, The Hartford announced its participation, along
with several dozen other insurance carriers, in a settlement in principle with
its insured, PPG Industries ("PPG"), of litigation arising from asbestos
exposures involving Pittsburgh Corning Corporation, which is 50% owned by PPG.
(For further discussion, see Note 16(b) of Notes to Consolidated Financial
Statements.)
- 14 -
<PAGE>
On March 15, 2002, a jury in the U.S. District Court for the Eastern District of
Missouri issued a verdict in Bancorp Services, LLC ("Bancorp") v. Hartford Life
Insurance Company ("HLIC"), et al., in favor of Bancorp in the amount of $118.
The case involved claims of patent infringement, misappropriation of trade
secrets, and breach of contract against HLIC and its affiliate International
Corporate Marketing Group, LLC ("ICMG"). The judge dismissed the patent
infringement claim on summary judgment. The jury's award was based on the last
two claims. On August 28, 2002, the Court entered an order awarding Bancorp
prejudgment interest on the breach of contract claim in the amount of $16.
HLIC and ICMG have appealed the judgment on the trade secret and breach of
contract claims. Bancorp has cross-appealed the pretrial dismissal of its patent
infringement claim. The Company's management, based on the advice of its legal
counsel, believes that there is a substantial likelihood that the judgment will
not survive at its current amount. Based on the advice of legal counsel
regarding the potential outcomes of this litigation, the Company recorded an $11
after-tax charge for this matter in the first quarter of 2002 to increase
litigation reserves. Should HLIC and ICMG not succeed in eliminating or reducing
the judgment, a significant additional expense would be recorded in the future
related to this matter.
The Company is involved in arbitration with one of its primary reinsurers
relating to policies with death benefit guarantees written from 1994 to 1999.
The arbitration involves alleged breaches under the reinsurance treaties.
Although the Company believes that its position in this pending arbitration is
strong, an adverse outcome could result in a decrease to the Company's statutory
surplus and capital and potentially increase the death benefit costs incurred by
the Company in the future. The arbitration hearing was held during the fourth
quarter of 2002, but no decision has been rendered.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of security holders of The Hartford during the
fourth quarter of 2002.
PART II
ITEM 5. MARKET FOR THE HARTFORD'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS
The Hartford's common stock is traded on the New York Stock Exchange ("NYSE")
under the trading symbol "HIG".
The following table presents the high and low closing prices for the common
stock of The Hartford on the NYSE for the periods indicated, and the quarterly
dividends declared per share.
1st Qtr. 2nd Qtr. 3rd Qtr. 4th Qtr.
- -----------------------------------------------------------------
2002
Common Stock Price
High $68.56 $69.97 $58.63 $50.10
Low 59.93 58.04 41.00 37.38
Dividends Declared 0.26 0.26 0.26 0.27
2001
Common Stock Price
High $67.75 $70.46 $69.28 $62.83
Low 55.15 56.88 50.10 53.91
Dividends Declared 0.25 0.25 0.25 0.26
=================================================================
As of February 19, 2003, the Company had approximately 115,000 shareholders. The
closing price of The Hartford's common stock on the NYSE on February 19, 2003
was $37.11.
On October 24, 2002, The Hartford's Board of Directors declared a quarterly
dividend of $0.27 per share payable on January 2, 2003 to shareholders of record
as of December 2, 2002. The dividend represented a 4% increase from the prior
quarter. Dividend decisions are based on and affected by a number of factors,
including the operating results and financial requirements of The Hartford and
the impact of regulatory restrictions discussed in the Capital Resources and
Liquidity section of the MD&A under "Liquidity Requirements".
There are also various legal limitations governing the extent to which The
Hartford's insurance subsidiaries may extend credit, pay dividends or otherwise
provide funds to The Hartford Financial Services Group, Inc. as discussed in the
Capital Resources and Liquidity section of the MD&A under "Liquidity
Requirements".
- 15 -
<PAGE>
<TABLE>
<CAPTION>
ITEM 6. SELECTED FINANCIAL DATA
(IN MILLIONS, EXCEPT FOR PER SHARE DATA AND COMBINED RATIOS)
2002 2001 2000 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA
Total revenues [1] $ 15,907 $ 15,147 $ 14,703 $ 13,528 $ 15,022
Income before cumulative effect of accounting
changes [2] 1,000 541 974 862 1,015
Net income [2] [3] 1,000 507 974 862 1,015
- ------------------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA
Total assets $ 182,043 $ 181,593 $ 171,951 $ 167,486 $ 150,632
Long-term debt 2,596 1,965 1,862 1,548 1,548
Company obligated mandatorily redeemable preferred
securities of subsidiary trusts holding solely junior
subordinated debentures 1,468 1,412 1,243 1,250 1,250
Total stockholders' equity 10,734 9,013 7,464 5,466 6,423
- ------------------------------------------------------------------------------------------------------------------------------------
EARNINGS PER SHARE DATA
BASIC EARNINGS PER SHARE [2]
Income before cumulative effect of accounting changes
[2] $ 4.01 $ 2.27 $ 4.42 $ 3.83 $ 4.36
Net income [2] [3] 4.01 2.13 4.42 3.83 4.36
DILUTED EARNINGS PER SHARE [2]
Income before cumulative effect of accounting changes
[2] 3.97 2.24 4.34 3.79 4.30
Net income [2] [3] 3.97 2.10 4.34 3.79 4.30
Dividends declared per common share 1.05 1.01 0.97 0.92 0.85
- ------------------------------------------------------------------------------------------------------------------------------------
OTHER DATA
Mutual fund assets [4] $ 15,321 $ 16,809 $ 11,432 $ 6,374 $ 2,506
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING DATA
COMBINED RATIOS
North American Property & Casualty [5] 99.2 112.4 102.4 103.3 102.9
====================================================================================================================================
<FN>
[1] 2001 includes a $91 reduction in premiums from reinsurance cessions
related to September 11. 1998 includes $541 related to the recapture of an
in-force block of COLI business from MBL Life Assurance Co. of New Jersey.
Also, 1998 includes revenues from London & Edinburgh, which was sold in
November 1998, of $1,117.
[2] 2002 includes $76 tax benefit in Life, $11 after-tax expense in Life
related to Bancorp and an $8 after-tax benefit in Life's September 11
exposure. 2001 includes $440 of losses related to September 11 and a $130
tax benefit at Life.
[3] 2001 includes a $34 after-tax charge ($0.14 per basic and per diluted
share) related to the cumulative effect of accounting changes for the
Company's adoption of SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities" and EITF Issue No. 99-20, "Recognition of Interest
Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets".
[4] Mutual funds are owned by the shareholders of those funds and not by the
Company. As a result, they are not reflected in total assets on the
Company's balance sheet.
[5] Represents statutory ratio. 2001 includes the impact of September 11.
Excluding the impact of September 11, the 2001 combined ratio was 103.4.
</FN>
</TABLE>
Outlined in the table below are United States Industry Combined Ratios for each
of the five years ended December 31:
<TABLE>
<CAPTION>
2002 2001 2000 1999 1998
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
United States Industry Combined Ratios [1] 105.7 116.0 110.1 107.8 105.6
- ------------------------------------------------------------------------------------------------------------------------------------
<FN>
[1] Represents statutory ratio. U.S. Industry Combined Ratio information
obtained from A.M. Best. Combined ratio for 2002 is an A.M. Best estimate
prepared as of January 2003.
</FN>
</TABLE>
- 16 -
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
(DOLLAR AMOUNTS IN MILLIONS, EXCEPT FOR PER SHARE DATA, UNLESS OTHERWISE STATED)
Management's Discussion and Analysis of Financial Condition and Results of
Operations ("MD&A") addresses the financial condition of The Hartford Financial
Services Group, Inc. and its subsidiaries (collectively, "The Hartford" or the
"Company") as of December 31, 2002, compared with December 31, 2001, and its
results of operations for each of the three years in the period ended December
31, 2002. This discussion should be read in conjunction with the Consolidated
Financial Statements and related Notes beginning on page F-1.
Certain of the statements contained herein (other than statements of historical
fact) are forward-looking statements. These forward-looking statements are made
pursuant to the safe harbor provisions of the Private Securities Litigation
Reform Act of 1995 and include estimates and assumptions related to economic,
competitive and legislative developments. These forward-looking statements are
subject to change and uncertainty which are, in many instances, beyond the
Company's control and have been made based upon management's expectations and
beliefs concerning future developments and their potential effect upon the
Company. There can be no assurance that future developments will be in
accordance with management's expectations or that the effect of future
developments on The Hartford will be those anticipated by management. Actual
results could differ materially from those expected by the Company, depending on
the outcome of various factors. These factors include: the difficulty in
predicting the Company's potential exposure for asbestos and environmental
claims and related litigation, in particular, significant uncertainty with
regard to the outcome of the Company's current dispute with Mac Arthur Company
and its subsidiary, Western MacArthur Company (collectively or individually,
"MacArthur"); the uncertain nature of damage theories and loss amounts and the
development of additional facts related to the September 11 terrorist attack
("September 11"); the uncertain impact on the Company of the Bush
Administration's budget proposals relating to the distribution of nontaxable
dividends to shareholders and the creation of new tax-favored individual savings
accounts; the response of reinsurance companies under reinsurance contracts, the
impact of increasing reinsurance rates, and the availability and adequacy of
reinsurance to protect the Company against losses; the possibility of more
unfavorable loss experience than anticipated; the possibility of general
economic and business conditions that are less favorable than anticipated; the
incidence and severity of catastrophes, both natural and man-made; the effect of
changes in interest rates, the stock markets or other financial markets;
stronger than anticipated competitive activity; unfavorable legislative,
regulatory or judicial developments; the Company's ability to distribute its
products through distribution channels, both current and future; the uncertain
effects of emerging claim and coverage issues; the effect of assessments and
other surcharges for guaranty funds and second-injury funds and other mandatory
pooling arrangements; a downgrade in the Company's claims-paying, financial
strength or credit ratings; the ability of the Company's subsidiaries to pay
dividends to the Company; and other factors described in such forward-looking
statements.
Certain reclassifications have been made to prior year financial information to
conform to the current year presentation.
- --------------------------------------------------------------------------------
INDEX
- --------------------------------------------------------------------------------
Critical Accounting Estimates 17
Consolidated Results of Operations: Operating Summary 23
Life 27
Investment Products 29
Individual Life 30
Group Benefits 31
Corporate Owned Life Insurance (COLI) 32
Property & Casualty 33
Business Insurance 36
Personal Lines 37
Specialty Commercial 38
Reinsurance 40
Other Operations (Including Asbestos and
Environmental Claims) 41
Investments 46
Capital Markets Risk Management 50
Capital Resources and Liquidity 64
Effect of Inflation 71
- --------------------------------------------------------------------------------
CRITICAL ACCOUNTING ESTIMATES
- --------------------------------------------------------------------------------
The preparation of financial statements, in conformity with accounting
principles generally accepted in the United States of America, requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates.
The Company has identified the following estimates as critical in that they
involve a higher degree of judgment and are subject to a significant degree of
variability: reserves; valuation of investments and derivative instruments;
deferred policy acquisition costs; pension and other postretirement benefits;
and contingencies. In developing these estimates management makes subjective and
complex judgments that are inherently uncertain and subject to material change
as facts and circumstances develop. Although variability is inherent in these
estimates, management believes the amounts provided are appropriate based upon
the facts available upon compilation of the financial statements.
- 17 -
<PAGE>
RESERVES
LIFE
Life insurance subsidiaries of The Hartford establish and carry as liabilities
actuarially determined reserves, which are calculated to meet The Hartford's
future obligations. Reserves for life insurance and disability contracts are
based on actuarially recognized methods using prescribed morbidity and mortality
tables in general use in the United States, which are modified to reflect The
Hartford's actual experience when appropriate. These reserves are computed at
amounts that, with additions from estimated premiums to be received and with
interest on such reserves compounded annually at certain assumed rates, are
expected to be sufficient to meet The Hartford's policy obligations at their
maturities or in the event of an insured's death. Changes in or deviations from
the assumptions used for mortality, morbidity, expected future premiums and
interest can significantly affect the Life reserve levels and related future
operations. Reserves also include unearned premiums, premium deposits, claims
incurred but not reported ("IBNR") and claims reported but not yet paid.
Reserves for assumed reinsurance are computed in a manner that is comparable to
direct insurance reserves.
The liability for policy benefits for universal life-type contracts and
interest-sensitive whole life policies is equal to the balance that accrues to
the benefit of policyholders, including credited interest, amounts that have
been assessed to compensate the Company for services to be performed over future
periods and any amounts previously assessed against policyholders that are
refundable on termination of the contract.
For investment contracts, policyholder liabilities are equal to the accumulated
policy account values, which consist of an accumulation of deposit payments plus
credited interest, less withdrawals and amounts assessed through the end of the
period. Certain investment contracts include provisions whereby a guaranteed
minimum death benefit is provided in the event that the contractholder's account
value at death is below the guaranteed value. Although the Company reinsures the
majority of the death benefit guarantees associated with its in-force block of
business, declines in the equity market may increase the Company's net exposure
to death benefits under these contracts. In addition, these contracts contain
various provisions for determining the amount of the death benefit guaranteed
following the withdrawal of a portion of the account value by the policyholder.
Partial withdrawals under certain of these contracts may not result in a
reduction in the guaranteed minimum death benefit in proportion to the portion
surrendered. The Company records the death benefit costs, net of reinsurance,
when deaths occur.
For the Company's group disability policies, the level of reserves is based on a
variety of factors including particular diagnoses, termination rates and benefit
levels.
PROPERTY & CASUALTY
The Hartford establishes property and casualty reserves to provide for the
estimated costs of paying claims made under policies written by the Company.
These reserves include estimates for both claims that have been reported and
those that have been incurred but not reported, and include estimates of all
expenses associated with processing and settling these claims. Estimating the
ultimate cost of future claims and claim adjustment expenses is an uncertain and
complex process. This estimation process is based largely on the assumption that
past developments are an appropriate predictor of future events and involves a
variety of actuarial techniques that analyze experience, trends and other
relevant factors. Reserve estimates can change over time because of unexpected
changes in the external environment. Potential external factors include (1)
changes in the inflation rate for goods and services related to covered damages
such as medical care, hospital care, auto parts, wages and home repair, (2)
changes in the general economic environment that could cause unanticipated
changes in the claim frequency per unit insured, (3) changes in the litigious
environment as evidenced by changes in claimant attorney representation in the
claims negotiation and settlement process, (4) changes in the judicial
environment regarding the interpretation of policy provisions relating to the
determination of coverage and/or the amount of damages awarded for certain types
of damages, (5) changes in the social environment regarding the general attitude
of juries in the determination of liability and damages, (6) changes in the
regulatory environment regarding rates, rating plans and policy forms, (7)
changes in the legislative environment regarding the definition of damages and
(8) new types of injuries caused by new types of exposure to injury: past
examples include breast implants, tobacco products, lead paint, construction
defect and blood product contamination. Reserve estimates can also change over
time because of changes in internal company operations. Potential internal
factors include (1) periodic changes in claims handling procedures, (2) growth
in new lines of business where exposure and loss development patterns are not
well established or (3) changes in the quality of risk selection in the
underwriting process. In the case of reinsurance, all of the above risks apply.
In addition, changes in ceding company case reserving and reporting patterns
create additional factors that need to be considered in estimating the reserves.
Due to the inherent complexity of the assumptions used, final claim settlements
may vary significantly from the present estimates, particularly when those
settlements may not occur until well into the future.
The Hartford, like other insurance companies, categorizes and tracks its
insurance reserves by "line of business", such as general liability, commercial
multi-peril, workers' compensation, auto bodily injury, homeowners and assumed
reinsurance. Furthermore, The Hartford regularly reviews the appropriateness of
reserve levels at the line of business level, taking into consideration the
variety of trends that impact the ultimate settlement of claims for the subsets
of claims in each particular line of business. Adjustments to previously
established reserves, if any, are reflected in the operating results of the
period in which the adjustment is determined to be necessary. In the judgment of
management, all information currently available has been properly considered in
the reserves established for claims and claim adjustment expenses.
In the opinion of management, based upon the known facts and current law, the
reserves recorded for The Hartford's property and casualty businesses at
December 31, 2002 represent the Company's best estimate of its ultimate
liability for claims and claim adjustment expenses related to losses covered by
policies written by the Company. However, because of the significant
uncertainties surrounding environmental and particularly asbestos exposures, it
is possible that management's estimate of
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<PAGE>
the ultimate liabilities for these claims may change and that the required
adjustment to recorded reserves could exceed the currently recorded reserves by
an amount that could be material to The Hartford's results of operations,
financial condition and liquidity.
ASBESTOS AND ENVIRONMENTAL CLAIMS
The Hartford continues to receive claims that assert damages from asbestos- and
environmental-related exposures. Asbestos claims relate primarily to bodily
injuries asserted by those who came in contact with asbestos or products
containing asbestos. Environmental claims relate primarily to pollution and
related clean-up costs.
The Hartford wrote several different categories of insurance coverage to which
asbestos and environmental claims may apply. First, The Hartford wrote direct
policies as a primary liability insurance carrier. Second, The Hartford wrote
direct excess insurance policies providing additional coverage for insureds that
exhaust their primary liability insurance coverage. Third, The Hartford acted as
a reinsurer assuming a portion of risks previously assumed by other insurers
writing primary, excess and reinsurance coverages. Fourth, The Hartford
participated as a London Market company that wrote both direct insurance and
assumed reinsurance business.
In establishing asbestos reserves, The Hartford evaluates the exposure presented
by each insured and the anticipated cost of resolution, if any, for each
insured. In the course of this evaluation, The Hartford considers: available
insurance coverage, including the role of any umbrella or excess insurance The
Hartford has issued to the insured; limits and deductibles; an analysis of each
insured's potential liability; the jurisdictions involved; past and anticipated
future claim activity; past settlement values of similar claims; allocated claim
adjustment expense; potential role of other insurance; the role, if any, of
non-asbestos claims or potential non-asbestos claims in any resolution process;
and applicable coverage defenses or determinations, if any, including whether
some or all of the asbestos claims for which the insured seeks coverage are
products or completed operations claims subject to the aggregate limit.
In establishing environmental reserves, The Hartford evaluates the exposure
presented by each insured and the anticipated cost of resolution, if any, for
each insured. In the course of this analysis, The Hartford considers the
probable liability, available coverage, relevant judicial interpretations and
historical value of similar exposures. In addition, The Hartford considers
numerous facts that are unique to each insured, to the extent known, such as the
nature of the alleged activities of the insured at each site; the allegations of
environmental harm at each site; the number of sites; the total number of
potentially responsible parties at each site; the nature of environmental harm
and the corresponding remedy at each site; the nature of government enforcement
activities at each site; the ownership and general use of each site; the overall
nature of the insurance relationship between The Hartford and the insured,
including the role of any umbrella or excess insurance The Hartford has issued
to the insured; the involvement of other insurers; the potential for other
available coverage, including the number of years of coverage; the role, if any,
of non-environmental claims or potential non-environmental claims in any
resolution process; and the applicable law in each jurisdiction.
For both asbestos and environmental reserves, The Hartford also compares its
historical direct net loss and expense paid and incurred experience, and net
loss and expense paid and incurred experience year by year, to assess any
emerging trends, fluctuations or characteristics suggested by the aggregate paid
and incurred activity.
Once the gross ultimate exposure for indemnity and allocated claim adjustment
expense is determined for each insured by each policy year, The Hartford
calculates its ceded reinsurance projection based on any applicable facultative
and treaty reinsurance and the Company's experience with reinsurance
collections.
Uncertainties Regarding Adequacy of Asbestos and Environmental Reserves
With regard to both environmental and particularly asbestos claims, significant
uncertainty limits the ability of insurers and reinsurers to estimate the
ultimate reserves necessary for unpaid losses and related settlement expenses.
Conventional reserving techniques cannot reasonably estimate the ultimate cost
of these claims, particularly during periods where theories of law are in flux.
As a result of the factors discussed in the following paragraphs, the degree of
variability of reserve estimates for these exposures is significantly greater
than for other more traditional exposures. In particular, The Hartford believes
there is a high degree of uncertainty inherent in the estimation of asbestos
loss reserves.
In the case of the reserves for asbestos exposures, factors contributing to the
high degree of uncertainty include inadequate development patterns, plaintiffs'
expanding theories of liability, the risks inherent in major litigation and
inconsistent emerging legal doctrines. Courts have reached inconsistent
conclusions as to when losses are deemed to have occurred and which policies
provide coverage; what types of losses are covered; whether there is an insurer
obligation to defend; how policy limits are determined; whether particular
claims are product/completed operation claims subject to an aggregate limit and
how policy exclusions and conditions are applied and interpreted. Furthermore,
insurers in general, including The Hartford, have recently experienced an
increase in the number of asbestos-related claims due to, among other things,
more intensive advertising by lawyers seeking asbestos claimants, plaintiffs'
increased focus on new and previously peripheral defendants and an increase in
the number of insureds seeking bankruptcy protection as a result of
asbestos-related liabilities. Plaintiffs and insureds have sought to use
bankruptcy proceedings to accelerate and increase loss payments by insurers. In
addition, some policyholders have begun to assert new classes of claims for so
called "non-product" coverages to which an aggregate limit of liability may not
apply. Recently, many insurers, including, in a limited number of instances, The
Hartford, also have been sued directly by asbestos claimants asserting that
insurers had a duty to protect the public from the dangers of asbestos.
Management believes these issues are not likely to be resolved in the near
future.
In the case of the reserves for environmental exposures, factors contributing to
the high degree of uncertainty include court
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<PAGE>
decisions that have interpreted the insurance coverage to be broader than
originally intended; inconsistent decisions, especially across jurisdictions and
uncertainty as to the monetary amount being sought by the claimant from the
insured.
Further uncertainties include the effect of the recent acceleration in the rate
of bankruptcy filings by asbestos defendants on the rate and amount of The
Hartford's asbestos claims payments; a further increase or decrease in asbestos
and environmental claims which cannot now be anticipated; whether some
policyholders' liabilities will reach the umbrella or excess layer of their
coverage; the resolution or adjudication of some disputes pertaining to the
amount of available coverage for asbestos claims in a manner inconsistent with
The Hartford's previous assessment of these claims; the number and outcome of
direct actions against The Hartford; and unanticipated developments pertaining
to The Hartford's ability to recover reinsurance for environmental and asbestos
claims. It is also not possible to predict changes in the legal and legislative
environment and their impact on the future development of asbestos and
environmental claims. Additionally, the reporting pattern for excess insurance
and reinsurance claims is much longer than direct claims. In many instances, it
takes months or years to determine that the customer's own obligations have been
met and how the reinsurance in question may apply to such claims. The delay in
reporting reinsurance claims and exposures adds to the uncertainty of estimating
the related reserves.
Given the factors and emerging trends described above, The Hartford believes the
actuarial tools and other techniques it employs to estimate the ultimate cost of
claims for more traditional kinds of insurance exposure are less precise in
estimating reserves for its asbestos exposures. The Hartford continually
evaluates new information and new methodologies in assessing its potential
asbestos exposures. At any time, The Hartford may be conducting an analysis of
newly identified information and completion of exposure analyses could cause The
Hartford to change its estimates of its asbestos reserves and the effect of
these changes could be material to the Company's consolidated operating results,
financial condition and liquidity.
VALUATION OF INVESTMENTS AND DERIVATIVE INSTRUMENTS
The Hartford's investments in both fixed maturities, which include bonds,
redeemable preferred stock and commercial paper, and equity securities, which
include common and non-redeemable preferred stocks, are classified as "available
for sale" as defined in Statement of Financial Accounting Standards ("SFAS") No.
115, "Accounting for Certain Investments in Debt and Equity Securities".
Accordingly, these securities are carried at fair value with the after-tax
difference from amortized cost, as adjusted for the effect of deducting the life
and pension policyholders' share of the immediate participation guaranteed
contracts and the change in amortization of deferred policy acquisition costs,
reflected in stockholders' equity as a component of accumulated other
comprehensive income ("AOCI"). Policy loans are carried at outstanding balance,
which approximates fair value. Other invested assets consist primarily of
limited partnership investments that are accounted for by the equity method. The
Company's net income from partnerships is included in net investment income.
Other investments also include mortgage loans at amortized cost and derivatives
at fair value.
The fair value of securities is based upon quoted market prices or broker
quotations when available. Where market prices or broker quotations are not
available, management typically estimates the fair value based upon discounted
cash flow, applying current interest rates for similar financial instruments
with comparable terms and credit quality. The estimated fair value of a
financial instrument may differ significantly from the amount that could be
realized if the security were sold immediately. Derivative instruments are
reported at fair value based upon internally established valuations that are
consistent with external valuation models, quotations furnished by dealers in
such instrument or market quotations.
One of the significant estimations inherent in the valuation of investments is
the evaluation of other than temporary impairments. The evaluation for other
than temporary impairments is a quantitative and qualitative process which is
subject to risks and uncertainties in the determination of whether declines in
the fair value of investments are other than temporary. The risks and
uncertainties include changes in general economic conditions, the issuer's
financial condition or near term recovery prospects and the effects of changes
in interest rates. The Company's accounting policy requires that a decline in
the value of a security below its amortized cost basis be assessed to determine
if the decline is other than temporary. If so, the security is deemed to be
impaired and, a charge is recorded in net realized capital losses equal to the
difference between the fair value and amortized cost basis of the security. The
fair value of the impaired investment becomes its new cost basis. The Company
has a security monitoring process overseen by a committee of investment and
accounting professionals that identifies securities that, due to certain
characteristics, are subjected to an enhanced analysis on a quarterly basis.
Such characteristics include, but are not limited to: a deterioration of the
financial condition of the issuer, the magnitude and duration of unrealized
losses, credit rating and industry category.
The primary factors considered in evaluating whether a decline in value for
corporate issued securities is other than temporary include: (a) the length of
time and the extent to which the fair value has been less than cost, (b) the
financial condition and near-term prospects of the issuer, (c) whether the
debtor is current on contractually obligated interest and principal payments and
(d) the intent and ability of the Company to retain the investment for a period
of time sufficient to allow for any anticipated recovery. Additionally, for
certain securitized financial assets with contractual cash flows (including
asset-backed securities), Emerging Issues Task Force ("EITF") Issue No. 99-20,
"Recognition of Interest Income and Impairment on Purchased and Retained
Beneficial Interests in Securitized Financial Assets", requires the Company to
periodically update its best estimate of cash flows over the life of the
security. If management estimates that the fair value of its securitized
financial asset is less than its carrying amount and there has been a decrease
in the present value of the estimated cash flows since the last revised
estimate, considering both timing and amount, then an other than temporary
impairment charge
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<PAGE>
is recognized. Projections of expected future cash flows may change based upon
new information regarding the performance of the underlying collateral.
Furthermore, for securities expected to be sold, an other than temporary
impairment charge is recognized if the Company does not expect the fair value of
a security to recover to amortized cost prior to the expected date of sale. Once
an impairment charge has been recorded, the Company then continues to review the
other than temporarily impaired securities for appropriate valuation on an
ongoing basis.
DEFERRED POLICY ACQUISITION COSTS
LIFE
Policy acquisition costs, which include commissions and certain other expenses
that vary with and are primarily associated with acquiring business, are
deferred and amortized over the estimated lives of the contracts, usually 20
years. The deferred costs are recorded as an asset commonly referred to as
deferred policy acquisition costs ("DAC"). At December 31, 2002 and 2001, the
carrying value of the Company's Life operations' DAC was $5.2 billion and $5.0
billion, respectively.
DAC related to traditional policies are amortized over the premium-paying period
in proportion to the present value of annual expected premium income.
Adjustments are made each year to recognize actual experience as compared to
assumed experience for the current period.
DAC related to investment contracts and universal life-type contracts are
deferred and amortized using the retrospective deposit method. Under the
retrospective deposit method, acquisition costs are amortized in proportion to
the present value of estimated gross profits ("EGPs") from projected investment,
mortality and expense margins and surrender charges. A portion of the DAC
amortization is allocated to realized gains and losses. The DAC balance is also
adjusted by an amount that represents the change in amortization of deferred
policy acquisition costs that would have been required as a charge or credit to
operations had unrealized amounts been realized. Actual gross profits can vary
from management's estimates, resulting in increases or decreases in the rate of
amortization.
The Company regularly evaluates its estimated gross profits to determine if
actual experience or other evidence suggests that earlier estimates should be
revised. Several assumptions considered to be significant in the development of
EGPs include separate account fund performance, surrender and lapse rates,
estimated interest spread and estimated mortality. The separate account fund
performance assumption is critical to the development of the EGPs related to the
Company's variable annuity and variable and interest-sensitive life insurance
businesses. The average long-term rate of assumed separate account fund
performance used in estimating gross profits for the variable annuity and
variable life business was 9% at December 31, 2002 and 2001. For all other
products including fixed annuities and other universal life-type contracts the
average assumed investment yield ranged from 5% to 8.5% for the years ended
December 31, 2002 and 2001.
Due to the increased volatility and precipitous decline experienced by the U.S.
equity markets in 2002, the Company enhanced its DAC evaluation process during
the course of the year. The Company developed sophisticated modeling
capabilities, which allowed it to run 250 stochastically determined scenarios of
separate account fund performance. These scenarios were then utilized to
calculate a reasonable range of estimates for the present value of future gross
profits. This range is then compared to the present value of future gross
profits currently utilized in the DAC amortization model. As of December 31,
2002, the current estimate falls within the reasonable range, and therefore, the
Company does not believe there is evidence to suggest a revision to the EGPs is
necessary.
Additionally, the Company has performed various sensitivity analyses with
respect to separate account fund performance to provide an indication of future
separate account fund performance levels, which could result in the need to
revise future EGPs. The Company has estimated that a revision to the future EGPs
is unlikely in 2003 in the event that the separate account fund performance
meets or exceeds the Company's long-term assumption of 9% and that a revision is
likely if the overall separate account fund performance is negative for the
year. In the event that separate account fund performance falls between 0% and
9% during 2003, the Company will need to evaluate the actual gross profits
versus the mean EGPs generated by the stochastic DAC analysis and determine
whether or not to make a revision to the future EGPs. Factors that will
influence this determination include the degree of volatility in separate
account fund performance, when during the year performance becomes negative and
shifts in asset allocation within the separate account made by policyholders.
The overall return generated by the separate account is dependent on several
factors, including the relative mix of the underlying sub-accounts among bond
funds and equity funds as well as equity sector weightings. The Company's
overall separate account fund performance has been reasonably correlated to the
overall performance of the S&P 500 Index, although no assurance can be provided
that this correlation will continue in the future.
Should the Company change its assumptions utilized to develop EGPs (commonly
referred to as "unlocking") the Company would record a charge (or credit) to
bring its DAC balance to the level it would have been had EGPs been calculated
using the new assumptions from the date of each policy. The Company evaluates
all critical assumptions utilized to develop EGPs (e.g. lapse, mortality) and
will make a revision to future EGPs to the extent that actual experience is
significantly different than expected.
The overall recoverability of the DAC asset is dependent on the future
profitability of the business. The Company tests the aggregate recoverability of
the DAC asset by comparing the amounts deferred to total EGPs. In addition, the
Company routinely stress tests its DAC asset for recoverability against severe
declines in its separate account assets, which could occur if the equity markets
experienced another significant sell-off, as the majority of policyholders'
money held in the separate accounts are invested in the equity market. As of
December 31, 2002, separate account assets could fall 25% and the Company
believes its DAC asset would still be recoverable.
PROPERTY & CASUALTY
The Property & Casualty operations also incur costs, including commissions,
premium taxes and certain underwriting and policy issuance costs, that vary with
and are related primarily to the acquisition of property casualty insurance
business and are deferred and amortized ratably over the period the related
premiums are earned. Deferred acquisition costs are reviewed to determine if
they are recoverable from future income, and if
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<PAGE>
not, are charged to expense. Anticipated investment income is considered in the
determination of the recoverability of deferred acquisition costs. For the years
ended December 31, 2002, 2001 and 2000, no material amounts of deferred
acquisition costs were charged to expense based on the determination of
recoverability.
PENSION AND OTHER POSTRETIREMENT BENEFIT OBLIGATIONS
Pursuant to accounting principles related to the Company's pension and other
postretirement benefit obligations to employees under its various benefit plans,
the Company is required to make a significant number of assumptions in order to
estimate the related liabilities and expense each period. The two economic
assumptions that have the most impact on pension expense are the discount rate
and the expected long-term rate of return. In determining the discount rate
assumption, the Company utilizes information provided by its plan actuaries. In
particular, the Company uses an interest rate yield curve developed and
published by its plan actuaries. The yield curve is comprised of AAA/AA bonds
with maturities between zero and thirty years. Discounting the cash flows of the
Company's pension plan using this yield curve, it was determined that 6.50% is
the appropriate discount rate as of December 31, 2002 to calculate the Company's
accrued benefit cost liability. Accordingly, the 6.50% discount rate will also
be used to determine the Company's 2003 pension expense.
The Company determines the long-term rate of return assumption for the pension
plan's asset portfolio based on analysis of the portfolio's historical rates of
return balanced with future long-term return expectations. Based on its
long-term outlook with respect to the markets, which has been influenced by the
poor equity market performance in recent years as well as the recent decline in
fixed income security yields, the Company lowered its long-term rate of return
assumption from 9.75% to 9.00% as of December 31, 2002.
To illustrate the impact of these assumptions on annual pension expense for 2003
and going forward, a 25 basis point change in the discount rate will
increase/decrease pension expense by approximately $12, and a 25 basis point
change in the long-term asset return assumption will increase/decrease pension
expense by approximately $5.
CONTINGENCIES
Management follows the requirements of SFAS No. 5 "Accounting for
Contingencies". This statement requires management to evaluate each contingent
matter separately. The evaluation is a two-step process, including: determining
a likelihood of loss, and, if a loss is probable, developing a potential range
of loss. Management establishes reserves for these contingencies at its "best
estimate", or, if no one number within the range of possible losses is more
probable than any other, the Company records an estimated reserve at the low end
of the range of losses. The majority of contingencies currently being evaluated
by the Company relate to litigation and tax matters, which are inherently
difficult to evaluate and subject to significant changes.
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<PAGE>
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------
CONSOLIDATED RESULTS OF OPERATIONS: OPERATING SUMMARY
- --------------------------------------------------------------------------------
OVERVIEW 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Earned premiums $ 10,301 $ 9,409 $ 8,941
Fee income 2,577 2,633 2,484
Net investment income 2,953 2,850 2,674
Other revenue 476 491 459
Net realized capital gains (losses) (400) (236) 145
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 15,907 15,147 14,703
--------------------------------------------------------------------------------------------------------------------------
Benefits, claims and claim adjustment expenses 9,524 9,764 8,419
Amortization of deferred policy acquisition costs and present value of
future profits 2,241 2,214 2,213
Insurance operating costs and expenses 2,317 2,037 1,958
Goodwill amortization -- 60 28
Other expenses [1] 757 731 667
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 14,839 14,806 13,285
--------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES, MINORITY INTEREST AND CUMULATIVE
EFFECT OF ACCOUNTING CHANGES 1,068 341 1,418
Income tax expense (benefit) 68 (200) 390
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE MINORITY INTEREST AND CUMULATIVE EFFECT OF
ACCOUNTING CHANGES 1,000 541 1,028
Minority interest in consolidated subsidiary -- -- (54)
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGES 1,000 541 974
Cumulative effect of accounting changes, net of tax [2] -- (34) --
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME [3] 1,000 507 974
Less: Restructuring charges, net of tax -- (11) --
Loss from early retirement of debt, net of tax -- (8) --
Cumulative effect of accounting changes, net of tax [2] -- (34) --
Net realized capital gains (losses), after-tax (250) (164) 12
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME [3] $ 1,250 $ 724 $ 962
- ------------------------------------------------------------------------------------------------------------------------------------
<FN>
[1] For the year ended December 31, 2001, includes $16 of restructuring charges
and $13 of accelerated amortization of issuance costs on the Company's
8.35% Cumulative Quarterly Income Preferred Securities, which were redeemed
on December 31, 2001.
[2] Represents the cumulative impact of the Company's adoption of SFAS No. 133,
as amended, "Accounting for Derivative Instruments and Hedging Activities"
of $(23) and EITF Issue No. 99-20, "Recognition of Interest Income and
Impairment on Purchased and Retained Beneficial Interests in Securitized
Financial Assets" of $(11).
[3] 2002 includes a $76 tax benefit at Life, $11 after-tax expense at Life
related to Bancorp Services, LLC litigation ("Bancorp") and $8 after-tax
benefit in Life's September 11 exposure. 2001 includes $440, after-tax, of
losses related to September 11 and a $130 tax benefit at Life.
</FN>
</TABLE>
The Hartford defines "operating income" as after-tax operational results
excluding, as applicable, net realized capital gains and losses, restructuring
charges, losses from early retirement of debt and the cumulative effect of
accounting changes. Operating income is a performance measure used by the
Company in the management of its operations. Management believes that this
performance measure delineates the results of operations of the Company's
ongoing businesses in a manner that allows for a better understanding of the
underlying trends in the Company's current business. However, operating income
should only be analyzed in conjunction with, and not in lieu of, net income and
may not be comparable to other performance measures used by the Company's
competitors.
OPERATING RESULTS
2002 COMPARED TO 2001 - Revenues increased $760, or 5%. This increase was driven
by strong earned premium growth within Business Insurance, Personal Lines and
Specialty Commercial whose premiums increased by $496, $237 and $200,
respectively. Also contributing to the growth was a $61 increase in fee income
for the Individual Life segment. Additionally, 2001 revenues included a
reduction of $91 in Property & Casualty earned premiums, resulting from
additional reinsurance cessions related to September 11. Partially offsetting
the increases described above were higher net realized capital losses, which
were $400 in 2002 compared with $236 in 2001. The increase in the net realized
capital losses was due primarily to other than temporary write-downs of
corporate and asset-backed securities including those in the telecommunication,
utility and airline industries.
Operating income increased $526, or 73%. The increase was partially due to $440
in losses, after-tax and net of reinsurance, included in 2001 results related to
September 11 and the Company's adoption of SFAS No. 142, "Goodwill and Other
Intangible Assets", which precluded the amortization of goodwill beginning on
January 1, 2002. The Company's goodwill totaled $52, after-tax, in 2001.
Improved underwriting results in Property & Casualty, as well as increased
operating income in the Group Benefits segment, also contributed to the
increase. Partially offsetting the increase was lower operating income in the
Investment Products segment.
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<PAGE>
Net income increased $493, or 97%. The increase was due primarily to the growth
in operating income described in the paragraph above, partially offset by higher
after-tax net realized capital losses in 2002 compared to 2001.
2001 COMPARED TO 2000 -- Revenues increased $444, or 3%. Included in revenues in
2001 was a $91 reduction in Property & Casualty earned premiums, resulting from
additional reinsurance cessions related to September 11. The increase in
revenues was related to continued new business growth in the Group Benefits
segment, increased fee income in Individual Life, primarily as a result of the
April 2001 acquisition of the United States individual life insurance, annuity
and mutual fund businesses of Fortis, Inc. (operating as "Fortis" or "Fortis
Financial Group") and earned premium growth in most of the Property & Casualty
segments. (For further discussion of the Fortis acquisition, see Note 18(a) of
Notes to Consolidated Financial Statements.) Also contributing to the increase
was higher net investment income, primarily due to income earned on fixed
maturities. These increases were partially offset by a decrease in revenues in
the Other Operations segment, reflecting the sales of Property & Casualty's
international subsidiaries.
Operating income decreased $238, or 25%. This decrease was primarily the result
of $440 of losses, after-tax and net of reinsurance, related to September 11.
Also contributing to the decline were decreased underwriting results in the
Personal Lines and Reinsurance segments. Partially offsetting the decrease were
a $130 tax benefit at Hartford Life, Inc. ("HLI"), primarily the result of the
favorable treatment of certain tax matters related to separate account
investment activity during the 1996-2000 tax years and increased operating
income in Life's four operating segments.
Net income decreased $467, or 48%. The decrease was due primarily to the decline
in operating income described above. In addition, net realized capital losses
were $236 in 2001, compared with net realized capital gains of $145 in 2000. The
change in net realized capital losses resulted from other than temporary
impairments on fixed maturities in 2001.
NET REALIZED CAPITAL GAINS AND LOSSES
See "Investment Results" in the Investments section.
INCOME TAXES
The effective tax rate for 2002, 2001 and 2000 was 6%, (59)% and 28%,
respectively. Excluding the impacts of September 11, net realized capital losses
and the HLI federal tax benefits of $76, $130 and $24 in 2002, 2001 and 2000,
respectively, the effective tax rate for 2002 was 20% compared with 19% and 22%,
respectively, for 2001 and 2000. Tax-exempt interest earned on invested assets
and the separate account dividends received deduction were the principal causes
of effective rates being lower than the 35% United States statutory rate in all
years. Income taxes paid (received) in 2002, 2001 and 2000 were $(102), $(52)
and $95, respectively. (For additional information, see Note 15 of Notes to
Consolidated Financial Statements.)
MINORITY INTEREST IN CONSOLIDATED SUBSIDIARY
Prior to the June 27, 2000 acquisition of all of the outstanding shares of HLI
that The Hartford did not already own ("The HLI Repurchase"), the minority
interest in the consolidated subsidiary's operating results represented
approximately 19%.
PER COMMON SHARE
The following table represents earnings per common share data for the past three
years:
2002 2001 2000
- -----------------------------------------------------------------
Basic earnings per share $4.01 $2.13 $4.42
Diluted earnings per share $3.97 $2.10 $4.34
Weighted average common shares
outstanding 249.4 237.7 220.6
Weighted average common shares
outstanding and dilutive
potential common shares 251.8 241.4 224.4
=================================================================
ADOPTION OF FAIR-VALUE RECOGNITION PROVISIONS FOR STOCK COMPENSATION
In December 2002, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure
and Amendment to SFAS No. 123", which provides three optional transition methods
for entities that decide to voluntarily adopt the fair value recognition
principles of SFAS No. 123, "Accounting for Stock Issued to Employees", and
modifies the disclosure requirements of that Statement. Under the prospective
method, stock-based compensation expense is recognized for awards granted after
the beginning of the fiscal year in which the change is made. The modified
prospective method recognizes stock-based compensation expense related to new
and unvested awards in the year of change equal to that which would have been
recognized had SFAS No. 123 been adopted as of its effective date, fiscal years
beginning after December 15, 1994. The retrospective restatement method
recognizes stock compensation costs for the year of change and restates
financial statements for all prior periods presented as though the fair value
recognition provisions of SFAS No. 123 had been adopted as of its effective
date.
Beginning in January 2003, the Company adopted the fair-value recognition
provisions of accounting for employee stock compensation under SFAS No. 123. The
Company believes the use of the fair-value method to record employee stock-based
compensation expense is consistent with the Company's accounting for all other
forms of compensation.
The Company had applied the intrinsic value-based provisions set forth in
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock Issued
to Employees". Under the intrinsic value method, compensation expense is
determined on the measurement date, that is the first date on which both the
number of shares the employee is entitled to receive and the exercise price are
known. Compensation expense, if any, is measured based on the award's intrinsic
value, which is the excess of the market price of the stock over the exercise
price on the measurement date. For the years ended December 31, 2002, 2001 and
2000, compensation expense related to the Company's stock-based compensation
plans, including non-option plans, was $6, $8 and $23 after-tax, respectively.
The expense related to stock-based employee compensation included in the
determination of net income for 2002 is less than that which would have been
recognized if the fair value method had been
- 24 -
<PAGE>
applied to all awards since the effective date of
SFAS No. 123. (For further discussion of the Company's stock compensation plans,
see Notes 1(f) and 11 of Notes to Consolidated Financial Statements.)
SFAS No. 123 permits companies either to use the fair-value method and recognize
compensation expense upon the issuance of stock options, thereby lowering
earnings, or, alternatively, to disclose the pro-forma impact of the issuance.
The following table illustrates the effect on net income and earnings per share
as if the fair value method had been applied to all outstanding and unvested
awards in each period.
<TABLE>
<CAPTION>
For the years ended December 31,
--------------------------------------------------
(In millions, except for per share data) 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net income, as reported $ 1,000 $ 507 $ 974
Add: Stock-based employee compensation expense included in reported net
income, net of related tax effects [1] 3 2 1
Deduct: Total stock-based employee compensation expense determined under the
fair value method for all awards, net of related tax effects (56) (46) (37)
- ------------------------------------------------------------------------------------------------------------------------------------
Pro forma net income [2] $ 947 $ 463 $ 938
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings per share:
Basic - as reported $ 4.01 $ 2.13 $ 4.42
Basic - pro forma [2] $ 3.80 $ 1.95 $ 4.25
Diluted - as reported $ 3.97 $ 2.10 $ 4.34
Diluted - pro forma [2] $ 3.76 $ 1.92 $ 4.18
- ------------------------------------------------------------------------------------------------------------------------------------
<FN>
[1] Excludes impact of non-option plans of $3, $6 and $22 for the years ended
December 31, 2002, 2001 and 2000, respectively.
[2] The pro forma disclosures are not representative of the effects on net
income and earnings per share in future years.
</FN>
</TABLE>
The fair value of each option grant is estimated on the date of the grant using
the Black-Scholes options-pricing model with the following weighted average
assumptions used for grants in 2002, 2001 and 2000: dividend yield of 1.6% for
2002, 1.6% for 2001 and 1.5% for 2000; expected price variability of 40.8% for
2002, 29.1% for 2001 and 35.7% for 2000; risk-free interest rates of 4.27% for
2002 grants, 4.98% for 2001 grants and 6.41% for 2000 grants; and expected lives
of six years for 2002, six years for 2001 and four years for 2000.
The use of the fair value recognition method results in compensation expense
being recognized in the financial statements in different amounts and in
different periods than the related income tax deduction. Generally, the
compensation expense recognized under SFAS No. 123 will result in a deferred tax
asset since the stock compensation expense is not deductible for tax until the
option is exercised. Deferred tax assets arising under SFAS No. 123 will be
evaluated as to future realizability to determine whether a valuation allowance
is necessary.
SEGMENT RESULTS
The Hartford is organized into two major operations: Life and Property &
Casualty. Within these operations, The Hartford conducts business principally in
nine operating segments. Additionally, the capital raising and purchase
accounting adjustment activities related to The HLI Repurchase, capital raised
in 2002 that was not contributed to the Company's insurance subsidiaries and the
minority interest in HLI for pre-acquisition periods are included in Corporate.
Life is organized into four reportable operating segments: Investment Products,
Individual Life, Group Benefits and Corporate Owned Life Insurance ("COLI").
Life also includes in an Other category its international operations, which are
primarily located in Japan and Latin America; realized capital gains and losses;
as well as corporate items not directly allocated to any of its reportable
operating segments, principally interest expense; and intersegment eliminations.
In January 2002, Property & Casualty integrated its Affinity Personal Lines and
Personal Insurance segments, now reported as Personal Lines. As a result,
Property & Casualty is now organized into five reportable operating segments:
the North American underwriting segments of Business Insurance, Personal Lines,
Specialty Commercial and Reinsurance; and the Other Operations segment, which
includes substantially all of the Company's asbestos and environmental
exposures. "North American" includes the combined underwriting results of
Business Insurance, Personal Lines, Specialty Commercial and Reinsurance
underwriting segments along with income and expense items not directly allocated
to these segments, such as net investment income, net realized capital gains and
losses, other expenses including interest, and income taxes.
The measure of profit or loss used by The Hartford's management in evaluating
performance is operating income, except for its North American underwriting
segments, which are evaluated by The Hartford's management primarily based upon
underwriting results. While not considered segments, the Company also reports
and evaluates operating income results for Life, Property & Casualty and North
American. Property & Casualty includes operating income for North American and
the Other Operations segment.
Certain transactions between segments occur during the year that primarily
relate to tax settlements, insurance coverage, expense reimbursements, services
provided and capital contributions. Certain reinsurance stop loss agreements
exist between the segments which specify that one segment will reimburse another
for losses incurred in excess of a predetermined limit. Also, one segment may
purchase group annuity contracts from another to fund pension costs and claim
annuities to settle casualty claims. In addition, certain intersegment
transactions occur in Life. These transactions include interest income on
allocated surplus and the allocation of certain net realized capital gains and
losses through net investment income, utilizing the duration of the segment's
investment portfolios.
- 25 -
<PAGE>
The following is a summary of net income and operating income for each of the
Company's Life segments and aggregate net income and operating income for the
Company's Property & Casualty operations.
<TABLE>
<CAPTION>
NET INCOME
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Life
Investment Products $ 432 $ 463 $ 424
Individual Life 133 121 79
Group Benefits 128 106 90
COLI 32 37 34
Other (168) (42) (52)
- ------------------------------------------------------------------------------------------------------------------------------------
Total Life 557 685 575
Property & Casualty
North American 482 (125) 466
Other Operations (13) 10 28
- ------------------------------------------------------------------------------------------------------------------------------------
Total Property & Casualty 469 (115) 494
Corporate (26) (63) (95)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL NET INCOME $ 1,000 $ 507 $ 974
====================================================================================================================================
OPERATING INCOME
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Life
Investment Products $ 432 $ 463 $ 424
Individual Life 133 121 79
Group Benefits 128 106 90
COLI 32 37 34
Other 28 73 5
- ------------------------------------------------------------------------------------------------------------------------------------
Total Life 753 800 632
Property & Casualty
North American 519 (20) 412
Other Operations 4 6 17
- ------------------------------------------------------------------------------------------------------------------------------------
Total Property & Casualty 523 (14) 429
Corporate (26) (62) (99)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL OPERATING INCOME $ 1,250 $ 724 $ 962
====================================================================================================================================
</TABLE>
<PAGE>
The following is a summary of North American underwriting results by
underwriting segment within Property & Casualty. Underwriting results represent
premiums earned less incurred claims, claim adjustment expenses and underwriting
expenses.
<TABLE>
<CAPTION>
UNDERWRITING RESULTS (BEFORE-TAX)
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Business Insurance $ 44 $ 3 $ (50)
Personal Lines (46) (78) 2
Specialty Commercial (23) (95) (103)
Reinsurance (59) (149) (73)
- ------------------------------------------------------------------------------------------------------------------------------------
Underwriting results excluding September 11 (84) (319) (224)
September 11 -- (647) --
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL NORTH AMERICAN UNDERWRITING RESULTS $ (84) $ (966) $ (224)
====================================================================================================================================
</TABLE>
In the sections that follow, the Company analyzes the results of operations of
its various segments using the performance measurements that the Company
believes are meaningful.
- 26 -
<PAGE>
- --------------------------------------------------------------------------------
LIFE
- --------------------------------------------------------------------------------
Life provides investment and retirement products such as variable and fixed
annuities; mutual funds and retirement plan services; individual and corporate
owned life insurance; and group benefit products, such as group life and group
disability insurance.
Life derives its revenues principally from: (a) fee income, including asset
management fees on separate account and mutual fund assets and mortality and
expense fees, as well as cost of insurance charges; (b) fully insured premiums;
(c) certain other fees; and (d) net investment income on general account assets.
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, variable life products and mutual funds. Cost of
insurance charges are assessed on the net amount at risk for investment-oriented
life insurance products. Premium revenues are derived primarily from the sale of
group life and group disability insurance products.
Life's expenses essentially consist of interest credited to policyholders on
general account liabilities, insurance benefits provided, dividends to
policyholders, costs of selling and servicing the various products offered by
the Company and other general business expenses.
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, claims management and operating efficiencies and its
ability to earn target spreads between earned investment rates on general
account assets and credited rates to customers. The level of assets under
management is generally impacted by equity market performance, persistency of
the in-force block of business, sales and other deposits, as well as any
acquired blocks of business.
<TABLE>
<CAPTION>
OPERATING SUMMARY [1]
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Fee income $ 2,577 $ 2,633 $ 2,484
Earned premiums 2,187 2,142 1,886
Net investment income 1,858 1,779 1,592
Other revenue 120 128 116
Net realized capital losses (317) (133) (88)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 6,425 6,549 5,990
--------------------------------------------------------------------------------------------------------------------------
Benefits, claims and claim adjustment expenses 3,648 3,611 3,162
Insurance operating costs and expenses 1,438 1,390 1,281
Amortization of deferred policy acquisition costs and present value of
future profits 628 642 671
Goodwill amortization -- 24 6
Other expenses 144 117 82
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 5,858 5,784 5,202
--------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF ACCOUNTING
CHANGES 567 765 788
Income tax expense 10 54 213
Cumulative effect of accounting changes, net of tax [2] -- (26) --
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME [3] 557 685 575
Less: Cumulative effect of accounting changes, net of tax [2] -- (26) --
Net realized capital losses, after-tax (196) (89) (57)
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME [3] $ 753 $ 800 $ 632
====================================================================================================================================
<FN>
[1] Life excludes the effect of The HLI Repurchase, along with the minority
interest for pre-acquisition periods, both of which are reflected in
Corporate.
[2] For the year ended December 31, 2001, represents the cumulative impact of
the Company's adoption of SFAS No. 133 of $(23) and EITF Issue No. 99-20 of
$(3).
[3] For the year ended December 31, 2002, includes $76 tax benefit related to
separate account investment activity and an $8 after-tax benefit related to
September 11. Additionally, for the year ended December 31, 2002, includes
$11 after-tax expense related to the Bancorp litigation. For the year ended
December 31, 2001, includes $130 tax benefit related to separate account
investment activity and $20 of after-tax losses related to September 11.
For the year ended December 31, 2000, includes $32 tax benefit related to
favorable tax items.
</FN>
</TABLE>
As discussed above, Life consists of the following reportable operating
segments: Investment Products, Individual Life, Group Benefits and COLI. In
addition, Life includes in an Other category its international operations, which
are primarily located in Japan and Latin America, and corporate items not
directly allocated to any of its reportable operating segments.
On April 2, 2001, The Hartford acquired the United States individual life
insurance, annuity and mutual fund businesses of Fortis. (For further
discussion, see "Acquisitions" in the Capital Resources and Liquidity section
and Note 18(a) of Notes to Consolidated Financial Statements.) This transaction
was accounted for as a purchase and, as such, the revenues and
- 27 -
<PAGE>
expenses generated by this business from April 2, 2001 forward are included in
Life's consolidated results of operations.
On June 27, 2000, The Hartford acquired all of the outstanding shares of HLI
that it did not already own. (For additional information, see Note 18(a) of
Notes to Consolidated Financial Statements.)
2002 COMPARED TO 2001 -- Revenues in the Life operation decreased $124, or 2%,
primarily driven by realized capital losses of $317 in 2002 as compared to $133
in 2001. (See the Investments section for further discussion of investment
results and related realized capital losses.) Additionally, COLI experienced a
decline in revenues of $127, or 18%, as a result of the decrease in leveraged
COLI account values as compared to a year ago. However, the Life operation
experienced revenue growth across its other operating segments. Revenues related
to the Investment Products segment increased $91, or 4%, as a result of
continued growth related to its institutional investment product business, which
more than offset the decline of $40, or 3%, in revenues within the individual
annuity operation. Lower assets under management due to the decline in the
equity markets are the principal driver of declining revenues for the individual
annuity operation. The Group Benefits segment experienced an increase in
revenues of $75, or 3%, as a result of strong sales to new customers and solid
persistency within the in-force block of business. Additionally, Individual Life
revenues increased by $68, or 8%, as a result of the Fortis acquisition and
increased life insurance in force.
Expenses increased $30, or 1%, due to a lower benefit recorded related to
favorable resolution of dividends received deduction ("DRD") related tax items
(see also the discussion of DRD tax matter at Note 16(d) of Notes to
Consolidated Financial Statements), an increase in benefits and claims of $37,
or 1%, due primarily to growth in the Group Benefits segment and higher death
benefits in the Investment Products segment, as a result of the lower equity
markets and additional expenses related to the Fortis acquisition. These
increases were offset by a decrease in income tax expense due to lower pre-tax
income as compared to a year ago. Expenses increased $122, or 6%, in the
Investment Products segment, principally related to the growth in the
institutional investment product business and a $31 increase in death benefits
related to the individual annuity operation, as a result of depressed
contractowner account values driven by the lower equity markets. In addition,
2002 expenses include $11, after-tax, of accrued expenses recorded within the
COLI segment related to the Bancorp litigation. (For a discussion of the Bancorp
litigation, see Note 16(a) of Notes to Consolidated Financial Statements.) Also
included in expenses was an after-tax benefit of $8, recorded within "Other",
associated with favorable development related to Life's estimated September 11
exposure.
Net income and operating income decreased $128, or 19%, and $47, or 6%,
respectively, due to the decline in revenues and increase in expenses described
above. In 2002, Life recognized an $8 after-tax benefit due to favorable
development related to September 11. In 2001, Life recorded a $20 after-tax loss
related to September 11. Excluding the impact of September 11, net income
decreased $156, or 22%, and operating income decreased $75, or 9%. Net income
for the Investment Products segment was down $31, or 7%, as growth in the other
investment products businesses, particularly institutional investment products,
was more than offset by the decline in revenues in the individual annuity
operation, which was negatively impacted by the lower equity markets. COLI net
income decreased $5, or 14%. Excluding the impact of September 11, COLI's net
income decreased $7, or 18%, primarily the result of the charge associated with
the Bancorp litigation. The declines in net income for those segments were
partially offset by increases in net income for the Group Benefits and
Individual Life segments. Group Benefits earnings increased $22, or 21%.
Excluding the impact of September 11, Group Benefits net income increased $20,
or 19%. The increases were principally driven by ongoing premium growth and
stable loss and expense ratios and improving loss ratios. Individual Life net
income increased $12, or 10%. Excluding the impact of September 11, Individual
Life's net income increased $9, or 7%, as the result of the Fortis acquisition.
Net income for Other decreased $126 and operating income decreased $45, or 62%.
In 2002, Life recognized an $8 after-tax benefit due to favorable development
related to September 11 in Other. In 2001, Life recorded a $13 after-tax loss
related to September 11 in Other. Excluding the impact of September 11, Other
net income decreased $147 and operating income decreased $66, or 77%. The
decline in net income of the Other segment is principally due to higher realized
capitalized losses and a lower tax benefit recorded in 2002 compared to 2001 as
discussed above.
2001 COMPARED TO 2000 -- Revenues increased $559, or 9%, primarily related to
the growth across each of Life's primary operating segments, particularly the
Individual Life and Group Benefits segments, where revenues increased $250, or
39%, and $300, or 14%, respectively. The revenue growth in the Individual Life
segment was primarily due to higher earned fee income and net investment income
resulting from the business acquired from Fortis. The Group Benefits segment
experienced higher earned premiums due to strong sales and persistency. The
Investment Products segment also contributed to the revenue increase as a result
of higher fee income in the retail mutual fund business and higher net
investment income in the institutional business. Revenues related to the
Company's Individual Annuity business were down $46, or 3%, primarily due to
lower fee income as a result of the lower equity markets in 2001. Additionally,
COLI revenues were below prior year due to a decrease in variable COLI sales and
the declining block of leveraged COLI business.
Benefits claims and expenses increased $582, or 11%, primarily associated with
the growth in Life revenues discussed above.
Net income increased $110, or 19%, and operating income increased $168, or 27%,
led by the Individual Life and Group Benefits segments, where net income
increased $42, or 53%, and $16, or 18%, respectively. In addition, the 2001
results include a $130 federal income tax benefit primarily related to separate
account investment activity and a $20 loss associated with the impact of
September 11. Additionally, 2000 results include a benefit of $32 also related
to favorable tax items. Excluding these tax items and the impact of September
11, net income increased $32, or 6%, and operating income increased $90, or 15%,
for the year ended December 31, 2001, as each of the Company's operating
segments experienced growth from the prior year.
- 28 -
<PAGE>
- --------------------------------------------------------------------------------
INVESTMENT PRODUCTS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
OPERATING SUMMARY
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Fee income and other $ 1,518 $ 1,620 $ 1,639
Net investment income 1,079 886 741
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 2,597 2,506 2,380
--------------------------------------------------------------------------------------------------------------------------
Benefits, claims and claim adjustment expenses 944 819 700
Insurance operating costs and other expenses 648 608 551
Amortization of deferred policy acquisition costs 444 461 516
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 2,036 1,888 1,767
--------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 561 618 613
Income tax expense 129 155 189
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 432 $ 463 $ 424
--------------------------------------------------------------------------------------------------------------------------
Individual variable annuity account values $ 64,343 $ 74,581 $ 78,174
Other individual annuity account values 10,565 9,572 9,059
Other investment products account values 19,921 19,322 17,376
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ACCOUNT VALUES 94,829 103,475 104,609
Mutual fund assets under management 15,321 16,809 11,432
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENT PRODUCTS ASSETS UNDER MANAGEMENT $ 110,150 $ 120,284 $ 116,041
====================================================================================================================================
</TABLE>
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 variable and fixed annuities,
mutual funds, retirement plan services and other investment products. The
Company is both a leading writer of individual variable annuities and a top
seller of individual variable annuities through banks in the United States. In
addition, in 2001 The Hartford Mutual Funds, Inc. reached $12 billion in assets
faster than any other retail-oriented mutual fund family in history, according
to Strategic Insight.
2002 COMPARED TO 2001 -- Revenues in the Investment Products segment increased
$91, or 4%. These increases in revenues are primarily driven by growth in the
institutional investment product business, where related assets under management
increased $669, or 7%, to $9.7 billion as of December 31, 2002. This revenue
increase was partially offset by lower fee income related to the individual
annuity operation as average account values decreased from $85.7 billion to
$79.5 billion compared to prior year, primarily due to the lower equity markets.
Expenses increased $122, or 6%, driven by increases of $84, or 11%, in interest
credited on general account assets, $61, or 6%, in commissions and wholesaling
expenses, and $31 in individual annuity death benefit costs due to the lower
equity markets, and an increase of $37, or 23%, in operating expenses incurred
by other investment products, primarily driven by the mutual fund business.
Partially offsetting these increases was a $34, or 8%, decrease in amortization
of deferred policy acquisition costs related to the individual annuity business,
which declined as a result of lower gross profits, driven by the decrease in fee
income and the increase in death benefit costs.
Net income decreased $31, or 7%, driven by the continued lower equity markets
resulting in the decline in revenues in the individual annuity operation and
increases in the death benefit costs incurred by the individual annuity
operation. The decrease in individual annuity revenues was significantly offset
by growth in revenues related to other investment products, particularly the
institutional investment product business. (For discussion of the potential
future financial statement impact of continued declines in the equity market on
the Investment Products segment, see the Capital Markets Risk Management section
under "Market Risk".)
2001 COMPARED TO 2000 -- Revenues in the Investment Products segment increased
$126, or 5%, driven primarily by other investment products. Fee income from
other investment products increased $59, or 21%, principally due to growth in
Life's mutual fund assets under management. Mutual fund assets increased $5.4
billion, or 47%, to $16.8 billion as of December 31, 2001, due to strong sales
and the inclusion of the mutual fund assets acquired from Fortis. Net investment
income from other investment products increased $113, or 20%, due mostly to
growth in the institutional business, where account values were $9.1 billion at
December 31, 2001, an increase of $1.4 billion, or 18%, from a year ago. The
increase in revenues from other investment products was partially offset by
individual annuity revenues, which decreased $46, or 3%. Fee income and net
investment income from the individual annuity business acquired from Fortis
helped to partially offset lower revenues in the individual annuity operation
which was primarily associated with decreased account values resulting from the
lower equity markets as compared to the prior year. Individual annuity account
values at December 31, 2001 were $84.2 billion, a decrease of $3.1 billion, or
4%, from December 31, 2000.
Benefits, claims and expenses increased $121, or 7%, driven by higher interest
credited and insurance operating expenses related to other investment products
consistent with the revenue growth described above. Interest credited related to
other investment products increased $83, or 18%, while insurance operating
expenses increased $44, or 17%. Also, individual annuity benefits and claims
expenses increased $35, or 14%, principally due to the business acquired from
Fortis and higher death benefits resulting from the lower equity markets in
2001. Individual annuity's insurance operating costs increased $13, or 4%, due
to the business acquired from Fortis. Excluding Fortis, individual annuity's
operating expenses decreased $39, or 4%, from prior year, driven by management's
continued focus on maintaining operating expense levels. Partially offsetting
the
- 29 -
<PAGE>
increase in benefits, claims and insurance operating costs was a decrease in
amortization of deferred policy acquisition costs resulting from the lower gross
profits associated with the individual annuity business. In addition, income tax
expense for the twelve months ended December 31, 2001, was $118, a $45, or 28%,
decrease due to lower pretax operating income and the ongoing tax impact related
to separate account investment activity.
Net income increased $39, or 9%. These increases were driven by the growth in
revenues in other investment products described above, the favorable impact of
Fortis and the lower effective tax rate related to the individual annuity
business.
OUTLOOK
Management believes the market for retirement products continues to expand as
individuals increasingly save and plan for retirement. Demographic trends
suggest that as the "baby boom" generation matures, a significant portion of the
United States population will allocate a greater percentage of their disposable
incomes to saving for their retirement years due to uncertainty surrounding the
Social Security system and increases in average life expectancy. As this market
grows, particularly for variable annuities and mutual funds, new companies are
continually entering the market, aggressively seeking distribution channels and
pursuing market share. One factor which could impact the Investment Products
segment is the President's 2004 budget proposal. See Capital Resources and
Liquidity section under "Legislative Initiatives" for further discussion of this
proposed legislation.
The individual annuity segment continues to be impacted by the lower equity
markets in terms of lower assets under management. However, the Company
experienced strong sales of annuities which were $11.6 billion in 2002 as
compared to $10.0 billion in 2001. Partially contributing to the growth in sales
is The Hartford's introduction of Principal First, a guaranteed withdrawal
benefit rider, which was developed in response to the customers' needs. Based on
VARDS, the Company had 9.4% market share as of December 31, 2002 as compared to
8.7% at December 31, 2001. (For discussion of the potential future financial
statement impact of continued declines in the equity market on the Investment
Products segment, see the Capital Markets Risk Management section under "Equity
Risk".)
Management believes that it has developed and implemented strategies to maintain
and enhance its position as a market leader in the financial services industry.
For example, The Hartford introduced a tax advantaged college savings product
("529 plan") in early 2002 called SMART 529. SMART 529 is a state-sponsored
education savings program established by the State of West Virginia which offers
an easy way for both the residents of West Virginia and out-of-state
participants to invest for a college education. The SMART 529 product
complements HLI's existing offering of investment products (mutual funds,
variable annuities, 401(k), 457 and 403(b) plans). It also leverages the
Company's capabilities in distribution, service and fund performance. In its
first year the SMART 529 product has been well received by many Americans saving
for college.
- --------------------------------------------------------------------------------
INDIVIDUAL LIFE
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
OPERATING SUMMARY
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Fee income and other $ 697 $ 647 $ 459
Net investment income 261 243 181
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 958 890 640
--------------------------------------------------------------------------------------------------------------------------
Benefits, claims and claim adjustment expenses 443 385 274
Amortization of deferred policy acquisition costs 160 168 145
Insurance operating costs and other expenses 159 159 103
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 762 712 522
--------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 196 178 118
Income tax expense 63 57 39
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 133 $ 121 $ 79
--------------------------------------------------------------------------------------------------------------------------
Variable life account values $ 3,648 $ 3,993 $ 2,947
Total account values $ 7,557 $ 7,868 $ 5,849
- ------------------------------------------------------------------------------------------------------------------------------------
Variable life insurance in force $ 66,715 $ 61,617 $ 33,460
Total life insurance in force $ 126,680 $ 120,269 $ 75,113
====================================================================================================================================
</TABLE>
The Individual Life segment provides life insurance solutions to a wide array of
partners to solve the wealth protection, accumulation and transfer needs of
their affluent, emerging affluent and business insurance clients. Additionally,
the Fortis transaction, through the addition of a retail broker dealer, which
has been renamed Woodbury Financial Services, has allowed the Individual Life
segment to increase its reach in the emerging affluent market.
2002 COMPARED TO 2001 -- Revenues in the Individual Life segment increased $68,
or 8%, primarily driven by business growth, including the impact of the Fortis
transaction. However, the Company sold $173 of new business in 2002, as compared
to $228 in 2001.
Expenses increased $56, or 7%, principally driven by the growth in the business
resulting from the Fortis acquisition. In addition, mortality experience
(expressed as death claims as a percentage of net amount at risk) for 2002
increased as compared to the prior year, but was in line with management's
expectations.
Net income increased $12, or 10%. Individual Life incurred an after-tax charge
of $3 related to September 11 in the third quarter of 2001. Excluding this
charge, Individual Life's earnings increased $9, or 7%, for the year ended
December 31,
- 30 -
<PAGE>
2002, due to the contribution to earnings from the Fortis transaction.
2001 COMPARED TO 2000 -- Revenues in the Individual Life segment increased $250,
or 39%, primarily due to the business acquired from Fortis. Fee income,
including cost of insurance charges, increased $180, or 40%, driven principally
by growth in the variable life business, where account values increased $1.0
billion, or 35%, and life insurance in-force increased $28.2 billion, or 84%,
from 2000. In addition, net investment income on general account business
(universal life, interest sensitive whole life and term life) increased $66, or
34%, consistent with the growth in related account values.
Benefits, claims and expenses increased $190, or 36%, due principally to the
growth in revenues described above. Although death benefits were higher in 2001
than the prior year as a result of the increase in life insurance in-force,
year-to-date mortality experience (expressed as death claims as a percentage of
net amount at risk) for 2001 was within pricing assumptions. Net income
increased $42, or 53%, primarily due to the revenue growth described above.
Individual Life incurred an after-tax loss of $3 related to September 11.
Excluding this loss, net income increased $45, or 57%, primarily due to the
growth factors described above.
OUTLOOK
Individual Life sales continue to be impacted by the lower equity markets,
uncertainty surrounding estate tax legislation and aggressive competition from
universal life providers. However, The Hartford's acquisition of the United
States individual life insurance business of Fortis has increased its scale
while broadening its distribution capabilities as described above. Additionally,
The Hartford continues to introduce new and enhanced products, which are
expected to increase universal life sales.
- --------------------------------------------------------------------------------
GROUP BENEFITS
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
OPERATING SUMMARY
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Earned premiums and other $ 2,327 $ 2,259 $ 1,981
Net investment income 255 248 226
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 2,582 2,507 2,207
--------------------------------------------------------------------------------------------------------------------------
Benefits, claims and claim adjustment expenses 1,878 1,874 1,643
Insurance operating costs and other expenses 541 498 450
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 2,419 2,372 2,093
--------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 163 135 114
Income tax expense 35 29 24
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 128 $ 106 $ 90
====================================================================================================================================
</TABLE>
The Hartford is a leading provider of group benefits, and through this segment,
sells group life and group disability insurance as well as other products,
including stop loss and supplementary medical coverages to employers and
employer sponsored plans, accidental death and dismemberment, travel accident
and other special risk coverages to employers and associations. The Company also
offers disability underwriting, administration, claims processing services and
reinsurance to other insurers and self-funded employer plans.
2002 COMPARED TO 2001 -- Revenues in the Group Benefits segment increased $75,
or 3%, and excluding buyouts, increased $159, or 7%, driven primarily by growth
in premiums, which increased $66, or 3%. The growth in premiums was due to an
increase of $281, or 14%, in fully insured ongoing premiums, as a result of
steady persistency and pricing actions on the in-force block of business and
strong sales to new customers. Offsetting this increase was a decrease in
military Medicare supplement premiums of $131 resulting from federal legislation
effective in the fourth quarter of 2001. This legislation provides retired
military officers age 65 and older with full medical insurance paid for by the
government, eliminating the need for Medicare supplement insurance.
Additionally, premium revenues for 2002 were offset by an $84 decrease in total
buyouts. Buyouts involve the acquisition of claim liabilities from another
carrier for a purchase price calculated to cover the run off of those
liabilities plus administration expenses and profit. Due to the nature of the
buyout market place, the predictability of buyout premiums is uncertain. Fully
insured ongoing sales were $597, an increase of $66, or 12%.
Expenses increased $53, or 2%, and excluding buyouts, increased $137, or 6%. The
increase in expenses is consistent with the growth in revenues previously
described. Benefits and claims expenses, excluding buyouts, increased $88, or
5%. The segment's loss ratio (defined as benefits, claims and claim adjustment
expenses as a percentage of premiums and other considerations, excluding
buyouts) was 81% down slightly from 82% in 2001. Insurance operating costs and
other expenses increased $43, or 9%, due to the fully insured ongoing premium
growth previously described and continued investments in technology and service.
The segment's expense ratio of insurance operating costs and other expenses to
premiums and other considerations was approximately 23%, consistent with prior
year.
Net income increased $22, or 21%. Group Benefits incurred an after-tax charge of
$2 related to September 11 in the third quarter of 2001. Excluding this charge,
earnings increased $20, or 19%, for the year ended December 31, 2002 compared to
a year ago. The increase in earnings is due to the increase in premium revenues
and favorable loss costs, which was partially offset by increased insurance
operating costs and other expenses as previously described.
2001 COMPARED TO 2000 -- Revenues in the Group Benefits segment increased $300,
or 14%, driven primarily by growth in
- 31 -
<PAGE>
premiums, which increased $278, or 14%, due to solid persistency and increased
premium rates related to the in-force block of business, and strong sales to new
customers. Fully insured ongoing sales for the year ended December 31, 2001 were
$531, an increase of $85, or 19%, compared to 2000. Additionally, net investment
income increased $22, or 10%, due to the overall growth in the in-force
business.
Total benefits, claims and expenses increased $279, or 13%, driven primarily by
higher benefits and claims, which increased $231, or 14%. These increases are
consistent with the growth in the business described above as the loss ratio has
remained relatively consistent compared to the 2000 loss ratio. In addition,
expenses other than benefits and claims increased $48, or 11%, for the year
ended December 31, 2001, also consistent with the overall growth in the segment.
Net income increased $16, or 18%, driven by overall revenue growth and
consistent loss and expense ratios as compared to the prior year. Group Benefits
incurred an after-tax loss of $2 related to September 11; excluding this loss,
net income increased $18, or 20%.
OUTLOOK
Employees continue to look to the workplace for a broader and ever expanding
array of insurance products. As employers design benefit strategies to attract
and retain employees while attempting to control their benefit costs, management
believes that the need the Group Benefits segment's products will continue to
expand. This, combined with the significant number of employees who currently do
not have coverage or adequate levels of coverage, creates unique opportunities
for the Group Benefits segment's products and services. Current market
conditions, including low interest rates, rising medical costs and cost
containment pressure on employers, create a challenging business environment.
However, the Company's strength in claim and risk management, service and
distribution will enable the Group Benefits segment to continue to capitalize on
market opportunities despite the challenging business environment.
- --------------------------------------------------------------------------------
CORPORATE OWNED LIFE INSURANCE (COLI)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
OPERATING SUMMARY
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Fee income and other $ 316 $ 367 $ 401
Net investment income 276 352 366
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 592 719 767
--------------------------------------------------------------------------------------------------------------------------
Benefits, claims and claim adjustment expenses 401 514 545
Insurance operating costs and expenses 82 84 102
Dividends to policyholders 62 66 67
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 545 664 714
--------------------------------------------------------------------------------------------------------------------------
INCOME BEFORE INCOME TAXES 47 55 53
Income tax expense 15 18 19
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 32 $ 37 $ 34
--------------------------------------------------------------------------------------------------------------------------
Variable COLI account values $ 19,674 $ 18,019 $ 15,937
Leveraged COLI account values 3,321 4,315 4,978
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL ACCOUNT VALUES $ 22,995 $ 22,334 $ 20,915
====================================================================================================================================
</TABLE>
The Hartford is a leader in the COLI market, which includes life insurance
policies purchased by a company on the lives of its employees, with the company
or a trust sponsored by the company named as beneficiary under the policy. Until
passage of the Health Insurance Portability and Accountability Act of 1996
("HIPAA"), the Company sold two principal types of COLI business: leveraged and
variable products. Leveraged COLI is a fixed premium life insurance policy owned
by a company or a trust sponsored by a company. HIPAA phased out the
deductibility of interest on policy loans under leveraged COLI through the end
of 1998, virtually eliminating all future sales of this product. Variable COLI
continues to be a product used by employers to fund non-qualified benefits or
other postemployment benefit liabilities.
2002 COMPARED TO 2001 -- COLI revenues decreased $127, or 18%, primarily related
to lower net investment and fee income due to the declining block of leveraged
COLI, where related account values declined by $994, or 23%. Net investment
income decreased $76, or 22%, while fee income decreased $50, or 14%.
Expenses decreased $122, or 18%, which is relatively consistent with the
decrease in revenues described above. However, the decrease was partially offset
by $11, after-tax, in accrued litigation expenses related to the Bancorp
dispute. (For a discussion of the Bancorp litigation, see Note 16(a) of Notes to
Consolidated Financial Statements.)
Net income decreased $5, or 14%, compared to prior year. COLI incurred an
after-tax charge of $2 related to September 11 in the third quarter of 2001.
Excluding the impact of September 11, COLI's net income decreased $7, or 18%,
principally due to the $11 after-tax expense accrued in connection with the
Bancorp litigation.
2001 COMPARED TO 2000 -- COLI revenues decreased $48, or 6%, mostly due to lower
fee income and net investment income. Fee income and other decreased $34, or 8%,
due to a decline in variable COLI sales and deposits which were approximately
$1.5 billion in 2001 as compared to $2.9 billion in 2000. In addition, net
investment income decreased $14, or 4%, due primarily to lower interest rates
and the decline in leveraged COLI account values.
Benefits, claims and expenses decreased $50, or 7%, directly related to the
decrease in revenue discussed above.
- 32 -
<PAGE>
Net income increased $3, or 9%, primarily due to the overall growth in variable
COLI business and earnings associated with the leveraged COLI business
recaptured in 1998. COLI incurred an after-tax charge of $2 related to September
11; excluding this charge, net income increased $5, or 15%.
OUTLOOK
The focus of this segment is variable COLI, which continues to be a product
generally used by employers to fund non-qualified benefits or other
postemployment benefit liabilities. The leveraged COLI product has been an
important contributor to The Hartford's profitability in recent years and will
continue to contribute to the profitability of The Hartford in the future,
although the level of profit has declined in 2002, as compared to 2001. COLI
continues to be subject to a changing legislative and regulatory environment
that could have a material adverse effect on its business.
- --------------------------------------------------------------------------------
PROPERTY & CASUALTY
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
OPERATING SUMMARY
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Earned premiums $ 8,114 $ 7,267 $ 7,055
Net investment income 1,075 1,053 1,072
Other revenue [1] 356 363 343
Net realized capital gains (losses) (83) (103) 234
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 9,462 8,580 8,704
--------------------------------------------------------------------------------------------------------------------------
Benefits, claims and claim adjustment expenses 5,870 6,146 5,253
Amortization of deferred policy acquisition costs 1,613 1,572 1,542
Insurance operating costs and expenses 879 647 677
Goodwill amortization -- 3 5
Other expenses [2] 559 560 543
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 8,921 8,928 8,020
--------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES AND CUMULATIVE EFFECT OF
ACCOUNTING CHANGE 541 (348) 684
Income tax expense (benefit) 72 (241) 190
- ------------------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE CUMULATIVE EFFECT OF ACCOUNTING CHANGE 469 (107) 494
Cumulative effect of accounting change, net of tax [3] -- (8) --
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) [4] 469 (115) 494
Less: Restructuring charges, net of tax -- (10) --
Cumulative effect of accounting change, net of tax [3] -- (8) --
Loss from early retirement of debt, net of tax -- (8) --
Net realized capital gains (losses), after-tax (54) (75) 65
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME (LOSS) [4] $ 523 $ (14) $ 429
- ------------------------------------------------------------------------------------------------------------------------------------
NORTH AMERICAN PROPERTY & CASUALTY UNDERWRITING RATIOS
Loss ratio [5] 59.6 70.3 60.8
Loss adjustment expense ratio [5] 11.2 12.5 11.5
Expense ratio [5] 27.7 29.0 29.7
COMBINED RATIO [5] [6] [7] 99.2 112.4 102.4
====================================================================================================================================
<FN>
[1] Primarily servicing revenue.
[2] Includes restructuring charges of $15 for the year ended December 31, 2001
and $13 of accelerated amortization of issuance costs on the Company's
8.35% Cumulative Quarterly Income Preferred Securities which were redeemed
on December 31, 2001.
[3] Represents the cumulative impact of the Company's adoption of EITF Issue
No. 99-20.
[4] 2001 includes $420 of after-tax losses related to September 11.
[5] For 2001, excluding the impact of September 11, loss ratio was 62.8, loss
adjustment expense ratio was 11.4, expense ratio was 28.7 and combined
ratio was 103.4.
[6] Includes policyholder dividend ratios of 0.7, 0.5, and 0.5 for the years
ended December 31, 2002, 2001 (including and excluding the impact of
September 11), and 2000, respectively.
[7] GAAP combined ratios were 99.8, 112.5 (including a 9.0 point impact related
to September 11) and 102.9 for the years ended December 31, 2002, 2001 and
2000, respectively.
</FN>
</TABLE>
2002 COMPARED TO 2001 -- Net income increased $584 primarily due to after-tax
losses related to September 11 of $420 in 2001, an increase in operating income
as discussed below and a decrease in net realized capital losses.
2001 COMPARED TO 2000 -- Net income decreased $609 primarily due to after-tax
losses related to September 11 of $420, an increase in net realized capital
losses, and a decrease in operating income as discussed below.
In January 2002, Property & Casualty integrated its Affinity Personal Lines and
Personal Insurance segments, now reported as Personal Lines. As a result,
Property & Casualty is now organized into five reportable operating segments:
the North
- 33 -
<PAGE>
American underwriting segments of Business Insurance, Personal Lines, Specialty
Commercial and Reinsurance; and the Other Operations segment, which includes
substantially all of the Company's asbestos and environmental exposures. Also
reported within Property & Casualty is North American, which includes the
combined underwriting results of the North American underwriting segments along
with income and expense items not directly allocated to these segments, such as
net investment income, net realized capital gains and losses, other expenses
including interest and income taxes.
RATIOS
The previous table and the following segment discussions for the years ended
December 31, 2002, 2001 and 2000 include various operating ratios. Management
believes that these ratios are useful in understanding the underlying trends in
The Hartford's current business. However, these measures should only be used in
conjunction with, and not in lieu of, underwriting income and may not be
comparable to other performance measures used by the Company's competitors. The
"loss ratio" is the ratio of claims expense (exclusive of claim adjustment
expenses) to earned premiums. The "loss adjustment expense ratio" represents the
ratio of claim adjustment expenses to earned premiums. The "expense ratio" is
the ratio of statutory underwriting expenses (commissions; taxes, licenses and
fees; as well as other underwriting expenses) to written premiums. The
"policyholder dividend ratio" is the ratio of policyholder dividends to earned
premiums. The "combined ratio" is the sum of the loss ratio, the loss adjustment
expense ratio, the expense ratio and the policyholder dividend ratio. These
ratios are relative measurements that describe for every $100 of net premiums
earned or written, the cost of losses and statutory expenses, respectively. The
combined ratio presents the total cost per $100 of premium production. A
combined ratio below 100 demonstrates underwriting profit; a combined ratio
above 100 demonstrates underwriting losses. GAAP combined ratios differ from
statutory combined ratios primarily due to the deferral and amortization of
certain expenses for GAAP reporting purposes and the use of earned premium in
the expense ratio rather than written premium.
The following is a summary of Property & Casualty operating income, after-tax.
Operating income represents after-tax operating results excluding, as
applicable, net realized capital gains or losses, losses from early retirement
of debt, the cumulative effect of accounting changes and restructuring charges.
Operating income is a performance measure used by The Hartford in the management
of its operations. Management believes that this performance measure delineates
the results of The Hartford's ongoing businesses in a manner that allows for a
better understanding of the underlying trends in the Company's current business.
<TABLE>
<CAPTION>
2001
----------------------------------
INCLUDING EXCLUDING
(after-tax) 2002 SEPTEMBER 11 SEPTEMBER 11 2000
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
North American
Underwriting results $ (54) $ (627) $ (207) $ (146)
Net investment income 736 722 722 695
Other expenses [1] (163) (115) (115) (137)
- ------------------------------------------------------------------------------------------------------------------------------------
NORTH AMERICAN OPERATING INCOME (LOSS) [2] 519 (20) 400 412
Other operations operating income [2] 4 6 6 17
- ------------------------------------------------------------------------------------------------------------------------------------
PROPERTY CASUALTY OPERATING INCOME (LOSS) [2] $ 523 $ (14) $ 406 $ 429
====================================================================================================================================
<FN>
[1] Includes interest expense, net servicing income and goodwill amortization.
[2] A reconciliation of net income (loss) to operating income (loss) is
provided in the preceding table.
</FN>
</TABLE>
Underwriting results are discussed in each of the Business Insurance, Personal
Lines, Specialty Commercial and Reinsurance segment sections. Net investment
income and net realized capital gains and losses are discussed in the
Investments section. (For a further discussion of September 11, see Note 2 of
Notes to Consolidated Financial Statements.)
2002 COMPARED TO 2001 -- Operating income, excluding the after-tax $420 impact
of September 11, increased $117, or 29%, primarily due to improved underwriting
results across each of the North American underwriting segments, particularly in
Specialty Commercial and Reinsurance. Partially offsetting the improvement was
an increase in other expenses primarily as a result of an increase in e-business
research and development expenses and certain employee benefits costs, as well
as expenses incurred related to the transfer of the Company's New Jersey
personal lines agency auto business to Palisades Safety and Insurance
Association and Palisades Insurance Co.
2001 COMPARED TO 2000 -- Operating income, excluding the after-tax $420 impact
of September 11, decreased $23, or 5%. Earned premium growth in Business
Insurance due to price increases, strong new business growth and improved
premium renewal retention, as well as an increase in North American investment
income, was offset by increased losses in the personal automobile lines of
business and in Reinsurance. A decrease in underwriting results of $16,
after-tax, related to Enron Corporation and lower income resulting from the
sales of international subsidiaries also contributed to the decrease.
RESERVES
As discussed in Notes 1(l), 7 and 16(b) of Notes to Consolidated Financial
Statements and in the Critical Accounting Estimates section, reserving for
property and casualty losses is an estimation process. As additional experience
and other relevant claim data become available, reserve levels are adjusted
accordingly. Such adjustments of reserves related to claims incurred in prior
years are a natural occurrence in the loss reserving process and are referred to
as "reserve development". Reserve development that increases previous estimates
of ultimate cost is called "reserve strengthening". Reserve
- 34 -
<PAGE>
development that decreases previous estimates of ultimate cost is called
"reserve releases". Reserve development can influence the comparability of year
over year underwriting results and are set forth in the paragraphs and tables
that follow.
Reserve strengthening in the Business Insurance segment for the year ended
December 31, 2002 was not significant. In Personal Lines, prior accident year
loss and loss adjustment expenses for non-standard auto were strengthened due to
heavier than expected frequency, severity and litigation rates on prior accident
years. In addition, the prior accident year provision was increased modestly for
mold losses. Virtually all of the strengthening in Specialty Commercial is due
to deductible workers' compensation losses on a few large accounts. Reserve
strengthening in the Reinsurance segment occurred across multiple accident
years, primarily 1997 through 2000, and across several lines of business. High
reported losses from ceding companies have persisted throughout 2002 and loss
ratios have been revised upward. Virtually all of the reserve strengthening in
the Other Operations segment related to asbestos. There was little reserve
strengthening or weakening by segment in 2001 with the exception of Other
Operations, where the strengthening was related almost entirely to non-asbestos
and environmental exposures. (For further discussion of reserve activity related
to asbestos and environmental, see the Other Operations section of the MD&A.)
A rollforward of liabilities for unpaid claims and claim adjustment expenses by
segment for Property & Casualty follows:
<TABLE>
<CAPTION>
For the year ended December 31, 2002
- ------------------------------------------------------------------------------------------------------------------------------------
Business Personal Specialty Other Total
Insurance Lines Commercial Reinsurance Operations P&C
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BEGINNING LIABILITIES FOR UNPAID CLAIMS AND
CLAIM ADJUSTMENT EXPENSES-GROSS $ 4,440 $ 1,530 $ 5,073 $ 1,956 $ 4,037 $ 17,036
Reinsurance and other recoverables 375 51 2,088 448 1,214 4,176
- ------------------------------------------------------------------------------------------------------------------------------------
BEGINNING LIABILITIES FOR UNPAID CLAIMS AND
CLAIM ADJUSTMENT EXPENSES-NET 4,065 1,479 2,985 1,508 2,823 12,860
- ------------------------------------------------------------------------------------------------------------------------------------
ADD PROVISION FOR UNPAID CLAIMS AND CLAIM
ADJUSTMENT EXPENSES
Current year 1,943 2,244 820 492 78 5,577
Prior years 19 75 29 77 93 293
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL PROVISION FOR UNPAID CLAIMS AND CLAIM
ADJUSTMENT EXPENSES 1,962 2,319 849 569 171 5,870
- ------------------------------------------------------------------------------------------------------------------------------------
LESS PAYMENTS 1,649 2,155 875 551 359 5,589
Other [1] -- -- -- (300) 300 --
- ------------------------------------------------------------------------------------------------------------------------------------
ENDING LIABILITIES FOR UNPAID CLAIMS AND CLAIM
ADJUSTMENT EXPENSES-NET 4,378 1,643 2,959 1,226 2,935 13,141
Reinsurance and other recoverables 368 50 2,041 388 1,171 4,018
- ------------------------------------------------------------------------------------------------------------------------------------
ENDING LIABILITIES FOR UNPAID CLAIMS AND CLAIM
ADJUSTMENT EXPENSES-GROSS $ 4,746 $ 1,693 $ 5,000 $ 1,614 $ 4,106 $ 17,159
====================================================================================================================================
<FN>
[1] $300 represents the transfer of the international lines of the Reinsurance
segment to Other Operations.
</FN>
</TABLE>
<TABLE>
<CAPTION>
For the year ended December 31, 2001
- ------------------------------------------------------------------------------------------------------------------------------------
Business Personal Specialty Other Total
Insurance Lines Commercial Reinsurance Operations P&C
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BEGINNING LIABILITIES FOR UNPAID CLAIMS AND
CLAIM ADJUSTMENT EXPENSES-GROSS $ 3,954 $ 1,403 $ 5,628 $ 1,416 $ 3,892 $ 16,293
Reinsurance and other recoverables 195 42 2,011 234 1,389 3,871
- ------------------------------------------------------------------------------------------------------------------------------------
BEGINNING LIABILITIES FOR UNPAID CLAIMS AND
CLAIM ADJUSTMENT EXPENSES-NET 3,759 1,361 3,617 1,182 2,503 12,422
- ------------------------------------------------------------------------------------------------------------------------------------
ADD PROVISION FOR UNPAID CLAIMS AND CLAIM
ADJUSTMENT EXPENSES
Current year 1,944 2,156 897 983 12 5,992
Prior years (10) 17 28 (11) 119 143
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL PROVISION FOR UNPAID CLAIMS AND CLAIM
ADJUSTMENT EXPENSES 1,934 2,173 925 972 131 6,135
- ------------------------------------------------------------------------------------------------------------------------------------
LESS PAYMENTS 1,628 2,055 955 646 308 5,592
Other [1] [2] -- -- (602) -- 497 (105)
- ------------------------------------------------------------------------------------------------------------------------------------
ENDING LIABILITIES FOR UNPAID CLAIMS AND CLAIM
ADJUSTMENT EXPENSES-NET 4,065 1,479 2,985 1,508 2,823 12,860
Reinsurance and other recoverables 375 51 2,088 448 1,214 4,176
- ------------------------------------------------------------------------------------------------------------------------------------
ENDING LIABILITIES FOR UNPAID CLAIMS AND CLAIM
ADJUSTMENT EXPENSES-GROSS $ 4,440 $ 1,530 $ 5,073 $ 1,956 $ 4,037 $ 17,036
====================================================================================================================================
<FN>
[1] $602 represents the transfer of asbestos and environmental reserves to
Other Operations
[2] Includes $(101) related to the sale of international subsidiaries.
</FN>
</TABLE>
- 35 -
<PAGE>
<TABLE>
<CAPTION>
For the year ended December 31, 2000
- ------------------------------------------------------------------------------------------------------------------------------------
Business Personal Specialty Other Total
Insurance Lines Commercial Reinsurance Operations P&C
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
BEGINNING LIABILITIES FOR UNPAID CLAIMS AND
CLAIM ADJUSTMENT EXPENSES-GROSS $ 3,913 $ 1,304 $ 5,694 $ 1,330 $ 4,208 $ 16,449
Reinsurance and other recoverables 155 25 1,954 168 1,404 3,706
- ------------------------------------------------------------------------------------------------------------------------------------
BEGINNING LIABILITIES FOR UNPAID CLAIMS AND
CLAIM ADJUSTMENT EXPENSES-NET 3,758 1,279 3,740 1,162 2,804 12,743
- ------------------------------------------------------------------------------------------------------------------------------------
ADD PROVISION FOR UNPAID CLAIMS AND CLAIM
ADJUSTMENT EXPENSES
Current year 1,492 1,898 857 704 219 5,170
Prior years 14 23 (78) (80) 148 27
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL PROVISION FOR UNPAID CLAIMS AND CLAIM
ADJUSTMENT EXPENSES 1,506 1,921 779 624 367 5,197
- ------------------------------------------------------------------------------------------------------------------------------------
LESS PAYMENTS 1,505 1,839 902 604 484 5,334
Other [1] -- -- -- -- (184) (184)
- ------------------------------------------------------------------------------------------------------------------------------------
ENDING LIABILITIES FOR UNPAID CLAIMS AND CLAIM
ADJUSTMENT EXPENSES-NET 3,759 1,361 3,617 1,182 2,503 12,422
Reinsurance and other recoverables 195 42 2,011 234 1,389 3,871
- ------------------------------------------------------------------------------------------------------------------------------------
ENDING LIABILITIES FOR UNPAID CLAIMS AND CLAIM
ADJUSTMENT EXPENSES-GROSS $ 3,954 $ 1,403 $ 5,628 $ 1,416 $ 3,892 $ 16,293
====================================================================================================================================
<FN>
[1] Includes $(161) related to the sale of international subsidiaries.
</FN>
</TABLE>
- --------------------------------------------------------------------------------
BUSINESS INSURANCE
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
OPERATING SUMMARY
2001
---------------------------------
INCLUDING EXCLUDING
2002 SEPTEMBER 11 SEPTEMBER 11 2000
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Written premiums $ 3,412 $ 2,871 $ 2,886 $ 2,405
Change in unearned premium reserve 286 241 241 107
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums $ 3,126 $ 2,630 $ 2,645 $ 2,298
Benefits, claims and claim adjustment expenses 1,962 1,934 1,704 1,506
Amortization of deferred policy acquisition costs 779 681 681 605
Insurance operating costs and expenses 341 257 257 237
- ------------------------------------------------------------------------------------------------------------------------------------
UNDERWRITING RESULTS $ 44 $ (242) $ 3 $ (50)
-------------------------------------------------------------------------------------------------------------------------------
Loss ratio 50.7 59.9 52.3 52.4
Loss adjustment expense ratio 12.0 13.7 12.1 13.1
Expense ratio 31.9 32.3 32.1 33.8
Combined ratio [1] [2] 96.2 107.1 97.8 100.6
====================================================================================================================================
<FN>
[1] Includes policyholder dividend ratios of 1.5, 1.3, and 1.3, for the years
ended December 31, 2002, 2001 (including and excluding September 11), and
2000, respectively.
[2] GAAP combined ratios were 97.0, 108.0 (including a 9.3 point impact related
to September 11) and 101.2 for the years ended December 31, 2002, 2001 and
2000, respectively.
</FN>
</TABLE>
Business Insurance provides standard commercial insurance coverage to small and
middle market commercial businesses primarily throughout the United States. This
segment offers workers' compensation, property, automobile, liability, umbrella
and marine coverages. The Business Insurance segment also provides commercial
risk management products and services.
2002 COMPARED TO 2001 -- Business Insurance achieved written premium growth of
$541 (including $15 of reinsurance cessions related to September 11), or 19%,
due to strong growth in both middle market and small commercial. The increase in
middle market of $295, or 21%, was due primarily to double-digit pricing
increases as well as continued strong new business growth and premium renewal
retention. Small commercial increased $231, or 16%, reflecting double-digit
written pricing increases, particularly in the property line of business.
Business Insurance earned premiums increased $496 (including $15 of reinsurance
cessions related to September 11), or 19%, due to strong 2002 and 2001 written
pricing increases impacting 2002 earned premiums. Middle market increased $260,
or 20%, and small commercial increased $221, or 16%, reflecting double-digit
earned pricing increases.
Underwriting results improved $286 (including $245 of underwriting loss related
to September 11 in 2001), with a corresponding 10.9 point decrease (including a
9.3 point impact related to September 11) in the combined ratio. The improvement
in underwriting results and combined ratio, excluding September 11, was
primarily due to double-digit earned pricing increases and minimal loss costs.
Business Insurance continues to benefit from favorable frequency loss costs.
While 2002 catastrophe losses are in line with prior year, the level of
catastrophes is below management expectations. In
- 36 -
<PAGE>
addition, the beneficial effects of strong pricing on the underwriting expense
ratio have been offset by an increase in taxes, licenses and fees rates, and
increased technology spending.
2001 COMPARED TO 2000 -- Written premiums increased $466 (including $15 of
reinsurance cessions related to September 11), or 19%, driven by strong growth
in small commercial and middle market. Small commercial increased $278, or 24%,
as a result of written pricing increases, strong premium renewal retention and
the success of product, marketing, technology and service growth initiatives.
The increase in middle market of $203, or 16%, was attributable primarily to
double-digit pricing increases and improved premium renewal retention as well as
strong new business growth.
Earned premiums increased $332 (including $15 of reinsurance cessions related to
September 11), or 14%, due primarily to strong earned premium growth in both
small commercial and middle market. Small commercial increased $252, or 23%, as
a result of mid-single digit earned pricing increases, while middle market
achieved double-digit earned pricing increases, driving $95, or 8% growth.
Underwriting results decreased $192 (including $245 of underwriting loss related
to September 11) with a corresponding 6.5 point increase (including a 9.3 point
impact related to September 11) in the combined ratio. Excluding the impact of
September 11, the improvement in underwriting results and the combined ratio was
primarily due to strong pricing and decreased frequency loss costs as well as an
improved expense ratio. The favorable expense ratio was the result of 2001
benefits from the field office reorganization and reorganization costs in 2000
not recurring in 2001.
OUTLOOK
Firming market conditions in the standard commercial sector are expected to
continue in 2003, although price competition within many markets of the
commercial industry will remain a challenge. Passage of the Terrorism Risk
Insurance Act of 2002 alleviates some of the economic uncertainty surrounding
the industry in the event of future terrorist attacks. (For further discussion,
see Capital Resources and Liquidity section under "Terrorism Risk Insurance Act
of 2002".) Management expects the Business Insurance segment to continue to
deliver positive results in 2003 despite an expected return to a normal level of
catastrophes. Significant growth in small commercial and middle market
businesses is expected to be achieved, in part, due to continued strategic
actions being implemented. This includes providing a complete product solution
for agents and customers, expanding non-traditional distribution alternatives,
executing geographic market share strategies and developing technology solutions
that deliver superior business tools to The Hartford's agents and alliances.
Continued pricing and underwriting actions are expected to have a positive
impact on the segment's overall profitability in 2003.
- --------------------------------------------------------------------------------
PERSONAL LINES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
OPERATING SUMMARY
2001
---------------------------------
INCLUDING EXCLUDING
2002 SEPTEMBER 11 SEPTEMBER 11 2000
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Written premiums $ 3,050 $ 2,860 $ 2,860 $ 2,647
Change in unearned premium reserve 66 113 113 100
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums $ 2,984 $ 2,747 $ 2,747 $ 2,547
Benefits, claims and claim adjustment expenses 2,319 2,173 2,164 1,921
Amortization of deferred policy acquisition costs 415 385 385 377
Insurance operating costs and expenses 296 276 276 247
- ------------------------------------------------------------------------------------------------------------------------------------
UNDERWRITING RESULTS $ (46) $ (87) $ (78) $ 2
-------------------------------------------------------------------------------------------------------------------------------
Loss ratio 66.1 67.4 67.2 64.7
Loss adjustment expense ratio 11.6 11.7 11.6 10.8
Expense ratio 23.0 24.0 24.0 24.6
Combined ratio [1] 100.8 103.1 102.8 100.1
Other revenue [2] $ 123 $ 150 $ 150 $ 166
====================================================================================================================================
<FN>
[1] GAAP combined ratios were 101.0, 102.7 (including a 0.3 point impact
related to September 11) and 99.6 for the years ended December 31, 2002,
2001 and 2000, respectively.
[2] Represents servicing revenue.
</FN>
</TABLE>
Personal Lines provides automobile, homeowners' and home-based business
coverages to the members of AARP through a direct marketing operation; to
individuals who prefer local agent involvement through a network of independent
agents in the standard personal lines market ("Standard") and in the
non-standard automobile market through the Company's Omni Insurance Group, Inc.
("Omni") subsidiary. Personal Lines also operates a member contact center for
health insurance products offered through AARP's Health Care Options. The
Hartford's exclusive licensing arrangement with AARP, which was renewed during
the fourth quarter of 2001, continues through January 1, 2010 for automobile,
homeowners and home-based business. The Health Care Options agreement continues
through 2007.
2002 COMPARED TO 2001 -- Personal Lines written premiums increased $190, or 7%,
primarily driven by growth in AARP, partially offset by a reduction in Standard.
AARP increased $217, or 13%, primarily as a result of written pricing increases
and improved premium renewal retention. Standard decreased $27, or 3%, due
primarily to the conversion to six-month policies in certain states.
- 37 -
<PAGE>
Earned premiums increased $237, or 9%, due primarily to growth in AARP and
Standard. AARP increased $187, or 12%, and Standard increased $30, or 4%, due
primarily to earned pricing increases.
Underwriting results improved $41 (including $9 of underwriting loss related to
September 11), with a corresponding 2.3 point decrease (including a 0.3 point
impact related to September 11) in the combined ratio. While automobile results
improved due to favorable frequency loss costs, the line of business was
negatively impacted by the increasing severity of automobile claims as a result
of medical inflation and higher repair costs. The underwriting experience
relating to homeowners has remained favorable due to improved frequency of
claims, despite an increase in the severity of individual homeowners' claims. An
improvement in the underwriting expense ratio, primarily due to written pricing
increases and prudent expense management, resulted in a 1.0 point decrease in
the expense ratio over the prior year.
2001 COMPARED TO 2000 -- Written premiums increased $213, or 8%, driven by
growth in both the AARP program and Standard. AARP increased primarily as a
result of strong new business growth and continued steady premium renewal
retention. Written premium growth in the standard automobile and homeowners
lines was primarily due to pricing increases and strong premium renewal
retention.
Earned premiums increased $200, or 8%, driven by growth in AARP and Standard.
AARP increased $113, or 8%, and Standard increased $50, or 7%, due primarily to
earned pricing increases.
Underwriting results decreased $89 (including $9 of underwriting loss related to
September 11), with a corresponding 3.0 point increase (including a 0.3 point
impact related to September 11) in the combined ratio. Higher automobile losses
continue to adversely impact underwriting results and the combined ratio. In
addition, the loss adjustment expense ratio increased, primarily as a result of
higher losses and increased litigation costs. Although underwriting expenses
increased, primarily due to increased written premiums, the expense ratio
improved as compared to the prior year, primarily as a result of lower
commissions and prudent expense management.
OUTLOOK
While the personal lines industry operating fundamentals are expected to improve
in 2003, the market will continue to face significant challenges. Price
increases in automobile and homeowners are expected to continue, but industry
rates may remain inadequate. State regulatory constraints may prevent companies
from obtaining the necessary rates. Regulatory requirements applying to premium
rates vary from state to state, and, in most states, rates are subject to prior
regulatory approval. Industry loss costs are expected to continue to increase in
2003, but pricing is expected to exceed loss cost inflation. The deterioration
in loss performance since 2000 has been driven primarily by severity loss costs.
Issues surrounding mold and medical inflation may continue to impact loss
performance in Personal Lines.
The Personal Lines segment is focused on managing premium growth to optimize
earnings, while investing to enhance its product and technology platforms.
Improved financial results in 2003 are expected for the Personal Lines segment
as a result of continuing state-driven pricing and underwriting actions, even
though catastrophes are expected to return to a normal level. Personal Lines'
product breadth, channel diversity and technology position this segment to deal
effectively with the market risks that face the personal lines industry.
- --------------------------------------------------------------------------------
SPECIALTY COMMERCIAL
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
OPERATING SUMMARY
2001
---------------------------------
INCLUDING EXCLUDING
2002 SEPTEMBER 11 SEPTEMBER 11 2000
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Written premiums $ 1,362 $ 989 $ 996 $ 1,080
Change in unearned premium reserve 140 (33) (33) 46
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums $ 1,222 $ 1,022 $ 1,029 $ 1,034
Benefits, claims and claim adjustment expenses 849 925 766 779
Amortization of deferred policy acquisition costs 240 267 267 268
Insurance operating costs and expenses 156 92 91 90
- ------------------------------------------------------------------------------------------------------------------------------------
UNDERWRITING RESULTS $ (23) $ (262) $ (95) $ (103)
-------------------------------------------------------------------------------------------------------------------------------
Loss ratio 57.6 73.1 59.5 60.4
Loss adjustment expense ratio 11.8 17.6 15.0 15.1
Expense ratio 27.9 33.8 33.4 31.3
Combined ratio [1] [2] 98.1 124.8 108.3 107.1
Other revenue [3] $ 233 $ 213 $ 213 $ 168
====================================================================================================================================
<FN>
[1] Includes policyholder dividend ratios of 0.7, 0.4, and 0.2, for the years
ended December 31, 2002, 2001 (including and excluding the impact of
September 11), and 2000, respectively.
[2] GAAP combined ratios were 99.4, 124.2 (including a 16.5 point impact
related to September 11) and 109.7 for the years ended December 31, 2002,
2001 and 2000, respectively.
[3] Represents servicing revenue.
</FN>
</TABLE>
- 38 -
<PAGE>
Specialty Commercial offers a variety of customized insurance products and risk
management services. The segment provides standard commercial insurance products
including workers' compensation, automobile and liability coverages to
large-sized companies. Specialty Commercial also provides bond, professional
liability, specialty casualty and agricultural coverages, as well as core
property and excess and surplus lines coverages not normally written by standard
lines insurers. Alternative markets, within Specialty Commercial, provides
insurance products and services primarily to captive insurance companies, pools
and self-insurance groups. In addition, Specialty Commercial provides third
party administrator services for claims administration, integrated benefits,
loss control and performance measurement through Specialty Risk Services.
2002 COMPARED TO 2001 -- Specialty Commercial written premiums increased $373
(including $7 of reinsurance cessions related to September 11), or 38%,
primarily driven by the property, specialty casualty and professional liability
lines of business. Written premiums for property grew $121, or 43%, while
specialty casualty grew $114, or 55%, both primarily due to significant price
increases and new business growth reflecting an improving operating environment.
Professional liability written premiums grew $71, or 42%, also due to
significant price increases.
Earned premiums increased $200 (including $7 of reinsurance cessions related to
September 11), or 20%, primarily driven by robust earned premium growth in
property of $65, or 23%, specialty casualty of $73, or 35%, and professional
liability of $83, or 71%, as a result of double-digit earned pricing increases.
Underwriting results improved $239 (including $167 of underwriting loss related
to September 11), with a corresponding 26.7 point decrease (including a 16.5
point impact related to September 11) in the combined ratio. The improvement in
underwriting results and combined ratio, excluding September 11, was primarily
due to favorable property, specialty casualty and professional liability
results, as a result of the favorable pricing environment. Increased losses
incurred in agriculture, due to the Midwest drought; the risk management
division, due to deductible workers' compensation losses on a few large
accounts; and bond partially mitigated the improvement. In addition, the
underwriting expense ratio improved primarily due to pricing increases and
prudent expense management. Lower catastrophes, primarily as a result of the
Seattle earthquake in the first quarter of 2001, also contributed to the
improvement in underwriting results.
2001 COMPARED TO 2000 -- Written premiums decreased $91 (including $7 of
reinsurance cessions related to September 11), or 8%, primarily due to a
decrease in written premiums from sold or exited business lines which include
farm, public entity and Canada. Partially offsetting the decrease was an
increase in written premiums due to The Hartford's purchase, in the third
quarter of 2000, of the in-force, new and renewal financial products business,
as well as the majority of the excess and surplus lines business, of Reliance
Group Holdings, Inc. ("Reliance"), which resulted in $60 of additional written
premiums as compared with 2000.
Earned premiums declined $12 (including $7 of reinsurance cessions related to
September 11), or 1%, primarily due to a decrease in earned premiums from the
sold or exited business lines referred to above. Partially offsetting the
decrease was an increase in earned premiums due to The Hartford's purchase of
the financial products and excess and surplus lines businesses of Reliance
mentioned above, which resulted in $74 of additional earned premiums as compared
with 2000.
Underwriting results decreased $159 (including $167 of underwriting loss related
to September 11), with a corresponding 17.7 point increase (including a 16.5
point impact related to September 11) in the combined ratio. Excluding the
impact of September 11, underwriting results improved despite an increase in the
combined ratio. The improved underwriting results were primarily a result of
favorable results in the property lines of business and lower losses and
underwriting expenses from the sold or exited business lines. Partially
offsetting the improvement were deteriorating underwriting results in risk
management and a decrease in underwriting results related to Enron Corporation.
The increase in the combined ratio was primarily due to an increase in the net
commissions as well as additional taxes, licenses and fees in the risk
management and professional liability lines of business. The increase in the
commission ratio was primarily a result of lower ceding commissions.
OUTLOOK
Specialty Commercial is made up of a diverse group of businesses that are unique
to commercial lines. Each line of business operates independently with its own
set of business objectives and focuses on the operational dynamics of its
specific industry. These businesses, while somewhat interrelated, each have a
unique business model and operating cycle. Firming market conditions in most of
the specialty commercial sectors are expected to continue in 2003. Passage of
the Terrorism Risk Insurance Act of 2002 alleviates some of the economic
uncertainty surrounding the industry in the event of future terrorist attacks.
(For further discussion, see the Capital Resources and Liquidity section under
"Terrorism Risk Insurance Act of 2002".) Strong written pricing in 2002 will
contribute to earned premium growth expected in 2003. Management believes that
continued strategic actions being taken, which include focusing on maximizing
growth in the segment's most profitable lines; providing innovative new
products; expanding non-traditional distribution alternatives; and further
leveraging underwriting discipline and capabilities will continue to enable the
segment to capitalize on an improved marketplace.
- 39 -
<PAGE>
- --------------------------------------------------------------------------------
REINSURANCE
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
OPERATING SUMMARY
2001
---------------------------------
INCLUDING EXCLUDING
2002 SEPTEMBER 11 SEPTEMBER 11 2000
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Written premiums $ 703 $ 849 $ 918 $ 826
Change in unearned premium reserve (10) (2) (2) 17
- ------------------------------------------------------------------------------------------------------------------------------------
Earned premiums $ 713 $ 851 $ 920 $ 809
Benefits, claims and claim adjustment expenses 569 972 815 624
Amortization of deferred policy acquisition costs 179 239 239 243
Insurance operating costs and expenses 24 15 15 15
- ------------------------------------------------------------------------------------------------------------------------------------
UNDERWRITING RESULTS $ (59) $ (375) $ (149) $ (73)
-------------------------------------------------------------------------------------------------------------------------------
Loss ratio 74.9 108.9 83.7 72.7
Loss adjustment expense ratio 4.9 5.3 4.9 4.4
Expense ratio 27.2 29.7 27.4 31.7
Combined ratio [1] 107.1 143.9 116.1 108.9
====================================================================================================================================
<FN>
[1] GAAP combined ratios were 107.9, 144.0 (including a 27.8 point impact
related to September 11) and 109.0 for the years ended December 31, 2002,
2001 and 2000, respectively.
</FN>
</TABLE>
The Reinsurance segment offers a full range of treaty and facultative
reinsurance products including property, casualty, catastrophe, marine and
alternative risk transfer which includes non-traditional reinsurance products
such as multi-year property catastrophe treaties, aggregate of excess of loss
agreements and quota share treaties with event or aggregate loss ratio caps. The
segment assumes insurance from other insurers, primarily through reinsurance
brokers, but also through direct channels and pools in the worldwide reinsurance
market.
2002 COMPARED TO 2001 -- Reinsurance written premiums decreased $146 (including
$69 of reinsurance cessions related to September 11), or 17%, and earned
premiums decreased $138 (including $69 related to September 11), or 16%, due to
the exclusion of the exited international business, which in January 2002, was
transferred to Other Operations and a reduction in the Alternative Risk Transfer
("ART") line of business. Written and earned premiums from the international
business in 2001 were $131 and $136, respectively. ART written and earned
premiums decreased $97, or 53%, and $94, or 51%, respectively, due primarily to
the expiration of a non-recurring loss portfolio reinsurance contract and the
non-renewal of a quota share treaty with one ceding company. Excluding ART,
international and the impact of September 11, written premiums increased $13, or
2%, and earned premiums increased $23, or 4%, due primarily to significant
pricing increases as a result of continued market firming, substantially offset
by premium reductions due to underwriting requirements to maintain profitability
targets.
Underwriting results improved $316 (including $226 of underwriting loss related
to September 11), with a corresponding 36.8 point decrease (including a 27.8
point impact related to September 11) in the combined ratio. The improvement in
underwriting results and combined ratio, excluding September 11, was primarily
due to underwriting initiatives including a shift to excess of loss policies and
increased property business mix, as well as the exit from nearly all
international lines, an intense focus on returns and lower catastrophes.
Underwriting results and the combined ratio were negatively impacted by adverse
loss development on prior underwriting years.
2001 COMPARED TO 2000 -- Written premiums increased $23 (including $69 of
reinsurance cessions related to September 11), or 3%, and earned premiums
increased $42 (including $69 related to September 11), or 5%, primarily due to
growth in the ART line of business. ART written and earned premiums increased
$91, or 100%, and $98, or 111%, respectively, driven primarily by a significant
first quarter ART transaction. The achievement of double-digit pricing increases
in traditional reinsurance was offset by the termination of business that failed
to meet profitability targets.
Underwriting results decreased $302 (including $226 of underwriting loss related
to September 11), with a corresponding 35.0 point increase (including a 27.8
point impact related to September 11) in the combined ratio. Excluding September
11, the decrease in underwriting results and corresponding increase in the
combined ratio were primarily attributable to reserve development in 2001
compared to 2000.
OUTLOOK
The property and casualty reinsurance market remains extremely competitive and
stressed. The pricing environment continued to improve in 2002, and it is
anticipated by management that favorable rates and terms will continue in 2003.
Reserve deficiencies, low investment yields and poor historical performance are
driving a renewed focus on profitability. The marketplace is also experiencing a
flight to quality as customers pay more for reinsurance. Additionally, terrorism
remains a key underwriting issue. Terrorism losses incurred by reinsurers are
not covered by the Terrorism Risk Insurance Act of 2002. The dislocation of
certain broker market competitors continues in the aftermath of September 11. In
addition, some companies are raising capital, while others are reviewing their
strategic options. New Bermuda companies are emerging with a greater share of
the overall market. This will continue to put pressure on industry rates and
terms.
- 40 -
<PAGE>
- --------------------------------------------------------------------------------
OTHER OPERATIONS (INCLUDING ASBESTOS AND ENVIRONMENTAL CLAIMS)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
OPERATING SUMMARY
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Earned premiums $ 69 $ 17 $ 367
Net investment income 147 146 210
Other revenue -- -- 9
Net realized capital gains (losses) (27) 5 16
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 189 168 602
--------------------------------------------------------------------------------------------------------------------------
Benefits, claims and claim adjustment expenses 171 142 423
Amortization of deferred policy acquisition costs -- -- 49
Insurance operating costs and expenses 62 7 88
Other expenses (25) 5 7
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL BENEFITS, CLAIMS AND EXPENSES 208 154 567
--------------------------------------------------------------------------------------------------------------------------
INCOME (LOSS) BEFORE INCOME TAXES (19) 14 35
Income tax expense (benefit) (6) 4 7
- ------------------------------------------------------------------------------------------------------------------------------------
NET INCOME (LOSS) (13) 10 28
Less: Net realized capital gains (losses), after-tax (17) 4 11
- ------------------------------------------------------------------------------------------------------------------------------------
OPERATING INCOME $ 4 $ 6 $ 17
====================================================================================================================================
</TABLE>
The Other Operations segment includes operations that are under a single
management structure, Heritage Holdings, that was finalized in late 2001 to be
responsible for two related activities. The first activity is the management of
certain subsidiaries and operations of The Hartford that have discontinued
writing new business. The second is the management of claims (and the associated
reserves) related to asbestos and environmental exposures.
The companies in this segment which are not writing new business include First
State Insurance Company and two affiliated subsidiaries, located in Boston,
Massachusetts; Heritage Reinsurance Company, Ltd. ("Heritage Re"), headquartered
in Bermuda; and Excess Insurance Company, Ltd., located in the United Kingdom.
Each of these companies is primarily focused on managing claims, resolving
disputes and collecting reinsurance proceeds, related largely to business
underwritten and reinsured in 1985 and prior years. While the business that was
written in these units on either a direct or reinsurance basis spanned a wide
variety of insurance and reinsurance policies and coverages, a significant and
increasing proportion of current and future claims activity arising from these
businesses relates to environmental and, to a greater extent, asbestos
exposures. Other Operations also includes the results of The Hartford's
international property-casualty businesses (substantially all of which were
disposed of in a series of transactions concluding in 2001) and the
international businesses of the Reinsurance segment, exited in the fourth
quarter of 2001. (For further discussion of the restructuring, see Note 18(c) of
Notes to Consolidated Financial Statements.)
In 2001, The Hartford consolidated management and claims handling of all of its
asbestos and environmental exposures under the Other Operations' management
structure. This action was taken to maximize The Hartford's management expertise
in this area. As part of this organizational change, the Company consolidated
substantially all of its asbestos and environmental loss reserves into one legal
entity, Heritage Re, within Other Operations through intercompany reinsurance
agreements. These reinsurance agreements ceded $602 of the then carried reserves
(net of reinsurance), primarily related to asbestos and environmental exposures
from 1985 and prior, from the Specialty Commercial segment to Other Operations.
In September 2001, The Hartford entered into an agreement to sell its
Singapore-based Hartford Insurance Company (Singapore), Ltd. The Company
recorded a net realized capital loss of $9 after-tax related to the sale, which
was recorded in the 2001 investment results of North American. The sale was
completed in January 2002.
On February 8, 2001, The Hartford completed the sale of its Spain-based
subsidiary, Hartford Seguros. The Hartford received $29, before costs of sale
and recorded a $16 after-tax net realized capital loss that was reported in the
2001 investment results of North American.
On December 22, 2000, The Hartford completed the sale of its Netherlands-based
Zwolsche Algemeene N.V. ("Zwolsche") subsidiary located in the Netherlands,
Belgium and Luxembourg. The Hartford received $547, before costs of sale and
recorded a $69 after-tax net realized capital gain that was reported in the 2000
investment results of North American.
2002 COMPARED TO 2001 -- Revenues for the year increased $21 due to earned
premium, offset by net realized capital losses. The increase in earned premium
was primarily due to runoff premium from the exited international business of
the Reinsurance segment, which was transferred to Other Operations in January
2002.
Operating income was relatively flat compared to the prior year period.
2001 COMPARED TO 2000 -- Revenues were down $434, or 72%, and operating income
was down $11, or 65%, primarily due to the sale of Zwolsche.
Asbestos and Environmental Claims
The Hartford continues to receive asbestos and environmental claims, both of
which affect Other Operations. These claims are made pursuant to several
different categories of insurance
- 41 -
<PAGE>
coverage. First, The Hartford wrote direct policies as a primary liability
insurance carrier. Second, The Hartford wrote direct excess insurance policies
providing additional coverage for insureds that exhaust their primary liability
insurance coverage. Third, The Hartford acted as a reinsurer assuming a portion
of risks previously assumed by other insurers writing primary, excess and
reinsurance coverages. Fourth, The Hartford participated as a London Market
company that wrote both direct insurance and assumed reinsurance business.
With regard to both environmental and particularly asbestos claims, significant
uncertainty limits the ability of insurers and reinsurers to estimate the
ultimate reserves necessary for unpaid losses and related settlement expenses.
Conventional reserving techniques cannot reasonably estimate the ultimate cost
of these claims, particularly during periods where theories of law are in flux.
As a result of the factors discussed in the following paragraphs, the degree of
variability of reserve estimates for these exposures is significantly greater
than for other more traditional exposures. In particular, The Hartford believes
there is a high degree of uncertainty inherent in the estimation of asbestos
loss reserves.
In the case of the reserves for asbestos exposures, factors contributing to the
high degree of uncertainty include inadequate development patterns, plaintiffs'
expanding theories of liability, the risks inherent in major litigation and
inconsistent emerging legal doctrines. Courts have reached inconsistent
conclusions as to when losses are deemed to have occurred and which policies
provide coverage; what types of losses are covered; whether there is an insurer
obligation to defend; how policy limits are determined; whether particular
claims are product/completed operation claims subject to an aggregate limit and
how policy exclusions and conditions are applied and interpreted. Furthermore,
insurers in general, including The Hartford, have recently experienced an
increase in the number of asbestos-related claims due to, among other things,
more intensive advertising by lawyers, seeking asbestos claimants, plaintiffs'
increased focus on new and previously peripheral defendants and an increase in
the number of insureds seeking bankruptcy protection as a result of
asbestos-related liabilities. Plaintiffs and insureds have sought to use
bankruptcy proceedings to accelerate and increase loss payments by insurers. In
addition some policyholders have begun to assert new classes of claims for so
called "non-product" coverages to which an aggregate limit of liability may not
apply. Recently, many insurers, including, in a limited number of instances, The
Hartford, also have been sued directly by asbestos claimants asserting that
insurers had a duty to protect the public from the dangers of asbestos.
Management believes these issues are not likely to be resolved in the near
future.
In the case of the reserves for environmental exposures, factors contributing to
the high degree of uncertainty include: court decisions that have interpreted
the insurance coverage to be broader than originally intended; inconsistent
decisions, especially across jurisdictions and uncertainty as to the monetary
amount being sought by the claimant from the insured.
Further uncertainties include the effect of the recent acceleration in the rate
of bankruptcy filings by asbestos defendants on the rate and amount of The
Hartford's asbestos claims payments; a further increase or decrease in asbestos
and environmental claims which cannot now be anticipated; whether some
policyholders' liabilities will reach the umbrella or excess layer of their
coverage; the resolution or adjudication of some disputes pertaining to the
amount of available coverage for asbestos claims in a manner inconsistent with
The Hartford's previous assessment of these claims; the number and outcome of
direct actions against The Hartford; and unanticipated developments pertaining
to The Hartford's ability to recover reinsurance for asbestos and environmental
claims. It is also not possible to predict changes in the legal and legislative
environment and their impact on the future development of asbestos and
environmental claims. Additionally, the reporting pattern for excess insurance
and reinsurance claims is much longer than direct claims. In many instances, it
takes months or years to determine that the customer's own obligations have been
met and how the reinsurance in question may apply to such claims. The delay in
reporting reinsurance claims and exposures adds to the uncertainty of estimating
the related reserves.
Given the factors and emerging trends described above, The Hartford believes the
actuarial tools and other techniques it employs to estimate the ultimate cost of
claims for more traditional kinds of insurance exposure are less precise in
estimating reserves for its asbestos and environmental exposures. The Hartford
continually evaluates new information and new methodologies in assessing its
potential asbestos exposures. At any time, The Hartford may be conducting an
analysis of newly identified information. Completion of exposure analyses could
cause The Hartford to change its estimates 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.
Reserve Activity
Reserves and reserve activity in the Other Operations segment are categorized
and reported as asbestos, environmental or "all other" activity. The discussion
below relates to reserves and reserve activity, net of applicable reinsurance.
There are a wide variety of claims that drive the reserves associated with
asbestos, environmental and all other categories the Company has defined in
Other Operations. Asbestos claims relate primarily to bodily injuries asserted
by those who came in contact with asbestos or products containing asbestos.
Environmental claims relate primarily to pollution and related clean-up costs.
The all other category of reserves covers a wide range of insurance coverages,
including liability for breast implants, blood products, construction defects
and lead paint.
The Other Operations historic book of business contains policies written from
the 1940s to 1992, with the majority of the business spanning the interval 1960
to 1990. The Hartford's experience has been that this book of business has over
time produced significantly higher claims and losses than were contemplated at
inception. The areas of active claim activity have also shifted based on changes
in plaintiff focus and the overall litigation environment. A significant portion
of the claim reserves of the Other Operations segment relates to exposure to the
insurance businesses of other insurers or reinsurers ("whole account" exposure).
Many of these whole account exposures arise from reinsurance agreements
previously written by The Hartford. The Hartford's net exposure in these
arrangements has increased for a variety of reasons including
- 42 -
<PAGE>
The Hartford's commutation of previous retrocessions of such business. Due to
the reporting practices of cedants to their reinsurers, determination of the
nature of the individual risks involved in these whole account exposures (such
as asbestos, environmental, or other exposures) requires various assumptions and
estimates, which are subject to uncertainty, as previously discussed.
Consistent with the Company's long-standing reserving practices, The Hartford
will continue to regularly review and monitor these reserves and, where future
developments indicate, make appropriate adjustments to the reserves. The loss
reserving assumptions, drawn from both industry data and the Company's
experience, have over time been applied to all of this business and have
resulted in strengthening or weakening actions at various times over the past
decade.
During 2001, the Company observed a decrease in newly reported environmental
claims as well as favorable settlements with respect to certain existing
environmental claims. Both observations were consistent with longer-term
positive trends for environmental liabilities. In the same period, consistent
with the reports of other insurers, The Hartford experienced an increase in the
number of new asbestos claims by policyholders not previously identified as
potentially significant claimants, including installers or handlers of
asbestos-containing products. In addition, new classes of claims were beginning
to arise whereby some policyholders were asserting that their asbestos-related
claims fall within so-called "non-products" coverage contained within their
policies rather than products hazard coverage and that the claimed non-products
coverage was not subject to any aggregate limit. Also, as previously noted, The
Hartford consolidated management and claims handling responsibility of all of
its asbestos and environmental exposures within Other Operations in 2001. Based
on a review of the environmental claim trends that was completed in the fourth
quarter of 2001 under the supervision of the then newly consolidated management
structure and in light of the further uncertainties posed by the foregoing
asbestos trends, the Company reclassified $100 of environmental reserves to
asbestos reserves.
During 2002, as part of the Company's ongoing monitoring of reserves, the
Company reclassified $600 of reserves from the all other reserve category, of
which $540 was reclassified to asbestos and $60 was reclassified to
environmental claim reserves. The increase in reserves categorized as
environmental of $60 (as contrasted with the $100 decrease in the fourth quarter
of 2001) occurred because the reviews in each of the two periods employed
actuarial techniques to analyze distinct and non-overlapping blocks of reserves
and associated exposures. Facts and circumstances associated with each block
determined the resulting changes in category. A portion of the 2002
reclassification relates to re-estimates of the appropriate allocation among the
asbestos, environmental and all other categories of the aggregate reserves (net
of reinsurance) carried for certain assumed reinsurance, commuted cessions and
commuted retrocessions of whole account business. As part of the 2002
reclassification, The Hartford also revised formulas that it will use to
allocate (among the asbestos, environmental and all other categories) future
claim payments for which reinsurance arrangements were commuted and to allocate
claim payments made to effect commutations. As a result of these revisions,
payments categorized as asbestos and environmental exposures will be higher in
future periods than in prior periods.
Approximately $390 of the $600 reclassification resulted from changes in the
estimates of the proportions of certain of the Company's broad-based liability
and assumed reinsurance reserves that would more appropriately be categorized as
asbestos or environmental reserves. The change in allocation did not involve a
change in The Hartford's estimated net liability with respect to the policies in
question. Instead, the Company's estimate of what type of claims the insured
would present against these liabilities changed. To give an example: when the
Company writes a broad reinsurance contract for another insurer, it gives the
insurer the right to submit a variety of different types of claims, up to a
limit, against that policy. The Company establishes a reserve for that policy
that considers the exposure for total incurred claims under that policy. Over
time, the Company changes its view as to what type of claims may be presented,
but its aggregate liability and appropriate reserve are less likely to change,
particularly if the reserves are already at the limit payable under the policy.
The foregoing $390 reduction of the all other reserves was related to the
Company's assessment of trends that suggested noteworthy changes in the claims
made against these reserves. These trends indicated that the categories of
claims presented were becoming better defined. In response to these noted
trends, management decided to study whether sufficient information existed to
change estimates of what portions of certain reserves were likely to be used for
asbestos and environmental claims. This study was completed in the second
quarter of 2002. On a net basis, it resulted in approximately $60 of reserves
being categorized as likely to be associated with an environmental claim and
approximately $330 as likely to be associated with an asbestos claim. This
resulted in a reclassification of $390 of reserves previously categorized in the
all other category to the asbestos and environmental reserves categories,
respectively.
In the 2000 review of non-asbestos or non-environmental latent exposures, the
Company noted that business written from 1986 to 1992 has produced less mass
tort development over the ensuing 10-15 years than was the case for the business
written from 1960 to 1986. At the time of this review, the Company developed an
estimated actuarial range that indicated there could be a potential reserve
deficiency but there was also a strong potential for reserve redundancy. At that
time, the Company concluded that there was insufficient foundation to make a
determination of redundancy and that to do so would be aggressive. In the second
quarter 2002, The Hartford also completed a separate but related study of
liabilities other than asbestos and environmental exposures in Other Operations.
The study confirmed a continuation of the trends previously noted. It also
produced a conservative end of the actuarial range indicating no material
potential deficiency. With this new information, the Company felt sufficient
foundation existed to estimate a redundancy of approximately $210 for reserves
covering latent exposures in Other Operations other than asbestos and
environmental.
While the Company was conducting the foregoing studies, the Company was also
monitoring the continued adverse trends in the reporting and settlement of
asbestos claims. In light of these trends, which management believed likely to
continue,
- 43 -
<PAGE>
management decided to increase the Company's reserves for asbestos liability by
approximately $210.
The following table presents reserve activity, inclusive of estimates for both
reported and incurred but not reported claims, net of reinsurance, for Other
Operations, categorized by asbestos, environmental and all other claims, for the
years ended December 31, 2002, 2001 and 2000. Also included are the remaining
asbestos and environmental exposures of North American.
<TABLE>
<CAPTION>
OTHER OPERATIONS CLAIMS AND CLAIM ADJUSTMENT EXPENSES
2002 Asbestos Environmental All Other Total
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Beginning liability - net $ 616 $ 654 $ 1,591 $ 2,861
Claims and claim adjustment expenses incurred 88 (11) 89 166
Claims and claim adjustment expenses paid (126) (112) (137) (375)
Transfer of international lines of Reinsurance [1] -- -- 300 300
Other [2] 540 60 (600) --
- ------------------------------------------------------------------------------------------------------------------------------------
ENDING LIABILITY - NET [3] [4] $ 1,118 $ 591 $ 1,243 $ 2,952
====================================================================================================================================
2001
- ------------------------------------------------------------------------------------------------------------------------------------
Beginning liability - net [5] $ 572 $ 911 $ 1,753 $ 3,236
Claims and claim adjustment expenses incurred 28 15 116 159
Claims and claim adjustment expenses paid (84) (172) (176) (432)
Other [2] [6] 100 (100) (102) (102)
- ------------------------------------------------------------------------------------------------------------------------------------
ENDING LIABILITY - NET [3] [4] $ 616 $ 654 $ 1,591 $ 2,861
====================================================================================================================================
2000
- ------------------------------------------------------------------------------------------------------------------------------------
Beginning liability - net [5] $ 625 $ 995 $ 1,976 $ 3,596
Claims and claim adjustment expenses incurred 8 8 368 384
Claims and claim adjustment expenses paid (61) (92) (430) (583)
Other [6] -- -- (161) (161)
- ------------------------------------------------------------------------------------------------------------------------------------
ENDING LIABILITY - NET [3] [4] $ 572 $ 911 $ 1,753 $ 3,236
====================================================================================================================================
<FN>
[1] Represents the January 1, 2002 transfer of reserves from the exited
international reinsurance business from the Reinsurance segment to Other
Operations.
[2] The nature of these reallocations is described in the preceding
discussions.
[3] Ending liabilities include reserves for asbestos, environmental and all
other reported in North American Property & Casualty of $13, $4 and $0,
respectively, as of December 31, 2002, $6, $32 and $0, respectively, as of
December 31, 2001, and $236, $430 and $67, respectively, as of December 31,
2000.
[4] Gross of reinsurance, reserves for asbestos and environmental were $1,994
and $682, respectively, as of December 31, 2002, $1,633 and $919,
respectively, as of December 31, 2001 and $1,506 and $1,483, respectively,
as of December 31, 2000.
[5] The net beginning liability has been adjusted to reflect the North American
liabilities subject to the fourth quarter 2001 intercompany reinsurance
cession, primarily related to asbestos and environmental reserves, from the
Specialty Commercial segment to Other Operations. Also, excludes reserves
of Property & Casualty's international businesses.
[6] Includes the net effect of the sale of international subsidiaries.
</FN>
</TABLE>
In comparing environmental claims and claim adjustment expenses paid from year
to year, 2001 includes $56 of payments resulting from a global commutation where
settlement was reached on both assumed and ceded reinsurance involvements. The
trend in all other paid losses, when adjusted for the 2002 inclusion of HartRe
international paids of $62, continues to decline year to year. Trends in
asbestos paids and incurreds are addressed in the paragraphs preceding the
table. The $11 negative incurred of environmental reserve development in 2002 is
the result of continued favorable trends in environmental claims, as previously
discussed.
The Company manages its asbestos and environmental claims in three distinct
categories of coverage types as reported in the following table. Direct policies
include insurance policies issued to customers providing either primary coverage
or excess of loss coverage over either The Hartford's own primary policies or
the primary policies of other insurance companies. Assumed Reinsurance includes
both "treaty" reinsurance (covering broad categories of claims or blocks of
business) and "facultative" reinsurance (covering specific risks or individual
policies of primary or excess insurance companies). London Market business
includes the business written by one or more subsidiaries in the United Kingdom,
which are no longer active in the insurance or reinsurance business. Such
business includes both direct insurance and contracts of assumed reinsurance.
Exposures on direct policies are the easiest to identify because specific
policies can be associated with specific accounts and reserves established,
where appropriate, for claims presented. Over the last three years, including
the current reporting period, the Company experienced a reduction in newly
reported environmental claims on Direct business, and actual claim payments have
been made at levels within the Company's previously established provisions for
loss. However, with respect to asbestos claims, the Company experienced a
variety of negative trends, including: increasing number of policyholders making
claims, an apparent increase in the number of claimants under such policies and
an accelerated rate of policyholder bankruptcies. The combination of such events
has the total value of potential claims higher into the excess
- 44 -
<PAGE>
layers of the Company's policies and into later years of coverage than had been
expected.
Assumed Reinsurance claims (treaty and facultative) related to asbestos and
environmental exposures continue to be reported by customers years after the
expiration of their contracts with the Company. The reports the Company has
received during 2002 are largely related to asbestos and environmental claims
and reflect the same trends as those of the Direct policies, as previously
discussed.
The asbestos and environmental liability components of the London Market book of
business consist of both direct policies of insurance and contracts of assumed
reinsurance. As a participant in the London Market (comprised of both Lloyd's of
London and London Company Markets), the Company wrote business on a subscription
basis, with the Company's involvement being limited to a relatively small
percentage of a total contract placement. Claims are reported, via a broker, to
the "lead" underwriter and, once agreed to, are presented to the following
markets for concurrence. This reporting and claim agreement process makes
estimating liabilities for this business the most uncertain of the three
categories of claims (Direct, Assumed - Domestic and London Market).
Over the last three years, The Hartford has been experiencing lower than
previously expected claim activity with respect to claims classified as
environmental. During the last two years, The Hartford has been experiencing
higher than previously expected claim activity with respect to claims classified
as asbestos. The increase in both the number of claims being submitted and the
number of customer bankruptcies, being driven by asbestos related issues, have
accelerated over the last year. The following table sets forth, for the three
years ended December 31, 2002, paid and incurred loss activity by the three
categories of claims for asbestos and environmental. The table shows that in
this timeframe asbestos payments and incurred losses have been increasing, while
environmental activity generally has been improving.
<TABLE>
<CAPTION>
PAID AND INCURRED LOSS AND LOSS ADJUSTMENT EXPENSE ("LAE") DEVELOPMENT - ASBESTOS AND ENVIRONMENTAL
ASBESTOS ENVIRONMENTAL
-------------------------------------- ------------------------------------
Paid Incurred Paid Incurred
2002 Loss & LAE Loss & LAE Loss & LAE Loss & LAE
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
GROSS
Direct $ 212 $ 559 $ 124 $ (9)
Assumed - Domestic 66 89 15 (39)
London Market 35 26 24 (26)
- ------------------------------------------------------------------------------------------------------------------------------------
Total 313 674 163 (74)
Ceded (187) (46) (51) 123
- ------------------------------------------------------------------------------------------------------------------------------------
Net $ 126 $ 628 $ 112 $ 49
====================================================================================================================================
2001
- ------------------------------------------------------------------------------------------------------------------------------------
GROSS
Direct $ 173 $ 329 $ 148 $ (247)
Assumed - Domestic 61 63 68 (65)
London Market 31 -- 36 --
- ------------------------------------------------------------------------------------------------------------------------------------
Total 265 392 252 (312)
Ceded (181) (264) (80) 227
- ------------------------------------------------------------------------------------------------------------------------------------
Net $ 84 $ 128 $ 172 $ (85)
====================================================================================================================================
2000
- ------------------------------------------------------------------------------------------------------------------------------------
GROSS
Direct $ 181 $ 163 $ 92 $ 15
Assumed - Domestic 25 35 15 --
London Market 21 1 34 --
- ------------------------------------------------------------------------------------------------------------------------------------
Total 227 199 141 15
Ceded (166) (191) (49) (7)
- ------------------------------------------------------------------------------------------------------------------------------------
Net $ 61 $ 8 $ 92 $ 8
====================================================================================================================================
</TABLE>
OUTLOOK
As previously noted, The Hartford reviews various components of its asbestos and
environmental reserves on a periodic basis. Given the continuing adverse
development experienced by The Hartford, as well as the negative trends that the
insurance industry as a whole has recently seen with respect to asbestos, it was
determined that a more in-depth and comprehensive review was necessary. In
January 2003, The Hartford announced a comprehensive ground-up study of its
asbestos related exposures, and expects the study to be completed by the second
quarter 2003. This study will accomplish three objectives: (1) provide a
ground-up framework to evaluate the Company's overall asbestos exposure, (2)
accumulate the detailed information necessary to provide even more detailed
disclosures of the components of asbestos reserves, and (3) evaluate the
Company's exposures in relation to current reserve levels.
- 45 -
<PAGE>
- --------------------------------------------------------------------------------
INVESTMENTS
- --------------------------------------------------------------------------------
General
- -------
The Hartford's investment portfolios are divided between Life and Property &
Casualty. The investment portfolios are managed based on the underlying
characteristics and nature of each operation's respective liabilities and within
established risk parameters. (For a further discussion of The Hartford's
approach to managing risks, see the Capital Markets Risk Management section.)
The investment portfolios of Life and Property & Casualty are managed by
Hartford Investment Management Company ("HIMCO"), a wholly-owned subsidiary of
The Hartford. HIMCO is responsible for monitoring and managing the
asset/liability profile, establishing investment objectives and guidelines and
determining, within specified risk tolerances and investment guidelines, the
appropriate asset allocation, duration, convexity and other characteristics of
the portfolios. Security selection and monitoring are performed by asset class
specialists working within dedicated portfolio management teams.
Return on general account invested assets is an important element of The
Hartford's financial results. Significant fluctuations in the fixed income or
equity markets could weaken the Company's financial condition or its results of
operations. Net investment income and net realized capital gains and losses
accounted for approximately 16%, 17% and 19% of the Company's consolidated
revenues for the years ended December 31, 2002, 2001 and 2000, respectively.
Fluctuations in interest rates affect the Company's return on, and the fair
value of, fixed maturity investments, which comprised approximately 90% and 86%
of the fair value of its invested assets as of December 31, 2002 and 2001,
respectively. Other events beyond the Company's control could also adversely
impact the fair value of these investments. Specifically, a downgrade of an
issuer's credit rating or default of payment by an issuer could reduce the
Company's investment return.
The Company also invests in unaffiliated limited partnership arrangements in
order to further diversify its investment portfolio. These limited partnerships
represent approximately 2% and 3% of the fair value of its invested assets as of
December 31, 2002 and 2001, respectively. Limited partnerships are typically
less liquid than direct investments in fixed income or equity investments.
Market volatility and other factors beyond the Company's control can adversely
affect the value of these investments. Because the Company is a limited partner,
its ability to control the timing or the realization of the related investment
income is restricted.
A decrease in the fair value of any investment that is deemed other than
temporary would result in the Company's recognition of a realized loss in its
financial results prior to the actual sale of the investment. (For a further
discussion, see the Company's discussion of evaluation of other than temporary
impairment in Critical Accounting Estimates under "Valuation of Investments and
Derivative Instruments".)
LIFE
The primary investment objective of Life's general account is to maximize
after-tax returns consistent with acceptable risk parameters, including the
management of the interest rate sensitivity of invested assets and the
generation of sufficient liquidity relative to that of corporate and
policyholder obligations, as discussed in the Capital Markets Risk Management
section under "Market Risk - Life - Interest Rate Risk".
The weighted average duration of the fixed maturity portfolio was 4.8 and 4.9 as
of December 31, 2002 and 2001, respectively. Duration is defined as the
approximate percentage change in market price of the portfolio for a 100 basis
point change in interest rates. For example, if interest rates increased by 100
basis points, the fair value of the portfolio would be expected to decrease by
approximately 4.8% and 4.9% as of December 31, 2002 and 2001, respectively. The
following table identifies the invested assets by type held in the general
account as of December 31, 2002 and 2001.
<TABLE>
<CAPTION>
COMPOSITION OF INVESTED ASSETS
- ------------------------------------------------------------------------------------------------------------------------------------
2002 2001
AMOUNT PERCENT AMOUNT PERCENT
-------------- -------------- -------------- -------------
<S> <C> <C> <C> <C>
Fixed maturities, at fair value $ 29,377 86.7% $ 23,301 82.1%
Equity securities, at fair value 458 1.3% 428 1.5%
Policy loans, at outstanding balance 2,934 8.7% 3,317 11.7%
Limited partnerships, at fair value 519 1.5% 811 2.9%
Other investments 603 1.8% 520 1.8%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS $ 33,891 100.0% $ 28,377 100.0%
====================================================================================================================================
</TABLE>
During 2002, fixed maturity investments increased 26% primarily due to increased
operating cash flows, transfers into the general account from the variable
annuity separate account and an increase in fair value due to a lower interest
rate environment. Limited partnerships decreased $292, or 36%, due to
redemptions and a decision to reallocate funds to other asset classes.
The following table identifies, by type, the fixed maturity securities held in
the general account as of December 31, 2002 and 2001.
- 46 -
<PAGE>
<TABLE>
<CAPTION>
FIXED MATURITIES BY TYPE
- ------------------------------------------------------------------------------------------------------------------------------------
2002 2001
FAIR VALUE PERCENT FAIR VALUE PERCENT
-----------------------------------------------------------
<S> <C> <C> <C> <C>
Corporate $ 14,596 49.7% $ 11,419 49.0%
Commercial mortgage-backed securities (CMBS) 4,234 14.4% 3,029 13.0%
Asset-backed securities (ABS) 3,954 13.5% 3,427 14.7%
Municipal - tax-exempt 2,000 6.8% 1,565 6.7%
Mortgage-backed securities (MBS) - agency 1,851 6.3% 981 4.2%
Collateralized mortgage obligations (CMO) 691 2.4% 767 3.3%
Government/Government agencies - Foreign 526 1.8% 390 1.7%
Government/Government agencies - United States 360 1.2% 374 1.6%
Municipal - taxable 31 0.1% 47 0.2%
Short-term 1,100 3.7% 1,245 5.3%
Redeemable preferred stock 34 0.1% 57 0.3%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 29,377 100.0% $ 23,301 100.0%
====================================================================================================================================
</TABLE>
There were no material changes in asset allocation during 2002 and 2001.
As of December 31, 2002 and 2001, 18% and 21%, respectively, of Life's fixed
maturities were invested in private placement securities (including 11% and 12%
of Rule 144A offerings as of December 31, 2002 and 2001, respectively). Private
placement securities are generally less liquid than public securities. However,
private placements generally have covenants designed to compensate for liquidity
risk. Most of the private placement securities in the Life operation's portfolio
are rated by nationally recognized rating agencies. (For further discussion of
the Company's investment credit policies, see the Capital Markets Risk
Management section under "Credit Risk".)
INVESTMENT RESULTS
The following table summarizes Life's investment results.
<TABLE>
<CAPTION>
(before-tax) 2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net investment income - excluding policy loan income $ 1,604 $ 1,472 $ 1,284
Policy loan income 254 307 308
---------------------------------------------------------
Net investment income - total $ 1,858 $ 1,779 $ 1,592
Yield on average invested assets [1] 6.2% 7.0% 7.0%
Net realized capital losses $ (317) $ (133) $ (88)
====================================================================================================================================
<FN>
[1] Represents net investment income (excluding net realized capital losses)
divided by average invested assets at cost (fixed maturities at amortized
cost).
</FN>
</TABLE>
2002 COMPARED TO 2001 -- Net investment income, excluding policy loan income,
increased $132, or 9%. The increase was primarily due to income earned on the
previously discussed higher invested asset base partially offset by $36 lower
income on limited partnerships and the impact of lower interest rates on new
investment purchases. Yields on average invested assets decreased as a result of
lower rates on new investment purchases, decreased policy loan income and
decreased income on limited partnerships.
Included in 2002 net realized capital losses were write-downs for other than
temporary impairments on primarily corporate and asset-backed fixed maturities
of $363. Write-downs on corporate fixed maturities totaled $185 and included
impairments in the communications and technology sector of $142 (including a $74
loss related to securities issued by WorldCom Corporation) and the utilities
sector of $32. Write-downs on asset-backed securities totaled $167 and included
impairments of securities backed by aircraft lease receivables of $73, corporate
debt of $35, manufactured housing receivables of $16, mutual fund fee
receivables of $16 and on various other asset-backed securities totaling $27.
Also included in 2002 net realized capital losses were write-downs for other
than temporary impairments on equity securities of $17. These losses were
partially offset by gains from the sale of fixed maturity securities.
2001 COMPARED TO 2000 -- Net investment income, excluding policy loan income,
increased $188, or 15%. The increase was primarily due to income earned on the
higher asset base of fixed maturity investments, partially offset by lower
yields on fixed maturities in the third and fourth quarters of 2001. Yields on
overall average invested assets were flat.
Included in 2001 net realized capital losses were write-downs for other than
temporary impairments on primarily corporate and asset-backed fixed maturities
of $105. Write-downs on corporate securities totaled $63 and included
impairments in the utilities sector of $37 and the communications and technology
sector of $17. Write-downs on corporate fixed maturities in the utilities sector
were on securities issued by Enron Corporation. Write-downs on asset-backed
securities totaled $31 and included impairments of securities backed by
corporate debt of $14 and on various other asset-backed securities totaling $17.
Also included in net realized capital losses is a $35 loss recognized on the
sale of the Company's interest in an Argentine insurance joint venture, in
addition to losses associated with the credit deterioration of certain
investments in which the Company has an indirect economic interest. These losses
were partially offset by gains from the sale of fixed maturities.
- 47 -
<PAGE>
SEPARATE ACCOUNT PRODUCTS
Separate account products are those for which a separate investment and
liability account is maintained on behalf of the policyholder. The Company's
separate accounts reflect two categories of risk assumption: non-guaranteed
separate accounts totaling $95.6 billion and $104.6 billion as of December 31,
2002 and 2001, respectively, wherein the policyholder assumes substantially all
the risk and reward; and guaranteed separate accounts totaling $11.5 billion and
$10.1 billion as of December 31, 2002 and 2001, respectively, wherein The
Hartford contractually guarantees either a minimum return or the account value
to the policyholder. Guaranteed separate account products primarily consist of
modified guaranteed individual annuities and modified guaranteed life insurance
and generally include market value adjustment features and surrender charges to
mitigate the risk of disintermediation. The primary investment objective of
guaranteed separate accounts is to maximize after-tax returns consistent with
acceptable risk parameters, including the management of the interest rate
sensitivity of invested assets relative to that of policyholder obligations, as
discussed in the Capital Markets Risk Management section under "Market Risk -
Life - Interest Rate Risk."
Investment objectives for non-guaranteed separate accounts vary by fund account
type, as outlined in the applicable fund prospectus or separate account plan of
operations. Non-guaranteed separate account products include variable annuities,
variable life insurance contracts and variable COLI.
PROPERTY & CASUALTY
The investment objective for the majority of Property & Casualty is to maximize
economic value while generating after-tax income and sufficient liquidity to
meet corporate and policyholder obligations. For Property & Casualty's Other
Operations segment, the investment objective is to ensure the full and timely
payment of all liabilities. Property & Casualty's investment strategies are
developed based on a variety of factors including business needs, regulatory
requirements and tax considerations.
The weighted average duration of the fixed maturity portfolio was 4.7 as of
December 31, 2002 and 2001. Duration is defined as the approximate percentage
change in the market value of the portfolio for a 100 basis point change in
interest rates. For example, if interest rates increased by 100 basis points,
the fair value of the portfolio would be expected to decrease by approximately
4.7%. The following table identifies the invested assets by type held as of
December 31, 2002 and 2001.
<TABLE>
<CAPTION>
COMPOSITION OF INVESTED ASSETS
- ------------------------------------------------------------------------------------------------------------------------------------
2002 2001
AMOUNT PERCENT AMOUNT PERCENT
-------------- -------------- -------------- -------------
<S> <C> <C> <C> <C>
Fixed maturities, at fair value $ 19,446 94.5% $ 16,742 91.5%
Equity securities, at fair value 459 2.2% 921 5.0%
Limited partnerships, at fair value 362 1.8% 561 3.0%
Other investments 306 1.5% 85 0.5%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL INVESTMENTS $ 20,573 100.0% $ 18,309 100.0%
====================================================================================================================================
</TABLE>
During 2002, fixed maturity investments increased 16% due to the investment of
increased operating cash flows and an increase in fair value due to a lower
interest rate environment. Total equity securities decreased 50% primarily due
to the sale of foreign and domestic equity holdings and declines in domestic
equity market values. Limited partnerships decreased $199, or 35%, due to
redemptions. Other investments increased due to the purchase of a corporate
owned life insurance contract and increased investment in mortgage loans.
The following table identifies, by type, the fixed maturity securities held as
of December 31, 2002 and 2001.
<TABLE>
<CAPTION>
FIXED MATURITIES BY TYPE
- ------------------------------------------------------------------------------------------------------------------------------------
2002 2001
FAIR VALUE PERCENT FAIR VALUE PERCENT
-------------- -------------- -------------- -------------
<S> <C> <C> <C> <C>
Municipal - tax-exempt $ 8,846 45.5% $ 8,401 50.2%
Corporate 5,459 28.0% 4,179 25.0%
Commercial mortgage-backed securities (CMBS) 1,573 8.1% 1,145 6.8%
Asset-backed securities (ABS) 731 3.8% 717 4.3%
Government/Government agencies - Foreign 1,088 5.6% 613 3.6%
Mortgage-backed securities (MBS) - agency 522 2.7% 381 2.3%
Government/Government agencies - United States 124 0.6% 201 1.2%
Collateralized mortgage obligations (CMO) 49 0.3% 97 0.6%
Municipal - taxable 52 0.3% 47 0.3%
Short-term 934 4.8% 862 5.1%
Redeemable preferred stock 68 0.3% 99 0.6%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 19,446 100.0% $ 16,742 100.0%
====================================================================================================================================
</TABLE>
- 48 -
<PAGE>
There were no material changes in asset allocation during 2002 and 2001.
INVESTMENT RESULTS
The following table below summarizes Property & Casualty's investment results.
<TABLE>
<CAPTION>
2002 2001 2000
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Net investment income, before-tax $ 1,075 $ 1,053 $ 1,072
Net investment income, after-tax [1] $ 833 $ 819 $ 836
Yield on average invested assets, before-tax [2] 5.8% 6.1% 6.2%
Yield on average invested assets, after-tax [1] [2] 4.5% 4.7% 4.9%
Net realized capital gains (losses), before-tax $ (83) $ (103) $ 234
====================================================================================================================================
<FN>
[1] Due to the significant holdings in tax-exempt investments, after-tax net
investment income and yield are included.
[2] Represents net investment income (losses) (excluding net realized capital
gains (losses)) divided by average invested assets at cost (fixed
maturities at amortized cost).
</FN>
</TABLE>
2002 COMPARED TO 2001 -- Both before- and after-tax net investment income
increased 2% compared to the prior year as increased operating cash flow
resulted in higher investment income on the higher invested asset base. Yields
on average invested assets declined due to the lower interest rate environment.
Net realized capital losses were $83 compared to $103 for the prior year.
Included in 2002 net realized capital losses were write-downs for other than
temporary impairments on primarily corporate and asset-backed fixed maturities
of $152. Write-downs on corporate securities totaled $109 (including a $36 loss
related to securities issued by WorldCom Corporation) and included impairments
in the communications and technology sector of $91 and the utilities sector of
$11. Write-downs on asset-backed securities totaled $40 and included impairments
of securities backed by corporate debt of $12, aircraft lease receivables of
$11, manufactured housing receivables of $8 and on various other asset-backed
securities totaling $9. Also included in 2002 net realized capital losses were
write-downs for other than temporary impairments on equity securities of $47.
These losses were partially offset by gains from the sale of fixed maturity and
equity securities.
2001 COMPARED TO 2000 -- Both before- and after-tax net investment income
decreased 2% compared to the prior year. The decreases were primarily due to a
reduction in investment income resulting from the sales of Zwolsche and Hartford
Seguros, partially offset by higher income on taxable fixed maturities in the
North American Property & Casualty operations. Yields on average invested assets
declined slightly due to the lower interest rate environment.
Net realized capital losses were $103 compared to net realized capital gains of
$234 for the prior year. The 2001 net realized capital losses included
write-downs for other than temporary impairments on primarily corporate and
asset-backed fixed maturities of $61. Write-downs on corporate securities
totaled $39 and included impairments in the communications sector of $17 and the
utilities sector of $16. Write-downs on corporate fixed maturities in the
utilities sector were all on securities issued by Enron Corporation. Write-downs
on asset-backed securities totaled $22 and included impairments of securities
backed by corporate debt of $9 and on various other asset-backed securities
totaling $13. The 2001 net realized capital losses also included write-downs for
other than temporary impairments of $30 on equities and other invested assets.
An additional $7 of losses were sustained on sales of Enron Corporation common
stock. Also included in 2001 net realized capital losses were losses generated
from the sales of international subsidiaries of $54, in addition to losses
associated with the credit deterioration of certain investments in which the
Company has an indirect economic interest. These losses were partially offset by
gains from the sale of fixed maturities.
CORPORATE
As of December 31, 2002 and 2001 Corporate held $66 and $3, respectively, of
short-term fixed maturity investments. These investments earned $2 of income in
2002.
In connection with The HLI Repurchase, the carrying value of the purchased fixed
maturity security investments was adjusted to fair market value as of the date
of the repurchase. This adjustment was reported in Corporate. The amortization
of the adjustment to the fixed maturity security investments' carrying values is
reported in Corporate's net investment income. The total amount of before-tax
amortization for the years ended December 31, 2002 and 2001 was $18.
- 49 -
<PAGE>
- --------------------------------------------------------------------------------
CAPITAL MARKETS RISK MANAGEMENT
- --------------------------------------------------------------------------------
<PAGE>
The Hartford has a disciplined approach to managing risks associated with its
capital markets and asset/liability management activities. Investment portfolio
management is organized to focus investment management expertise on specific
classes of investments, while asset/liability management is the responsibility
of dedicated risk management units supporting Life, including guaranteed
separate accounts, and Property & Casualty operations. Derivative instruments
are utilized in compliance with established Company policy and regulatory
requirements and are monitored internally and reviewed by senior management.
The Company is exposed to two primary sources of investment and asset/liability
management risk: credit risk, relating to the uncertainty associated with the
ability of an obligor or counterparty to make timely payments of principal
and/or interest, and market risk, relating to the market price and/or cash flow
variability associated with changes in interest rates, securities prices, market
indices, yield curves or currency exchange rates. The Company does not hold any
financial instruments purchased for trading purposes.
CREDIT RISK
The Hartford 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 and by the Company's
Finance Committee of the Board of Directors.
The Company invests primarily in securities which are rated investment grade and
has established exposure limits, diversification standards and review procedures
for all credit risks including borrower, issuer and counterparty.
Creditworthiness of specific obligors is determined by an internal credit
evaluation supplemented by consideration of external determinants of
creditworthiness, typically ratings assigned by nationally recognized ratings
agencies. Obligor, asset sector and industry concentrations are subject to
established limits and monitored on a regular basis.
The Hartford is not exposed to any credit concentration risk of a single issuer
greater than 10% of the Company's stockholders' equity.
DERIVATIVE INSTRUMENTS
The Company's derivative counterparty exposure policy establishes market-based
credit limits, favors long-term financial stability and creditworthiness and
typically requires credit enhancement/credit risk reducing agreements. Credit
risk is measured as the amount owed to the Company based on current market
conditions and potential payment obligations between the Company and its
counterparties. Credit exposures are generally quantified weekly and netted, and
collateral is pledged to and held by, or on behalf of, the Company to the extent
the current value of derivatives exceeds exposure policy thresholds.
The Company periodically enters into swap agreements in which the Company
assumes credit exposure from a single entity, referenced index or asset pool.
Total return swaps involve the periodic exchange of payments with other parties,
at specified intervals, calculated using the agreed upon index and notional
principal amounts. Generally, no cash or principal payments are exchanged at the
inception of the contract. Typically, at the time a swap is entered into, the
cash flow streams exchanged by the counterparties are equal in value.
Credit default swaps involve a transfer of credit risk from one party to another
in exchange for periodic payments. One party to the contract will make a payment
based on an agreed upon rate and a notional amount. The second party, who
assumes credit exposures, will only make a payment when there is a credit event,
and such payment will be equal to the notional value of the swap contract, and
in return, the second party will receive the debt obligation of the first party.
A credit event is generally defined as default on contractually obligated
interest or principal payment or restructure.
As of December 31, 2002 and 2001 the notional value of total return and credit
default swaps totaled $1.0 billion and $686, respectively, and the swap fair
value totaled $(78) and $(105), respectively.
The following tables identify fixed maturity securities for Life, including
guaranteed separate accounts, and Property & Casualty by credit quality. The
ratings referenced in the tables are based on the ratings of a nationally
recognized rating organization or, if not rated, assigned based on the Company's
internal analysis of such securities. In addition, an aging of the gross
unrealized loss position is presented for fixed maturity and equity securities.
LIFE
As of December 31, 2002 and 2001, over 94% and 96%, respectively, of the fixed
maturity portfolio was invested in securities rated investment grade (BBB and
above). During 2002, the percentage of BB and below rated fixed maturity
investments increased due to increased downgrades of corporate and asset-backed
securities.
- 50 -
<PAGE>
<TABLE>
<CAPTION>
FIXED MATURITIES BY CREDIT QUALITY
- ------------------------------------------------------------------------------------------------------------------------------------
2002 2001
--------------------------------------------------------------------------------
PERCENT OF PERCENT OF
AMORTIZED TOTAL FAIR AMORTIZED TOTAL FAIR
COST FAIR VALUE VALUE COST FAIR VALUE VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
United States Government/Government agencies $ 3,596 $ 3,737 9.2% $ 2,573 $ 2,639 8.0%
AAA 6,519 6,960 17.2% 4,915 5,070 15.3%
AA 4,161 4,396 10.9% 3,570 3,644 11.0%
A 11,745 12,467 30.8% 11,330 11,528 34.8%
BBB 9,211 9,665 23.9% 7,611 7,644 23.1%
BB & below 2,148 2,084 5.2% 1,214 1,148 3.4%
Short-term 1,153 1,153 2.8% 1,470 1,470 4.4%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 38,533 $ 40,462 100.0% $ 32,683 $ 33,143 100.0%
====================================================================================================================================
Total general account fixed maturities 27,982 29,377 72.6% 23,010 23,301 70.3%
Total guaranteed separate account fixed maturities 10,551 11,085 27.4% 9,673 9,842 29.7%
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The Company's total and below investment grade ("BIG") fixed maturity and equity
securities held as of December 31, 2002 and 2001 that were in an unrealized loss
position are presented in the tables below by length of time the security was in
an unrealized loss position.
<TABLE>
<CAPTION>
UNREALIZED LOSS AGING AT DECEMBER 31, 2002
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL SECURITIES BIG AND EQUITY SECURITIES
------------------------------------------ -----------------------------------------
AMORTIZED UNREALIZED AMORTIZED UNREALIZED
COST FAIR VALUE LOSS COST FAIR VALUE LOSS
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Three months or less $ 1,532 $ 1,459 $ (73) $ 162 $ 130 $ (32)
Greater than three months to six months 1,294 1,239 (55) 208 185 (23)
Greater than six months to nine months 568 508 (60) 175 145 (30)
Greater than nine months to twelve months 1,334 1,264 (70) 330 293 (37)
Greater than twelve months 2,135 1,927 (208) 501 431 (70)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 6,863 $ 6,397 $(466) $ 1,376 $ 1,184 $ (192)
====================================================================================================================================
</TABLE>
The total securities that were in an unrealized loss position for longer than
six months as of December 31, 2002 primarily consisted of corporate and
asset-backed securities. The significant corporate security industry sectors of
banking and financial services, utilities, technology and communications and
airlines comprised 20%, 13%, 13% and 3%, respectively, of the greater than six
months unrealized loss amount. Asset-backed securities comprised 33% of the
greater than six month unrealized loss amount and included securities backed by
corporate debt, aircraft lease receivables and credit card receivables. At
December 31, 2002, the Company held no securities of a single issuer that were
at an unrealized loss in excess of 4% of total unrealized losses. The total
unrealized loss position of $(466) consisted of $(344) in general account losses
and $(122) in guaranteed separate account losses.
The BIG and equity securities that were in an unrealized loss position for
longer than six months as of December 31, 2002 primarily consisted of corporate
securities in the technology and communications and utilities sectors as well as
asset-backed securities backed by corporate debt, equipment loans and credit
card receivables. The technology and communications and utilities sectors along
with diversified equity mutual funds and asset-backed securities comprised 26%,
22%, 18% and 15%, respectively, of the BIG and equity securities that were in an
unrealized loss position for greater than six months at December 31, 2002. The
total unrealized loss position of BIG and equity securities of $(192) consisted
of $(157) in general account losses and $(35) in guaranteed separate account
losses.
<TABLE>
<CAPTION>
UNREALIZED LOSS AGING AT DECEMBER 31, 2001
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL SECURITIES BIG AND EQUITY SECURITIES
------------------------------------------ -----------------------------------------
AMORTIZED UNREALIZED AMORTIZED UNREALIZED
COST FAIR VALUE LOSS COST FAIR VALUE LOSS
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Three months or less $ 5,075 $ 4,932 $ (143) $ 269 $ 242 $ (27)
Greater than three months to six months 755 686 (69) 99 77 (22)
Greater than six months to nine months 487 464 (23) 63 58 (5)
Greater than nine months to twelve months 2,128 2,051 (77) 245 217 (28)
Greater than twelve months 2,113 1,949 (164) 323 277 (46)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 10,558 $ 10,082 $ (476) $ 999 $ 871 $ (128)
====================================================================================================================================
</TABLE>
- 51 -
<PAGE>
The total securities that were in an unrealized loss position for longer than
six months as of December 31, 2001 primarily consisted of corporate and
asset-backed securities. The significant corporate security industry sectors
that were in an unrealized loss position for greater than six months included
banking and financial services of 22%. The communications and technology,
utilities and petroleum sectors comprised 13%, 12% and 4%, respectively of the
total securities that were in an unrealized loss position for greater than six
months at December 31, 2001. Asset-backed securities comprised 19% of the
greater than six month unrealized loss amount, and included securities backed by
corporate debt, franchise loans, aircraft lease receivables, credit card
receivables, and manufactured housing receivables. At December 31, 2001, the
Company held no securities of a single issuer that were at an unrealized loss in
excess of 3% of total unrealized losses. The total unrealized loss position of
$(476) consisted of $(370) in general account losses and $(106) in guaranteed
separate account losses.
The BIG and equity securities that were in an unrealized loss position for
longer than six months as of December 31, 2001 primarily consisted of corporate
securities in the utilities and technology and communications sectors as well as
asset-backed securities backed primarily by manufactured housing receivables,
corporate debt and equipment lease receivables. Diversified equity mutual funds,
asset-backed securities, technology and communications sector securities and
utilities sector securities comprised 28%, 21%, 18% and 14%, respectively, of
the BIG securities in an unrealized loss position for greater than six months at
December 31, 2001. The total unrealized loss position of BIG and equity
securities of $(128) consisted of $(90) in general account losses and $(38) in
guaranteed separate account losses.
As part of the Company's ongoing monitoring process by a committee of investment
and accounting professionals, the Company has reviewed these securities and
concluded that there were no additional other than temporary impairments as of
December 31, 2002 and 2001. Due to the issuers' continued satisfaction of the
securities' obligations in accordance with their contractual terms and their
continued expectation to do so, as well as the evaluation of the fundamentals of
the issuers' financial condition, the Company believes that the prices of the
securities in the sectors identified above, were temporarily depressed primarily
as a result of a market dislocation and generally poor cyclical economic
conditions and sentiment. (See the Critical Accounting Estimates section in the
MD&A for the factors considered in evaluating other than temporary impairments.)
The evaluation for other than temporary impairments is a quantitative and
qualitative process, which is subject to risks and uncertainties in the
determination of whether declines in the fair value of investments are other
than temporary. The risks and uncertainties include changes in general economic
conditions, the issuer's financial condition or near term recovery prospects and
the effects of changes in interest rates. In addition, for securitized financial
assets with contractual cash flows (e.g. asset-backed securities), projections
of expected future cash flows may change based upon new information regarding
the performance of the underlying collateral.
PROPERTY & CASUALTY
As of December 31, 2002 and 2001, over 94% of the fixed maturity portfolio was
invested in securities rated investment grade. During 2002, the percentage of BB
and below rated fixed maturity investments increased due to increased downgrades
of corporate and asset-backed securities.
<TABLE>
<CAPTION>
FIXED MATURITIES BY CREDIT QUALITY
- ------------------------------------------------------------------------------------------------------------------------------------
2002 2001
--------------------------------------------------------------------------------
PERCENT OF PERCENT OF
AMORTIZED TOTAL FAIR AMORTIZED TOTAL FAIR
COST FAIR VALUE VALUE COST FAIR VALUE VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
United States Government/Government agencies $ 638 $ 660 3.4% $ 628 $ 639 3.8%
AAA 6,825 7,398 38.1% 5,888 6,160 36.8%
AA 3,146 3,388 17.4% 3,012 3,126 18.7%
A 3,337 3,567 18.3% 3,092 3,193 19.1%
BBB 2,320 2,456 12.6% 1,844 1,876 11.2%
BB & below 1,035 1,043 5.4% 880 886 5.3%
Short-term 934 934 4.8% 862 862 5.1%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL FIXED MATURITIES $ 18,235 $ 19,446 100.0% $ 16,206 $ 16,742 100.0%
====================================================================================================================================
</TABLE>
The total and BIG fixed maturity and equity securities held as of December 31,
2002 and 2001 that were in an unrealized loss position are presented in the
tables below by length of time the security was in an unrealized loss position.
- 52 -
<PAGE>
<TABLE>
<CAPTION>
UNREALIZED LOSS AGING AT DECEMBER 31, 2002
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL SECURITIES BIG AND EQUITY SECURITIES
------------------------------------------ -----------------------------------------
AMORTIZED UNREALIZED AMORTIZED UNREALIZED
COST FAIR VALUE LOSS COST FAIR VALUE LOSS
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Three months or less $ 510 $ 490 $ (20) $ 112 $ 99 $ (13)
Greater than three months to six months 248 224 (24) 100 82 (18)
Greater than six months to nine months 135 103 (32) 91 68 (23)
Greater than nine months to twelve months 486 455 (31) 246 222 (24)
Greater than twelve months 216 176 (40) 109 86 (23)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 1,595 $ 1,448 $(147) $ 658 $ 557 $ (101)
====================================================================================================================================
</TABLE>
The total securities that were in an unrealized loss position for longer than
six months as of December 31, 2002 primarily consisted of corporate and
asset-backed securities. The significant corporate security industry sectors of
technology and communications, banking and financial services, utilities and
airlines comprised 22%, 8%, 12% and 6%, respectively, of the greater than six
months unrealized loss amount. Asset-backed securities comprised 17% of the
greater than six month unrealized loss amount and include securities backed by
corporate debt, aircraft lease receivables, home equity loans and credit card
receivables. At December 31, 2002, the Company held no securities of a single
issuer that were at an unrealized loss in excess of 6% of total unrealized
losses.
The BIG and equity securities that were in an unrealized loss position for
longer than six months as of December 31, 2002 primarily consisted of corporate
securities in the technology and communications and utilities sectors as well as
asset-backed securities backed by corporate debt and aircraft lease receivables.
The technology and communications, utilities and airline sectors along with the
asset-backed securities comprised 33%, 14%, 6% and 4%, respectively, of the BIG
and equity securities that were in an unrealized loss position for greater than
six months at December 31, 2002.
<TABLE>
<CAPTION>
UNREALIZED LOSS AGING AT DECEMBER 31, 2001
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL SECURITIES BIG AND EQUITY SECURITIES
------------------------------------------ -----------------------------------------
AMORTIZED UNREALIZED AMORTIZED UNREALIZED
COST FAIR VALUE LOSS COST FAIR VALUE LOSS
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Three months or less $ 1,879 $ 1,829 $ (50) $ 182 $ 164 $ (18)
Greater than three months to six months 261 218 (43) 140 103 (37)
Greater than six months to nine months 89 74 (15) 57 46 (11)
Greater than nine months to twelve months 853 784 (69) 343 286 (57)
Greater than twelve months 311 264 (47) 72 49 (23)
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 3,393 $ 3,169 $(224) $ 794 $ 648 $ (146)
====================================================================================================================================
</TABLE>
The total securities that were in an unrealized loss position for longer than
six months as of December 31, 2001 primarily consisted of corporate and
asset-backed securities. The significant corporate security industry sectors of
communications and technology, utilities and banking and financial services
comprised 31%, 16% and 8%, respectively, of the greater than six months
unrealized loss amount. Asset-backed securities comprised 14% of the greater
than six month unrealized loss amount and included securities backed by
corporate debt and manufactured housing receivables. The Company held no
securities of a single issuer that were at an unrealized loss in excess of 3% of
total unrealized losses at December 31, 2002.
The BIG and equity securities that were in an unrealized loss position for
longer than six months as of December 31, 2001 primarily consisted of corporate
securities in the utilities and technology and communications sectors as well as
asset-backed securities backed by manufactured housing receivables, corporate
debt and equipment lease receivables. The technology and communications,
asset-backed, utilities and banking and financial services sector securities
comprised 41%, 11%, 18% and 8%, respectively, of the BIG and equity securities
that were in an unrealized loss position for greater than six months at December
31, 2001. As part of the Company's ongoing monitoring process by a committee of
investment and accounting professionals, the Company has reviewed these
securities and concluded that there were no additional other than temporary
impairments as of December 31, 2002 and 2001. Due to the issuers' continued
satisfaction of the securities' obligations in accordance with their contractual
terms and their continued expectation to do so, as well as the evaluation of the
fundamentals of the issuers' financial condition, the Company believes that the
prices of the securities in the sectors identified above, were temporarily
depressed primarily as a result of a market dislocation and generally poor
cyclical economic conditions and sentiment. (See the Critical Accounting
Estimates section in the MD&A for the factors considered in evaluating other
than temporary impairments.)
The evaluation for other than temporary impairments is a quantitative and
qualitative process, which is subject to risks and uncertainties in the
determination of whether declines in the fair value of investments are other
than temporary. The risks and uncertainties include changes in general economic
conditions, the issuer's financial condition or near term recovery prospects and
the effects of changes in interest rates. In addition, for securitized financial
assets with contractual cash flows (e.g. asset-backed securities), projections
of expected
- 53 -
<PAGE>
future cash flows may change based upon new information regarding the
performance of the underlying collateral pools.
MARKET RISK
The Hartford has material exposure to both interest rate and equity market risk.
The Company analyzes interest rate risk using various models including
multi-scenario cash flow projection models that forecast cash flows of the
liabilities and their supporting investments, including derivative instruments.
The Hartford has several objectives in managing market risk associated with Life
and Property & Casualty. Life is responsible for maximizing after-tax returns
within acceptable risk parameters, including the management of the interest rate
sensitivity of invested assets and the generation of sufficient liquidity to
that of corporate and policyholder obligations. Life's fixed maturity portfolios
have material market exposure to interest rate risk. Property & Casualty
attempts to maximize economic value while generating appropriate after-tax
income and sufficient liquidity to meet corporate and policyholder obligations.
Property & Casualty has material exposure to interest rate and equity market
risk. The Company continually monitors these exposures and makes portfolio
adjustments to manage these risks within established limits.
Downward movement in market interest rates during 2002 resulted in a significant
increase in the unrealized appreciation of the fixed maturity security portfolio
from 2001. However, The Hartford's asset allocation and its exposure to market
risk as of December 31, 2002 have not changed materially from its position at
December 31, 2001.
The Company is subject to the risk of a change in financial condition due to the
effect of interest rate and equity market fluctuations on the calculation of the
Company's minimum pension liabilities. As discussed in the Capital Resources and
Liquidity section, in the fourth quarter 2002, the Company recorded a minimum
pension liability charge directly to stockholders' equity of $364, after-tax.
DERIVATIVE INSTRUMENTS
The Hartford utilizes a variety of derivative instruments, including swaps,
caps, floors, forwards and exchange traded futures and options, in compliance
with Company policy and regulatory requirements in order to achieve one of four
Company approved objectives: to hedge risk arising from interest rate, price or
currency exchange rate volatility; to manage liquidity; to control transaction
costs; or to enter into income enhancement and replication transactions.
Interest rate swaps involve the periodic exchange of payments with other
parties, at specified intervals, calculated using the agreed upon rates and
notional principal amounts. Generally, no cash or principal payments are
exchanged at the inception of the contract. Typically, at the time a swap is
entered into, the cash flow streams exchanged by the counterparties are equal in
value.
Foreign currency swaps exchange an initial principal amount in two currencies,
agreeing to re-exchange the currencies at a future date, at an agreed exchange
rate. There is also periodic exchange of payments at specified intervals
calculated using the agreed upon rates and exchanged principal amounts.
Interest rate cap and floor contracts entitle the purchaser to receive from the
issuer at specified dates, the amount, if any, by which a specified market rate
exceeds the cap strike rate or falls below the floor strike rate, applied to a
notional principal amount. A premium payment is made by the purchaser of the
contract at its inception, and no principal payments are exchanged.
Forward contracts are customized commitments to either purchase or sell
designated financial instruments, at a future date, for a specified price and
may be settled in cash or through delivery of the underlying instrument.
Financial futures are standardized commitments to either purchase or sell
designated financial instruments, at a future date, for a specified price and
may be settled in cash or through delivery of the underlying instrument. Futures
contracts trade on organized exchanges. Margin requirements for futures are met
by pledging securities, and changes in the futures' contract values are settled
daily in cash.
Option contracts grant the purchaser, for a premium payment, the right to either
purchase from or sell to the issuer a financial instrument at a specified price,
within a specified period or on a stated date.
Derivative activities are monitored by an internal compliance unit, reviewed
frequently by senior management and reported to the Finance Committee of the
Board of Directors. The notional amounts of derivative contracts represent the
basis upon which pay or receive amounts are calculated and are not reflective of
credit risk. Notional amounts pertaining to derivative instruments used in the
management of market risk for both general and guaranteed separate accounts at
December 31, 2002 and 2001 totaled $13.2 billion and $10.5 billion,
respectively.
The following discussions focus on the key market risk exposures within Life and
Property & Casualty.
LIFE
Interest Rate Risk
- ------------------
Life's general account and guaranteed separate account exposure to interest rate
risk relates to the market price and/or cash flow variability associated with
changes in market interest rates. Changes in interest rates can potentially
impact Life's profitability. In certain scenarios where interest rates are
volatile, Life could be exposed to disintermediation risk and reduction in net
interest rate spread or profit margins.
Life's general account and guaranteed separate account investment portfolios
primarily consist of investment grade, fixed maturity securities, including
corporate bonds, asset-backed securities, commercial mortgage-backed securities,
tax-exempt municipal securities and collateralized mortgage obligations. The
fair value of these and Life'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. 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
- 54 -
<PAGE>
declines, exposing the Company to the possibility of asset/liability cash flow
and yield mismatch. (For further discussion of the Company's risk management
techniques to manage this market risk, see the "Asset and Liability Management
Strategies Used to Manage Market Risk" discussed below.)
As described above, Life holds a significant fixed maturity portfolio that
includes both fixed and variable rate securities. The following table reflects
the principal amounts of Life's general and guaranteed separate accounts fixed
and variable rate fixed maturity portfolios, along with the respective weighted
average coupons by estimated maturity year at December 31, 2002. Comparative
totals are included as of December 31, 2001. Expected maturities differ from
contractual maturities due to call or prepayment provisions. The weighted
average coupon ("WAC") on variable rate securities is based on spot rates as of
December 31, 2002 and 2001, and is primarily based on 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 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 Life investment portfolio.
<TABLE>
<CAPTION>
2002 2001
2003 2004 2005 2006 2007 THEREAFTER TOTAL TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
CALLABLE BONDS
Fixed Rate
Par value $ 11 $ 25 $ 123 $ 24 $ 24 $ 3,304 $ 3,511 $ 2,924
WAC 6.6% 7.2% 4.6% 7.6% 8.1% 4.0% 4.1% 4.0%
Fair value $ 3,187 $ 2,445
Variable Rate
Par value $ 1 $ 6 $ 25 $ 9 $ 6 $ 834 $ 881 $ 1,065
WAC 3.7% 2.5% 3.0% 3.3% 4.0% 3.0% 3.0% 3.4%
Fair value $ 804 $ 972
- ------------------------------------------------------------------------------------------------------------------------------------
BONDS - OTHER
Fixed Rate
Par value $ 2,691 $ 1,397 $ 1,889 $ 2,026 $ 1,725 $ 10,859 $ 20,587 $ 18,245
WAC 5.7% 6.0% 7.2% 6.4% 6.4% 6.4% 6.4% 6.2%
Fair value $ 20,990 $ 17,424
Variable Rate
Par value $ 273 $ 66 $ 259 $ 113 $ 13 $ 355 $ 1,079 $ 1,047
WAC 3.1% 3.1% 4.1% 2.1% 7.2% 3.6% 3.5% 4.9%
Fair value $ 952 $ 947
- ------------------------------------------------------------------------------------------------------------------------------------
ASSET-BACKED SECURITIES
Fixed Rate
Par value $ 371 $ 461 $ 541 $ 255 $ 137 $ 718 $ 2,483 $ 2,252
WAC 6.8% 6.3% 5.7% 6.1% 6.2% 7.1% 6.4% 6.9%
Fair value $ 2,458 $ 2,234
Variable Rate
Par value $ 162 $ 314 $ 369 $ 378 $ 361 $ 1,494 $ 3,078 $ 2,396
WAC 2.1% 2.2% 2.3% 2.3% 2.4% 2.4% 2.3% 2.8%
Fair value $ 2,884 $ 2,333
- ------------------------------------------------------------------------------------------------------------------------------------
COLLATERALIZED MORTGAGE OBLIGATIONS
Fixed Rate
Par value $ 108 $ 95 $ 77 $ 71 $ 63 $ 365 $ 779 $ 968
WAC 6.3% 6.2% 6.2% 6.2% 6.2% 6.3% 6.3% 6.3%
Fair value $ 813 $ 960
Variable Rate
Par value $ 10 $ 13 $ 10 $ 7 $ 5 $ 46 $ 91 $ 15
WAC 2.4% 2.5% 2.7% 3.0% 3.1% 2.3% 2.5% 6.9%
Fair value $ 90 $ 16
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
- 55 -
<PAGE>
<TABLE>
<CAPTION>
2002 2001
2003 2004 2005 2006 2007 THEREAFTER TOTAL TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
COMMERCIAL MORTGAGE-BACKED SECURITIES
Fixed Rate
Par value $ 68 $ 112 $ 114 $ 243 $ 436 $ 3,073 $ 4,046 $ 3,018
WAC 6.2% 6.6% 6.5% 7.0% 6.9% 6.7% 6.7% 7.1%
Fair value $ 4,494 $ 3,123
Variable Rate
Par value $ 179 $ 169 $ 109 $ 84 $ 130 $ 745 $ 1,416 $ 1,501
WAC 3.5% 3.3% 4.2% 6.9% 5.5% 7.2% 5.9% 5.8%
Fair value $ 1,494 $ 1,498
- ------------------------------------------------------------------------------------------------------------------------------------
MORTGAGE-BACKED SECURITIES
Fixed Rate
Par value $ 303 $ 356 $ 289 $ 197 $ 141 $ 867 $ 2,153 $ 1,168
WAC 6.7% 6.7% 6.6% 6.6% 6.6% 6.6% 6.6% 6.8%
Fair value $ 2,260 $ 1,189
Variable Rate
Par value $ 2 $ 5 $ 5 $ 5 $ 4 $ 15 $ 36 $ 2
WAC 2.5% 2.4% 2.4% 2.4% 2.4% 2.4% 2.4% 5.4%
Fair value $ 36 $ 2
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
The table below provides information as of December 31, 2002 on debt obligations
and trust preferred securities and reflects principal cash flows and related
weighted average interest rates by maturity year. Comparative totals are
included as of December 31, 2001.
<TABLE>
<CAPTION>
2002 2001
2003 2004 2005 2006 2007 THEREAFTER TOTAL TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
LONG-TERM DEBT
Fixed Rate
Amount $ -- $ 200 $ -- $ -- $ 200 $ 725 $ 1,125 $ 1,050
Weighted average interest rate -- 6.9% -- -- 7.1% 7.1% 7.1% 7.3%
Fair value $ 1,217 $ 1,118
TRUST PREFERRED SECURITIES [1]
Fixed Rate
Amount $ -- $ -- $ -- $ -- $ -- $ 450 $ 450 $ 450
Weighted average interest rate -- -- -- -- -- 7.4% 7.4% 7.4%
Fair value $ 464 $ 461
====================================================================================================================================
<FN>
[1] Represents Company Obligated Mandatorily Redeemable Preferred Securities of
Subsidiary Trusts Holding Solely Junior Subordinated Debentures.
</FN>
</TABLE>
Asset and Liability Management Strategies Used to Manage Market Risk
- ---------------------------------------------------------------------
Life employs several risk management tools to quantify and manage market risk
arising from their investments and interest sensitive liabilities. For certain
portfolios, management monitors the changes in present value between assets and
liabilities resulting from various interest rate scenarios using integrated
asset/liability measurement systems and a proprietary system that simulates the
impacts of parallel and non-parallel yield curve shifts. Based on this current
and prospective information, management implements risk reducing techniques to
improve the match between assets and liabilities.
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.
Life 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. At December 31, 2002, notional amounts pertaining to
derivatives totaled $10.0 billion ($8.3 billion related to insurance investments
and $1.7 billion related to life insurance liabilities). Notional amounts
pertaining to derivatives totaled $9.3 billion at December 31, 2001 ($7.6
billion related to insurance investments and $1.7 billion related to life
insurance liabilities).
The economic objectives and strategies for which the Company utilizes
derivatives are categorized as follows:
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 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
(purchase) in interest rate futures or entering into an interest rate swap with
duration
- 56 -
<PAGE>
characteristics equivalent to the associated liabilities or anticipated
investments. The notional amounts of anticipatory hedges as of December 31, 2002
and 2001 were $265 and $320, respectively.
Liability Hedging -- Several products obligate the Company to credit a return to
the contract holder which is indexed to a market rate. To hedge risks associated
with these products, the Company enters into various derivative contracts.
Interest rate swaps are used to convert the contract rate into a rate that
trades in a more liquid and efficient market. This hedging strategy enables the
Company to customize contract terms and conditions to customer objectives and
satisfies the operation's asset/liability matching policy. In addition, interest
rate swaps are used to convert certain variable contract rates to different
variable rates, thereby allowing them to be appropriately matched against
variable rate assets. Finally, interest rate caps and option contracts are used
to hedge against the risk of contract holder disintermediation in a rising
interest rate environment. The notional amounts of derivatives used for
liability hedging as of December 31, 2002 and 2001 were $1.7 billion.
Asset Hedging -- To meet the various policyholder obligations and to provide
cost-effective, prudent investment risk diversification, the Company may combine
two or more financial instruments to achieve the investment characteristics of a
fixed maturity security or that match an associated liability. The use of
derivative instruments in this regard effectively transfers unwanted investment
risks or attributes to others. The selection of the appropriate derivative
instruments depends on the investment risk, the liquidity and efficiency of the
market and the asset and liability characteristics. The notional amounts of
asset hedges as of December 31, 2002 and 2001 were $7.2 billion and $6.2
billion, respectively.
Portfolio Hedging -- The Company periodically compares the duration and
convexity of its portfolios of assets to its corresponding liabilities and
enters into portfolio hedges to reduce any difference to desired levels.
Portfolio hedges reduce the duration and convexity mismatch between assets and
liabilities and offset the potential impact to cash flows caused by changes in
interest rates. The notional amounts of portfolio hedges as of December 31, 2002
and 2001 were $910 and $1.1 billion, respectively.
The following tables provide information as of December 31, 2002 with
comparative totals for December 31, 2001 on derivative instruments used in
accordance with the aforementioned hedging strategies. For interest rate swaps,
caps and floors, the tables present notional amounts with weighted average pay
and receive rates for swaps and weighted average strike rates for caps and
floors by maturity year. For interest rate futures, the table presents contract
amount and weighted average settlement price by expected maturity year. For
option contracts, the table presents contract amount by expected maturity year.
<TABLE>
<CAPTION>
2002 2001
INTEREST RATE SWAPS [1] 2003 2004 2005 2006 2007 THEREAFTER TOTAL TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Pay Fixed/Receive Variable
Notional value $ 295 $ 85 $ 126 $ 36 $ 140 $ 491 $ 1,173 $ 937
Weighted average pay rate 4.2% 3.5% 7.5% 6.7% 5.1% 6.7% 5.7% 6.5%
Weighted average receive rate 1.5% 1.4% 1.5% 1.8% 1.4% 1.6% 1.6% 2.2%
Fair value $ (132) $ (68)
Pay Variable/Receive Fixed
Notional value $ 473 $ 1,369 $ 1,045 $ 739 $ 664 $ 1,583 $ 5,873 $ 5,045
Weighted average pay rate 1.4% 1.6% 1.5% 1.5% 1.5% 1.5% 1.5% 2.1%
Weighted average receive rate 5.6% 5.5% 5.7% 5.5% 5.2% 5.3% 5.5% 5.8%
Fair value $ 514 $ 193
Pay Variable/Receive Different Variable
Notional value $ 2 $ 141 $ 11 $ -- $ 50 $ -- $ 204 $ 159
Weighted average pay rate 1.7% 2.4% 3.7% -- 1.4% -- 2.2% 3.2%
Weighted average receive rate [2] 1.4% 2.8% (11.0)% -- 2.6% -- 2.0% 4.4%
Fair value $ 2 $ 1
====================================================================================================================================
<FN>
[1] Swap agreements in which the Company assumes credit exposure from a single
entity, referenced index or asset pool are not included above, rather they
are included in the credit risk discussion. At December 31, 2002 and 2001,
these swaps had a notional value of $497 and $230, respectively, and a fair
value of $(41) and $(51), respectively. Also, swap agreements that reduce
foreign currency exposure in certain fixed maturity investments are not
included above, rather they are included in the foreign currency risk
discussion. At December 31, 2002 and 2001, these swaps had a notional value
of $794 and $435, respectively, and a fair value of $(67) and $6,
respectively.
[2] Negative weighted average receive rate in 2005 results when payments are
required on both sides of an index swap.
</FN>
</TABLE>
- 57 -
<PAGE>
<TABLE>
<CAPTION>
2002 2001
INTEREST RATE CAPS - LIBOR BASED 2003 2004 2005 2006 2007 THEREAFTER TOTAL TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Purchased
Notional value $ 54 $ -- $ 77 $ -- $ 30 $ -- $ 161 $ 171
Weighted average strike rate (8.0 - 9.9%) 8.5% -- 8.4% -- 8.3% -- 8.4% 8.5%
Fair value $ -- $ 1
Notional value $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ 19
Weighted average strike rate (10.1%) -- -- -- -- -- -- -- 10.1%
Fair value $ -- $ --
====================================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
2002 2001
INTEREST RATE CAPS - CMT BASED [1] 2003 2004 2005 2006 2007 THEREAFTER TOTAL TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Purchased
Notional value $ 250 $ -- $ 250 $ -- $ -- $ -- $ 500 $ 500
Weighted average strike rate (8.7%) 8.7% -- 8.7% -- -- -- 8.7% 8.7%
Fair value $ -- $ 3
====================================================================================================================================
<FN>
[1] CMT represents the Constant Maturity Treasury Rate.
</FN>
</TABLE>
<TABLE>
<CAPTION>
2002 2001
INTEREST RATE FLOORS - LIBOR BASED 2003 2004 2005 2006 2007 THEREAFTER TOTAL TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Purchased
Notional value $ -- $ 27 $ -- $ -- $ -- $ -- $ 27 $ 27
Weighted average strike rate (7.9%) -- 7.9% -- -- -- -- 7.9% 7.9%
Fair value $ 3 $ 3
Issued
Notional value $ 54 $ 34 $ 77 $ -- $ -- $ -- $ 165 $ 193
Weighted average strike rate (4.0 - 5.9%) 5.4% 5.3% 5.3% -- -- -- 5.3% 5.3%
Fair value $ (9) $ (8)
Notional value $ -- $ 27 $ -- $ -- $ -- $ -- $ 27 $ 27
Weighted average strike rate (7.8%) -- 7.8% -- -- -- -- 7.8% 7.8%
Fair value $ (3) $ (3)
====================================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
2002 2001
INTEREST RATE FLOORS - CMT BASED [1] 2003 2004 2005 2006 2007 THEREAFTER TOTAL TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Purchased
Notional value $ 150 $ -- $ -- $ -- $ -- $ -- $ 150 $ 150
Weighted average strike rate (5.5%) 5.5% -- -- -- -- -- 5.5% 5.5%
Fair value $ 1 $ 5
====================================================================================================================================
<FN>
[1] CMT represents the Constant Maturity Treasury Rate.
</FN>
</TABLE>
<TABLE>
<CAPTION>
2002 2001
INTEREST RATE FUTURES 2003 2004 2005 2006 2007 THEREAFTER TOTAL TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Long
Contract amount/notional $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ 266
Weighted average settlement price $ -- $ -- $ -- $ -- $ -- $ -- $ -- $ 105
Short
Contract amount/notional $ 11 $ -- $ -- $ -- $ -- $ -- $ 11 $ 25
Weighted average settlement price $ 114 $ -- $ -- $ -- $ -- $ -- $ 114 $ 105
====================================================================================================================================
</TABLE>
<TABLE>
<CAPTION>
2002 2001
OPTION CONTRACTS 2003 2004 2005 2006 2007 THEREAFTER TOTAL TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Long
Contract amount/notional $ 83 $ 88 $ 45 $ 324 $ 32 $ 78 $ 650 $ 723
Fair value $ 18 $ 28
Short
Contract amount/notional $ 172 $ 457 $ 189 $ 225 $ 25 $ 30 $ 1,098 $ 1,056
Fair value $ (37) $ (61)
====================================================================================================================================
</TABLE>
- 58 -
<PAGE>
Currency Exchange Risk
- ----------------------
Currency exchange risk exists with respect to investments in non-US dollar
denominated securities. The fair value of these fixed maturity securities at
December 31, 2002 and 2001 was $1.2 billion and $494, respectively. In order to
manage a portion of these currency exposures, the Company enters into foreign
currency swaps to hedge the variability in cash flow associated with certain
foreign denominated securities. These foreign currency swap agreements are
structured to match the foreign currency cash flows of the hedged foreign
denominated securities. At December 31, 2002 and 2001, the foreign currency
swaps had a notional value of $794 and $435, respectively, and fair value of
$(67) and $6, respectively. In the fourth quarter of 2002, the Company entered
into a costless collar strategy to temporarily mitigate a portion of its
residual currency risk in foreign denominated securities. Accordingly, the
Company purchased foreign put options and wrote foreign call options expiring in
January 2003. At December 31, 2002 the foreign put and call options had a
notional value of $469 and fair value of $(3). The Company had no foreign put or
call options at December 31, 2001.
Life Product Liability Characteristics
- --------------------------------------
Life's product liabilities, other than non-guaranteed separate accounts, include
accumulation vehicles such as fixed and variable annuities, other investment and
universal life-type contracts and other insurance products such as long-term
disability and term life insurance.
Asset Accumulation Vehicles
While interest rate risk associated with these insurance products has been
reduced through the use of market value adjustment features and surrender
charges, the primary risk associated with these products is that the spread
between investment return and credited rate may not be sufficient to earn
targeted returns.
Fixed Rate -- Products in this category require the payment of a fixed rate for
a certain period of time. The cash flows are not interest sensitive because the
products are written with a market value adjustment feature and the liabilities
have protection against the early withdrawal of funds through surrender charges.
Product examples include fixed rate annuities with a market value adjustment and
fixed rate guaranteed investment contracts. Contract duration is dependent on
the policyholder's choice of guarantee period.
Indexed -- Products in this category are similar to the fixed rate asset
accumulation vehicles but require the life operations to pay a rate that is
determined by an external index. The amount and/or timing of cash flows will
therefore vary based on the level of the particular index. The primary risks
inherent in these products are similar to the fixed rate asset accumulation
vehicles, with the additional risk that changes in the index may adversely
affect profitability. Product examples include indexed-guaranteed investment
contracts with an estimated duration of up to two years.
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 Life's variable annuity products. Liability duration is short- to
intermediate-term.
Other Insurance Products
Long-term Pay Out Liabilities -- Products in this category are long-term in
nature and may contain significant actuarial (including mortality and morbidity)
pricing and cash flow risks. The cash flows associated with these policy
liabilities are not interest rate sensitive but do vary based on the timing and
amount of benefit payments. The primary risks associated with these products are
that the benefits will exceed expected actuarial pricing and/or that the actual
timing of the cash flows differ from those anticipated, resulting in an
investment return lower than that assumed in pricing. Product examples include
structured settlement contracts, on-benefit annuities (i.e., the annuitant is
currently receiving benefits thereon) and long-term disability contracts.
Contract duration is generally five to ten years.
Short-term Pay Out Liabilities -- These liabilities are short-term in nature
with a duration of less than one year. The primary risks associated with these
products are determined by the non-investment contingencies such as mortality or
morbidity and the variability in the timing of the expected cash flows.
Liquidity is of greater concern than for the long-term pay out liabilities.
Products include individual and group term life insurance contracts and
short-term disability contracts.
Management of the duration of investments with respective policyholder
obligations is an explicit objective of Life's management strategy. The
estimated cash flows of insurance policy liabilities based upon internal
actuarial assumptions as of December 31, 2002 are reflected in the table below
by expected maturity year. Comparative totals are included for December 31,
2001.
- 59 -
<PAGE>
<TABLE>
<CAPTION>
(dollars in billions)
2002 2001
DESCRIPTION [1] 2003 2004 2005 2006 2007 THEREAFTER TOTAL TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Fixed rate asset accumulation vehicles $ 1.7 $ 3.0 $ 2.6 $ 2.0 $ 1.9 $ 2.4 $ 13.6 $ 15.8
Weighted average credited rate 6.0% 6.0% 5.9% 5.6% 5.5% 5.7% 5.8% 5.9%
Indexed asset accumulation vehicles $ 0.6 $ 0.1 $ -- $ -- $ -- $ -- $ 0.7 $ 0.8
Weighted average credited rate 3.0% 3.0% -- -- -- -- 3.0% 6.5%
Interest credited asset accumulation vehicles $ 3.3 $ 3.3 $ 3.2 $ 0.5 $ 0.5 $ 5.2 $ 16.0 $ 8.1
Weighted average credited rate 3.9% 3.9% 3.8% 4.8% 4.8% 4.8% 4.2% 5.7%
Long-term pay out liabilities $ 1.0 $ 0.8 $ 0.7 $ 0.5 $ 0.5 $ 5.6 $ 9.1 $ 8.6
Short-term pay out liabilities $ 0.9 $ 0.1 $ -- $ -- $ -- $ -- $ 1.0 $ 1.0
====================================================================================================================================
<FN>
[1] As of December 31, 2002 and 2001, the fair values of Life's investment
contracts, including guaranteed separate accounts, were $32.4 billion and
$26.0 billion, respectively.
</FN>
</TABLE>
Sensitivity to Changes in Interest Rates
- ----------------------------------------
For liabilities whose cash flows are not substantially affected by changes in
interest rates ("fixed liabilities") and where investment experience is
substantially absorbed by Life, the sensitivity of the net economic value
(discounted present value of asset cash flows less the discounted present value
of liability cash flows) of those portfolios to 100 basis point shifts in
interest rates is shown in the following table.
Change in Net Economic Value
2002 2001
------------------------------------------
Basis point shift - 100 + 100 - 100 + 100
- -----------------------------------------------------------------
Amount $ 17 $ (51) $ 6 $ (31)
Percent of liability
value 0.08% (0.23)% 0.03% (0.16)%
=================================================================
These fixed liabilities represented about 57% and 61% of Life's general and
guaranteed separate account liabilities at December 31, 2002 and 2001,
respectively. The remaining liabilities generally allow Life significant
flexibility to adjust credited rates to reflect actual investment experience and
thereby pass through a substantial portion of actual investment experience to
the policyholder. The fixed liability portfolios are managed and monitored
relative to defined objectives, are analyzed regularly by management for
internal risk management purposes using scenario simulation techniques and are
evaluated on an annual basis, in compliance with regulatory requirements.
Equity Risk
- -----------
The Company's Life operations are significantly influenced by changes in the
equity markets. Life's profitability depends largely on the amount of assets
under management, which is primarily driven by the level of sales, equity market
appreciation and depreciation and the persistency of the in-force block of
business. A prolonged and precipitous decline in the equity markets, as has been
experienced of late, can have a significant impact on the Company's operations,
as sales of variable products may decline and surrender activity may increase,
as customer sentiment towards the equity market turns negative. The lower assets
under management will have a negative impact on the Company's financial results,
primarily due to lower fee income related to the Investment Products and
Individual Life segments, where a heavy concentration of equity linked products
are administered and sold. Furthermore, the Company may experience a reduction
in profit margins if a significant portion of the assets held in the variable
annuity separate accounts move to the general account and the Company is unable
to earn an acceptable investment spread, particularly in light of the low
interest rate environment and the presence of contractually guaranteed minimum
interest credited rates, which for the most part are at a 3% rate.
In addition, prolonged declines in the equity market may also decrease the
Company's expectations of future gross profits, which are utilized to determine
the amount of DAC to be amortized in a given financial statement period. A
significant decrease in the Company's estimated gross profits would require the
Company to accelerate the amount of DAC amortization in a given period,
potentially causing a material adverse deviation in that period's net income.
Although an acceleration of DAC amortization would have a negative impact on the
Company's earnings, it would not affect the Company's cash flow or liquidity
position.
Additionally, the Investment Products segment sells variable annuity contracts
that offer various guaranteed death benefits. For certain guaranteed death
benefits, The Hartford pays the greater of (1) the account value at death; (2)
the sum of all premium payments less prior withdrawals; or (3) the maximum
anniversary value of the contract, plus any premium payments since the contract
anniversary, minus any withdrawals following the contract anniversary. The
Company currently reinsures a significant portion of these death benefit
guarantees associated with its in-force block of business. The Company currently
records the death benefit costs, net of reinsurance, as they are incurred.
Declines in the equity market may increase the Company's net exposure to death
benefits under these contracts.
The Company's total gross exposure (i.e. before reinsurance) to these guaranteed
death benefits as of December 31, 2002 is $22.4 billion. Due to the fact that
82% of this amount is reinsured, the Company's net exposure is $4.1 billion.
This amount is often referred to as the net amount at risk. However, the Company
will only incur these guaranteed death benefit payments in the future if the
policyholder has an in-the-money guaranteed death benefit at their time of
death. In order to analyze the total costs that the Company may incur in the
future related to these guaranteed death benefits, the Company performed an
actuarial present value analysis. This analysis included developing a model
utilizing 250 stochastically generated investment performance scenarios and best
estimate assumptions related to mortality and lapse rates. A range of projected
costs was developed and discounted back to the statement date utilizing the
Company's cost of capital, which for this purpose was assumed to be 9.25%. Based
on this analysis, the Company estimated that the present value of the retained
- 60 -
<PAGE>
death benefit costs to be incurred in the future fell within a range of $86 to
$349. This range was calculated utilizing a 95% confidence interval. The median
of the 250 stochastically generated scenarios was $159.
Furthermore, the Company is involved in arbitration with one of its primary
reinsurers relating to policies with such death benefit guarantees written from
1994 to 1999. The arbitration involves alleged breaches under the reinsurance
treaties. Although the Company believes that its position in this pending
arbitration is strong, an adverse outcome could result in a decrease to the
Company's statutory surplus and capital and potentially increase the death
benefit costs incurred by the Company in the future. The arbitration hearing was
held during the fourth quarter of 2002, but no decision has been rendered.
PROPERTY & CASUALTY
Interest Rate Risk
- ------------------
The primary exposure to interest rate risk in Property & Casualty relates to its
fixed maturity investments. Changes in market interest rates directly impact the
market value of the fixed maturity securities. In addition, but to a lesser
extent, interest rate risk exists on debt and trust preferred securities issued.
Derivative instruments are used to manage interest rate risk and had a total
notional amount as of December 31, 2002 and 2001 of $1.1 billion and $797,
respectively.
The principal amounts of the fixed and variable rate fixed maturity portfolios,
along with the respective weighted average coupons by estimated maturity year at
December 31, 2002, are reflected in the following table. Comparative totals are
included as of December 31, 2001. Expected maturities differ from contractual
maturities due to call or prepayment provisions. The WAC on variable rate
securities is based on spot rates as of December 31, 2002 and 2001, and is based
primarily on LIBOR. Callable bonds and notes are primarily municipal bonds, and
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 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
contained in broker consensus data. Such estimates are derived from prepayment
speeds previously experienced at 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, as they were immaterial to Property & Casualty's
investment portfolio.
<TABLE>
<CAPTION>
2002 2001
2003 2004 2005 2006 2007 THEREAFTER TOTAL TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
CALLABLE BONDS
Fixed Rate
Par value $ 9 $ 34 $ 137 $ 225 $ 280 $ 7,029 $ 7,714 $ 7,624
WAC 5.9% 5.5% 5.5% 5.4% 5.6% 5.3% 5.3% 5.3%
Fair value $ 8,084 $ 7,660
Variable Rate
Par value $ 1 $ 2 $ 16 $ 7 $ 2 $ 226 $ 254 $ 266
WAC 5.6% 4.3% 6.6% 3.3% 4.2% 3.9% 4.1% 5.4%
Fair value $ 207 $ 214
- ------------------------------------------------------------------------------------------------------------------------------------
BONDS - OTHER
Fixed Rate
Par value $ 1,205 $ 468 $ 673 $ 774 $ 702 $ 4,111 $ 7,933 $ 6,413
WAC 4.5% 6.6% 6.9% 6.4% 6.5% 6.4% 6.3% 6.4%
Fair value $ 8,132 $ 6,297
Variable Rate
Par value $ 2 $ 52 $ 2 $ 7 $ 3 $ 106 $ 172 $ 268
WAC 3.0% 2.7% 3.1% 5.8% 5.1% 4.8% 4.2% 4.8%
Fair value $ 148 $ 231
- ------------------------------------------------------------------------------------------------------------------------------------
ASSET-BACKED SECURITIES
Fixed Rate
Par value $ 71 $ 84 $ 102 $ 80 $ 58 $ 167 $ 562 $ 570
WAC 7.0% 6.0% 6.3% 6.4% 7.0% 7.4% 6.7% 7.2%
Fair value $ 554 $ 549
Variable Rate
Par value $ 3 $ 40 $ 14 $ 21 $ 15 $ 112 $ 205 $ 191
WAC 2.7% 3.0% 2.5% 2.5% 3.3% 2.3% 2.5% 3.8%
Fair value $ 177 $ 168
- ------------------------------------------------------------------------------------------------------------------------------------
</TABLE>
- 61 -
<PAGE>
<TABLE>
<CAPTION>
2002 2001
2003 2004 2005 2006 2007 THEREAFTER TOTAL TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
COLLATERALIZED MORTGAGE OBLIGATIONS
Fixed Rate
Par value $ 15 $ 7 $ 4 $ 4 $ 2 $ 11 $ 43 $ 87
WAC 6.9% 6.8% 6.6% 6.4% 6.4% 5.1% 6.3% 6.8%
Fair value $ 43 $ 88
Variable Rate
Par value $ 2 $ 1 $ 1 $ 1 $ -- $ -- $ 5 $ 8
WAC 17.1% 16.6% 16.0% 15.5% -- -- 16.2% 15.1%
Fair value $ 6 $ 9
- ------------------------------------------------------------------------------------------------------------------------------------
COMMERCIAL MORTGAGE-BACKED SECURITIES
Fixed Rate
Par value $ 6 $ 15 $ 8 $ 34 $ 117 $ 1,005 $ 1,185 $ 707
WAC 5.9% 6.9% 6.3% 7.1% 7.0% 5.9% 6.1% 7.1%
Fair value $ 1,183 $ 728
Variable Rate
Par value $ 99 $ 48 $ 22 $ 20 $ 22 $ 154 $ 365 $ 410
WAC 3.4% 4.4% 7.0% 7.9% 6.7% 8.0% 6.2% 6.2%
Fair value $ 390 $ 417
- ------------------------------------------------------------------------------------------------------------------------------------
MORTGAGE-BACKED SECURITIES
Fixed Rate
Par value $ 69 $ 87 $ 81 $ 54 $ 40 $ 167 $ 498 $ 379
WAC 6.7% 6.6% 6.5% 6.5% 6.5% 6.5% 6.5% 6.6%
Fair value $ 522 $ 381
====================================================================================================================================
</TABLE>
The following table provides information as of December 31, 2002 on interest
rate swaps used to manage interest rate risk on fixed maturities and trust
preferred securities and presents notional amounts with weighted average pay and
receive rates by maturity year. Comparative totals are included as of December
31, 2001. The weighted average rates are based on spot rates as of December 31,
2002 and 2001.
<TABLE>
<CAPTION>
THEREAFTER 2002 2001
INTEREST RATE SWAPS [1] 2003 2004 2005 2006 2007 [2] TOTAL TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Pay Variable/Receive Fixed
Notional value $ -- $ 35 $ 15 $ -- $ -- $ 500 $ 550 $ 545
Weighted average pay rate -- 1.5% 1.4% -- -- 2.5% 2.4% 3.1%
Weighted average receive rate -- 6.7% 2.8% -- -- 7.5% 7.3% 7.4%
Fair value $ 25 $ (29)
====================================================================================================================================
<FN>
[1] Swap agreements in which the Company assumes credit exposure from a single
entity, referenced index or asset pool are not included above, rather they
are included in the Credit Risk discussion. At December 31, 2002 and 2001,
these swaps had a notional value of $548 and $456, respectively, and fair
value of $(37) and $(54), respectively.
[2] Interest rate swap agreement of $500 notional value contains an embedded
call option. See Note 1(h) in Notes to Consolidated Financial Statements.
</FN>
</TABLE>
<TABLE>
<CAPTION>
2002 2001
INTEREST RATE CAPS - LIBOR BASED 2003 2004 2005 2006 2007 THEREAFTER TOTAL TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Purchased
Notional value $ -- $ -- $ -- $ -- $ -- $ 500 $ 500 $ --
Weighted average strike rate (8.0%) -- -- -- -- -- 8.0% 8.0% --
Fair value $ 11 $ --
====================================================================================================================================
</TABLE>
Property & Casualty uses option contracts to hedge fixed maturity investments
that totaled $141 and $252 in notional value and $0 and $1 in fair value as of
December 31, 2002 and 2001, respectively.
The table below provides information as of December 31, 2002 on debt obligations
and trust preferred securities and reflects principal cash flows and related
weighted average interest rates by maturity year. Comparative totals are
included as of December 31, 2001.
- 62 -
<PAGE>
<TABLE>
<CAPTION>
2002 2001
2003 2004 2005 2006 2007 THEREAFTER TOTAL TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
SHORT-TERM DEBT
Variable Rate
Amount $ 315 $ -- $ -- $ -- $ -- $ -- $ 315 $ 599
Weighted average interest rate 1.5% -- -- -- -- -- 1.5% 4.2%
Fair value $ 315 $ 607
LONG-TERM DEBT
Fixed Rate
Amount $ -- $ -- $ -- $ -- $ 300 $ 550 $ 850 $ 400
Weighted average interest rate -- -- -- -- 4.7% 6.1% 5.6% 6.8%
Fair value $ 889 $ 401
TRUST PREFERRED SECURITIES [1]
Fixed Rate
Amount $ -- $ -- $ -- $ -- $ -- $ 1,000 $ 1,000 $ 1,000
Weighted average interest rate -- -- -- -- -- 7.6% 7.6% 7.6%
Fair value $ 1,015 $ 968
====================================================================================================================================
<FN>
[1] Represents Company Obligated Mandatorily Redeemable Preferred Securities of
Subsidiary Trusts Holding Solely Junior Subordinated Debentures.
</FN>
</TABLE>
Equities Price Risk
- -------------------
Property & Casualty holds a diversified portfolio of investments in equity
securities representing firms in various countries, industries and market
segments ranging from small market capitalization stocks to Standard & Poor's
500 stocks. The risk associated with these securities relates to potential
decreases in value resulting from changes in equity prices.
The following table reflects equity securities owned at December 31, 2002 and
2001, grouped by major market type.
<TABLE>
<CAPTION>
2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
PERCENT OF PERCENT OF
AMORTIZED TOTAL FAIR AMORTIZED TOTAL FAIR
COST FAIR VALUE VALUE COST FAIR VALUE VALUE
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
EQUITY SECURITIES
Domestic
Large cap $ 209 $ 204 44.3% $ 386 $ 393 42.7%
Midcap/small cap 221 231 50.4% 318 342 37.1%
Foreign
EAFE [1]/ Canadian 23 23 5.0% 158 184 20.0%
Emerging 1 1 0.3% 2 2 0.2%
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL $ 454 $ 459 100.0% $ 864 $ 921 100.0%
====================================================================================================================================
<FN>
[1] Europe, Australia, Far East countries index.
</FN>
</TABLE>
Currency Exchange Risk
- ----------------------
Currency exchange risk exists with respect to investments in non-US dollar
denominated securities. The fair value of these fixed maturity securities at
December 31, 2002 and 2001 was $1 billion and $649, respectively. In the fourth
quarter of 2002, the Company entered into a costless collar strategy to
temporarily mitigate a portion of its currency risk in certain foreign
denominated securities. Accordingly, the Company purchased foreign put options
and wrote foreign call options expiring in January 2003. At December 31, 2002,
the foreign put and call options had a notional value of $793 and fair value of
$(4). Forward foreign contracts with a notional amount of $7 were used to manage
currency exchange risk at December 31, 2001.
CORPORATE
Interest Rate Risk
- ------------------
The primary exposure to interest rate risk in Corporate relates to the debt
issued in connection with The HLI Repurchase.
The table below provides information as of December 31, 2002 on Corporate's debt
obligations and reflects principal cash flows and related weighted average
interest rates by maturity year.
- 63 -
<PAGE>
<TABLE>
<CAPTION>
2002 2001
2003 2004 2005 2006 2007 THEREAFTER TOTAL TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
LONG-TERM DEBT
Fixed Rate
Amount $ -- $ -- $ 250 $ -- $ -- $ 380 $ 630 $ 525
Weighted average interest rate -- -- 7.8% -- -- 6.9% 7.2% 7.8%
Fair value $ 698 $ 563
====================================================================================================================================
</TABLE>
- --------------------------------------------------------------------------------
CAPITAL RESOURCES AND LIQUIDITY
- --------------------------------------------------------------------------------
Capital resources and liquidity represent the overall financial strength of The
Hartford and its ability to generate strong cash flows from each of the business
segments, borrow funds at competitive rates and raise new capital to meet
operating and growth needs. The capital structure of The Hartford as of December
31, 2002, 2001 and 2000 consisted of debt and equity, summarized as follows:
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
-----------------------------------------------
2002 2001 2000
- -----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Short-term debt $ 315 $ 599 $ 235
Long-term debt 2,596 1,965 1,862
Company obligated mandatorily redeemable preferred securities of subsidiary
trusts holding solely junior subordinated debentures (trust preferred 1,468 1,412 1,243
securities)
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL DEBT $ 4,379 $ 3,976 $ 3,340
------------------------------------------------------------------------------------------------------------------------------
Equity excluding accumulated other comprehensive income ("AOCI"), net of tax $ 9,640 $ 8,479 $ 7,095
AOCI, net of tax 1,094 534 369
- -----------------------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY $ 10,734 $ 9,013 $ 7,464
------------------------------------------------------------------------------------------------------------------------------
TOTAL CAPITALIZATION INCLUDING AOCI $ 15,113 $ 12,989 $ 10,804
------------------------------------------------------------------------------------------------------------------------------
TOTAL CAPITALIZATION EXCLUDING AOCI $ 14,019 $ 12,455 $ 10,435
------------------------------------------------------------------------------------------------------------------------------
Debt to equity [1] 41% 44% 45%
Debt to capitalization [1] 29% 31% 31%
===================================================================================================================================
<FN>
[1] Excluding trust preferred securities from total debt and AOCI from total
stockholders' equity and total capitalization, the debt to equity ratio was
30%, 30% and 30%, and the debt to capitalization ratio was 21%, 21% and 20%
as of December 31, 2002, 2001 and 2000, respectively.
</FN>
</TABLE>
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The following table identifies the Company's contractual obligations by payment
due period.
<TABLE>
<CAPTION>
2003 2004 2005 2006 2007 THEREAFTER TOTAL
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C>
Short-term debt $ 315 $ -- $ -- $ -- $ -- $ -- $ 315
Long-term debt -- 200 250 -- 500 1,655 2,605
Trust preferred securities -- -- -- -- -- 1,450 1,450
- ------------------------------------------------------------------------------------------------------------------------------------
Total debt $ 315 $ 200 $ 250 $ -- $ 500 $ 3,105 $ 4,370
Operating leases 134 121 108 93 78 160 694
- ------------------------------------------------------------------------------------------------------------------------------------
Total contractual obligations $ 449 $ 321 $ 358 $ 93 $ 578 $ 3,265 $ 5,064
====================================================================================================================================
</TABLE>
In addition to the contractual obligations above, The Hartford had certain
unfunded commitments at December 31, 2002 to fund limited partnership
investments totaling $396. These capital commitments can be called by the
partnerships during the commitment period (on average, 3-6 years) to fund
working capital needs or the purchase of new investments. If the commitment
period expires and the commitment has not been fully funded, The Hartford is not
required to fund the remaining unfunded commitment but may elect to do so.
CAPITALIZATION
The Hartford endeavors to maintain a capital structure that provides financial
and operational flexibility to its insurance subsidiaries, ratings that support
its competitive position in the financial services marketplace (see the Ratings
section below for further discussion), and strong shareholder returns. As a
result, the Company may from time to time raise capital from the issuance of
stock, debt or other capital securities. The issuance of common stock, debt or
other capital securities could result in the dilution of shareholder interests
or reduced net income due to additional interest expense.
During the third quarter of 2002, the Company increased its capitalization by
$649 through the issuance of $330 in common stock and $319 in equity units.
Proceeds of $300 were contributed to the property and casualty insurance
subsidiaries, proceeds of $150 were contributed to the life insurance
subsidiaries and the balance has been held for general corporate purposes, which
may include additional capital contributions to the insurance subsidiaries.
- 64 -
<PAGE>
In addition, as was the case after September 11, the Company may use the capital
markets to replace capital upon completion of its asbestos review.
During the year ended December 31, 2002, The Hartford's total capitalization
increased by $2.1 billion, while total capitalization excluding AOCI increased
by $1.6 billion. This increase was a result of 2002 net income; the
aforementioned third quarter 2002 capital raising activities; and stock issued
related to stock compensation plans. These increases were partially offset by
dividends declared.
AOCI - AOCI increased by $560 as of December 31, 2002 compared with December 31,
2001. The increase resulted primarily from the impact of decreased interest
rates on unrealized gains on the fixed maturity portfolio, the recognition of
unrealized losses on other than temporary impairments on fixed maturity and
equity securities and the net gain on cash-flow hedging instruments, partially
offset by an increase in the Company's minimum pension liability adjustment.
The funded status of the Company's pension and postretirement plans is dependent
upon many factors, including returns on invested assets and the level of market
interest rates. Recent declines in the value of securities traded in equity
markets coupled with declines in long-term interest rates have had a negative
impact on the funded status of the plans. As a result, the Company has recorded
a minimum pension liability as of December 31, 2002, which resulted in an
after-tax reduction of stockholders' equity of $383. This minimum pension
liability did not affect the Company's results of operations.
AOCI increased by $165 as of December 31, 2001 compared with December 31, 2000.
The increase resulted primarily from the impact of decreased interest rates on
unrealized gains on the fixed maturity portfolio, the recognition of unrealized
losses on other than temporary impairments on fixed maturity and equity
securities and the net gain on cash-flow hedging instruments.
For additional information on stockholders' equity, see Note 9 of Notes to
Consolidated Financial Statements.
SHELF REGISTRATION
On May 15, 2001, HLI filed with the SEC a shelf registration statement for the
potential offering and sale of up to $1.0 billion in debt and preferred
securities. The registration statement was declared effective on May 29, 2001.
As of December 31, 2002, HLI had $1.0 billion remaining on its shelf.
On November 9, 2000, The Hartford filed with the SEC a shelf registration
statement and a prospectus, as amended on May 21, 2002, for the potential
offering and sale of up to an additional $2.6 billion in debt and equity
securities. Specifically, the registration statement allows for the following
types of securities to be offered: debt securities, preferred stock, common
stock, depositary shares, warrants, stock purchase contracts, stock purchase
units and junior subordinated deferrable interest debentures of the Company,
preferred securities of any of one or more capital trusts organized by The
Hartford ("The Hartford Trusts") and guarantees by the Company with respect to
the preferred securities of any of The Hartford Trusts. As of December 31, 2002,
The Hartford had $1.3 billion remaining on the shelf.
DEBT
The following discussion describes the Company's debt financing activities. The
table below details the Company's short-term debt programs and the applicable
balances outstanding.
<TABLE>
<CAPTION>
As of December 31,
-----------------------------
Description Effective Date Expiration Date Maximum Available 2002 2001
- ------------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Commercial Paper
The Hartford 11/10/86 N/A $ 2,000 $ 315 $ 299
HLI 2/7/97 N/A 250 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total commercial paper $ 2,250 $ 315 $ 299
Revolving Credit Facility
5-year revolving credit facility 6/20/01 6/20/06 $ 1,000 $ -- $ --
3-year revolving credit facility 12/31/02 12/31/05 490 -- --
- ------------------------------------------------------------------------------------------------------------------------------------
Total revolving credit facility $ 1,490 $ -- $ --
- ------------------------------------------------------------------------------------------------------------------------------------
TOTAL SHORT-TERM DEBT $ 3,740 $ 315 $ 299
====================================================================================================================================
</TABLE>
The Hartford has a commercial paper program which allows the Company to borrow
up to a maximum amount of $2.0 billion in short-term commercial paper notes. As
of December 31, 2002, the Company had $315 of outstanding borrowings under the
program.
On December 31, 2002, the Company and HLI entered into a joint three-year $490
competitive advance and revolving credit facility comprised of 12 participating
banks, and HLI's previous revolving credit facility was terminated. As of
December 31, 2002, there were no outstanding borrowings under the facility.
On September 13, 2002, The Hartford issued 6.6 million 6% equity units at a
price of $50.00 per unit and received net proceeds of $319. The Hartford
contributed $150 of the net proceeds to its property and casualty insurance
subsidiaries and $75 of the net proceeds to its life insurance subsidiaries. The
remaining balance of the net proceeds is for general corporate purposes, which
may include additional capital contributions to subsidiaries.
Each equity unit offered initially consists of a corporate unit with a stated
amount of $50.00. Each corporate unit consists of one purchase contract for the
sale of a certain number of shares of the Company's stock and $50.00 principal
amount of senior notes due November 16, 2008.
The corporate unit may be converted by the holder into a treasury unit
consisting of the purchase contract and a 5% undivided beneficial interest in a
zero-coupon U.S. Treasury
- 65 -
<PAGE>
security with a principal amount of one-thousand dollars that matures on
November 15, 2006. The holder of an equity unit owns the underlying senior notes
or treasury portfolio but has pledged the senior notes or treasury portfolio to
the Company to secure the holder's obligations under the purchase contract.
The purchase contract obligates the holder to purchase, and obligates The
Hartford to sell, on November 16, 2006, for $50.00, a variable number of newly
issued common shares of The Hartford. The number of The Hartford's shares to be
issued will be determined at the time the purchase contracts are settled based
upon the then current price of The Hartford's common stock. If the price of The
Hartford's common stock is equal to or less than $47.25, then the Company will
deliver 1.0582 shares to the holder of the equity unit. If the price of The
Hartford's common stock is greater than $47.25 but less than $57.645, then the
Company will deliver a fraction of shares equal to $50.00 divided by the then
current price of The Hartford's common stock. Finally, if the price of The
Hartford's common stock is equal to or greater than $57.645, then the Company
will deliver 0.8674 shares to the holder. Accordingly, upon settlement of the
purchase contracts on November 16, 2006, The Hartford will receive proceeds of
approximately $330 and will deliver between 5.7 million and 7.0 million common
shares in the aggregate. The proceeds will be credited to stockholders' equity
and allocated between the common stock and additional paid-in-capital accounts.
The Hartford will make quarterly contract adjustment payments to the equity unit
holders at a rate of 1.90% of the stated amount per year until the purchase
contract is settled.
Each corporate unit also includes $50.00 principal amount of senior notes that
will mature on November 16, 2008. The notes are pledged by the holders to secure
their obligations under the purchase contracts. The Hartford will make quarterly
interest payments to the holders of the notes initially at an annual rate of
4.10%. On August 11, 2006, the notes will be remarketed. At that time, The
Hartford's remarketing agent will have the ability to reset the interest rate on
the notes in order to generate sufficient remarketing proceeds to satisfy the
holder's obligation under the purchase contract. In the event of an unsuccessful
remarketing, the Company will exercise its rights as a secured party to obtain
and extinguish the notes.
The total distributions payable on the equity units are at an annual rate of
6.0%, consisting of interest (4.10%) and contract adjustment payments (1.90%).
The corporate units are listed on the New York Stock Exchange under the symbol
"HIG PrA".
The present value of the contract adjustment payments of $23 was accrued upon
the issuance of the equity units as a charge to additional paid-in capital and
is included in other liabilities in the accompanying consolidated balance sheet
as of December 31, 2002. Subsequent contract adjustment payments will be
allocated between this liability account and interest expense based on a
constant rate calculation over the life of the transaction. Additional paid-in
capital as of December 31, 2002 reflected a charge of approximately $9
representing a portion of the equity unit issuance costs that were allocated to
the purchase contracts.
The equity units have been reflected in the diluted earnings per share
calculation using the treasury stock method, which would be used for the equity
units at any time before the issuance of shares of The Hartford's common stock
upon settlement of the purchase contracts. Under the treasury stock method, the
number of shares of common stock used in calculating diluted earnings per share
is increased by the excess, if any, of the number of shares issuable upon
settlement of the purchase contracts over the number of shares that could be
purchased by The Hartford in the market, at the average market price during the
period, using the proceeds received upon settlement. The Company anticipates
that there will be no dilutive effect on its earnings per share related to the
equity units, except during periods when the average market price of a share of
the Company's common stock is above the threshold appreciation price of $57.645.
Because the average market price of The Hartford's common stock during the
period from date of issuance through December 31, 2002 was below this threshold
appreciation price, the shares issuable under the purchase contract component of
the equity units have not been included in the diluted earnings per share
calculation for the period.
On August 29, 2002, The Hartford issued 4.7% senior notes due September 1, 2007
and received proceeds before underwriting expenses of $300. Interest on the
notes is payable semi-annually on March 1 and September 1, commencing on March
1, 2003. The Company used the proceeds to repay $300 of 6.375% senior notes that
matured on November 1, 2002.
In March 2002, the Company borrowed $16 of short-term commercial notes for
general corporate purposes.
Effective June 20, 2001, The Hartford entered into an amended and restated
five-year revolving $1.0 billion credit facility with fourteen banks. This
facility is available for general corporate purposes and to provide additional
support to the Company's commercial paper program. As of December 31, 2002,
there were no outstanding borrowings under the facility.
On December 1, 2001, The Hartford's 8.3% medium term notes became due. The
Company borrowed $200 under its commercial paper program to retire the debt.
On March 1, 2001, HLI issued and sold $400 of senior debt securities to
partially finance the Fortis acquisition.
For additional information regarding debt, see Note 8 of Notes to Consolidated
Financial Statements.
COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY
TRUSTS HOLDING SOLELY JUNIOR SUBORDINATED DEBENTURES (TRUST PREFERRED
SECURITIES)
On December 31, 2001, The Hartford redeemed its 20,000,000 Series B, 8.35%
Cumulative Quarterly Income Preferred Securities due October 30, 2026 for $500.
The Company used proceeds from its October 26, 2001 issuance of 7.45% Trust
Originated Preferred Securities, Series C to redeem the securities.
On October 26, 2001, Hartford Capital III, a Delaware statutory business trust
formed by The Hartford, issued 20,000,000 7.45% Trust Originated Preferred
Securities, Series C and received proceeds before underwriting expenses of $500.
On March 6, 2001, HLI issued and sold $200 of trust preferred securities to
partially finance the Fortis acquisition.
- 66 -
<PAGE>
For a further discussion of Company Obligated Mandatorily Redeemable Preferred
Securities of Subsidiary Trusts Holding Solely Junior Subordinated Debentures,
see Note 8(d) of Notes to Consolidated Financial Statements.
STOCKHOLDERS' EQUITY
Issuance of common stock - On September 13, 2002, The Hartford issued
approximately 7.3 million shares of common stock pursuant to an underwritten
offering for net proceeds of $330.
As a result of September 11, on October 22, 2001, The Hartford issued 7.0
million shares of common stock pursuant to an underwritten offering for net
proceeds of $400.
Issuance of common stock-Fortis Financial Group acquisition - On February 16,
2001, The Hartford issued 10 million shares of common stock pursuant to an
underwritten offering for net proceeds of $615 to partially fund the Fortis
Financial Group acquisition.
Increase in authorized shares - At the Company's annual meeting of shareholders
held on April 18, 2002, shareholders approved an amendment to Section (a)
Article Fourth of the Amended and Restated Certificate of Incorporation to
increase the aggregate authorized number of shares of common stock from 400
million to 750 million.
Dividends - The Hartford declared $262 and paid $257 in dividends to
shareholders in 2002, declared $242 and paid $235 in 2001 and declared $214 and
paid $210 in 2000.
On October 24, 2002, The Hartford's Board of Directors declared a quarterly
dividend of $0.27 per share payable on January 2, 2003 to shareholders of record
as of December 2, 2002. The dividend represented a 4% increase from the prior
quarter.
PENSION PLANS AND OTHER POSTRETIREMENT BENEFITS
The Company maintains a U.S. qualified defined benefit pension plan (the "Plan")
that covers substantially all employees, as well as unfunded excess plans to
provide benefits in excess of amounts permitted to be paid to participants of
the Plan under the provisions of the Internal Revenue Code. Additionally, the
Company has entered into individual retirement agreements with certain current
and retired directors providing for unfunded supplemental pension benefits.
The Company made a voluntary contribution of $90 in cash to the Plan in 2001 and
made no contributions in 2002 or 2000. Pension expense reflected in the
Company's operating earnings was $67, $57 and $48 in 2002, 2001 and 2000,
respectively. The Company estimates its 2003 pension expense will be
approximately $135, based on current assumptions provided below. The assumptions
that primarily impact the amount of the Company's pension obligations and
periodic pension expense are the weighted-average discount rate and the asset
portfolio's long-term rate of return.
In determining the discount rate assumption, the Company utilizes information
provided by its plan actuaries. In particular, the Company uses an interest rate
yield curve developed and published by its plan actuaries to make judgments
pursuant to EITF Topic No. D-36, "Selection of Discount Rates Used for Measuring
Defined Benefit Pension Obligations and Obligations of Postretirement Benefit
Plans Other Than Pensions". The yield curve is comprised of AAA/AA bonds with
maturities between zero and thirty years. Discounting the cash flows of the
Company's pension plan using this yield curve, it was determined that 6.50% is
the appropriate discount rate as of December 31, 2002 to calculate the Company's
accrued benefit cost liability. Accordingly, as prescribed by SFAS No. 87,
"Employers' Accounting for Pensions", the 6.50% discount rate will also be used
to determine the Company's 2003 pension expense.
The Company determines the long-term rate of return assumption for the Plan's
asset portfolio based on analysis of the portfolio's historical compound rates
of return since 1979 (the earliest date for which comparable portfolio data is
available) over rolling 5 year, 10 year and 20 year periods, balanced along with
future long-term return expectations. The Company selected these periods, as
well as shorter durations, to assess the portfolio's volatility, duration and
total returns as they relate to pension obligation characteristics, which are
influenced by the Company's workforce demographics. While the historical return
of the Plan's portfolio has been 10.7% since 1979, management lowered its
long-term rate of return assumption from 9.75% to 9.00% as of December 31, 2002
based on its long-term outlook with respect to the markets, which has been
influenced by the poor equity market performance in recent years coupled with
the recent decline in fixed income security yields during 2002.
The Plan's asset portfolio is generally structured over time to include
approximately 60% equity securities (substantially securities issued by United
States-based companies) and 40% fixed income securities (substantially
investment grade and above). At December 31, 2002, the portfolio composition
varied from the targeted mix and was approximately 55% equity securities and 45%
fixed income securities due in part to declines in the equity markets and
declining interest rates.
As provided for under SFAS No. 87, the Company uses a five-year averaging method
to determine the market-related value of Plan assets, which is used to determine
the expected return component of pension expense. Under this methodology, asset
gains/losses that result from returns that differ from the Company's long-term
rate of return assumption are recognized in the market-related value of assets
on a level basis over a five year period. Due primarily to the unfavorable
performance of the equity markets in 2001 and 2002, the actual asset
return/(loss) for the Plan was $(111) and $(119) for the years ended December
31, 2002 and 2001, respectively, as compared to an expected return of $183 and
$168 for the years ended December 31, 2002 and 2001, respectively. These
differentials will be fully reflected in the market-related value of Plan assets
over the next five years using the methodology described above. The effect of
the 2002 asset return loss has caused the level of unrecognized net losses to
exceed the allowable amortization corridor as defined under SFAS No. 87. Based
on the selected 2003 discount rate of 6.50% and taking into account estimated
future minimum funding, the differential between actual and expected performance
in 2002 will increase annual pension expense in future years by approximately
$10 in 2003, increasing to approximately $40 in 2007. Additionally, the decrease
in the long-term rate of return assumption from 9.75%
- 67 -
<PAGE>
to 9.00% is expected to increase the Company's annual pension expense by
approximately $15.
During 2002, the change in the discount rate from 7.50% (as of December 31,
2001) to 6.50% (as of December 31, 2002) increased the projected benefit
obligation ("PBO") by $354. The effect of this increase in PBO will serve to
increase annual pension expense by approximately $40, assuming no future changes
in discount rates going forward.
Changes in the economic assumptions used to determine pension expense will
impact the Company's pension expense. As mentioned earlier, the two economic
assumptions that have the most impact on pension expense are the discount rate
and the expected long-term rate of return. To illustrate the impact of these
assumptions on annual pension expense for 2003 and going forward, a 25 basis
point change in the discount rate will increase/decrease pension expense by
approximately $12, and a 25 basis point change in the long-term asset return
assumption will increase/decrease pension expense by approximately $5.
While the Company has significant discretion in making voluntary contributions
to the Plan, the Employee Retirement Income Security Act of 1974 regulations
mandate minimum contributions in certain circumstances. Under current
assumptions, the 2003 required minimum funding contributions are estimated to be
approximately $40.
CASH FLOW
2002 2001 2000
- ----------------------------------------------------------------
Net cash provided by
operating activities $ 2,649 $ 2,303 $ 2,435
Net cash used for investing
activities $ (6,624) $ (5,536) $ (2,164)
Net cash provided by (used
for) financing activities $ 3,989 $ 3,365 $ (208)
Cash - end of year $ 377 $ 353 $ 227
================================================================
2002 COMPARED TO 2001 -- The increase in cash provided by operating activities
was primarily the result of higher net income reported for the year ended
December 31, 2002 than for the prior year as well as an increase in income tax
refunds received in 2002 compared with the prior year. The increase in cash
provided by financing activities was primarily the result of increased proceeds
from investment and universal life-type contracts, partially offset by lower
proceeds received from issuances of common stock and no issuances of trust
preferred securities in 2002. The increase in cash from financing activities
accounted for the majority of the change in cash for investing activities.
2001 COMPARED TO 2000 -- The increase in cash from financing activities was the
result of current year proceeds on investment type contracts versus the prior
year disbursements for investment type contracts and financing activities
related to Fortis and September 11. Cash provided by financing and operating
activities accounted for the majority of the change in cash for investing
activities. The cash flows from operating activities were comparable with prior
year.
Operating cash flows in each of the last three years have been adequate to meet
liquidity requirements.
RATINGS
Ratings are an important factor in establishing the competitive position in the
insurance and financial services marketplace. There can be no assurance that the
Company's ratings will continue for any given period of time or that they will
not be changed. In the event the Company's ratings are downgraded, the level of
revenues or the persistency of the Company's business may be adversely impacted.
The following table summarizes The Hartford's significant United States member
companies' financial ratings from the major independent rating organizations as
of February 28, 2003.
A.M. STANDARD
BEST FITCH & POOR'S MOODY'S
- -----------------------------------------------------------------
INSURANCE FINANCIAL
STRENGTH RATINGS:
Hartford Fire A+ AA AA- Aa3
Hartford Life Insurance
Company A+ AA AA- Aa3
Hartford Life & Accident A+ AA AA- Aa3
Hartford Life & Annuity A+ AA AA- Aa3
OTHER RATINGS:
The Hartford Financial
Services Group, Inc.:
Senior debt a+ A A A2
Commercial paper AMB-1 F-1 A-2 P-1
Hartford Capital I
quarterly income
preferred securities a- A- BBB A3
Hartford Capital III
trust originated
preferred securities a- A- BBB A3
Hartford Life, Inc.:
Senior debt a+ A A- A2
Commercial paper -- F-1 A-2 P-1
Hartford Life, Inc.:
Capital I and II trust
preferred securities a- A- BBB A3
Hartford Life Insurance
Company:
Short Term Rating -- -- A-1+ P-1
=================================================================
The agencies consider many factors in determining the final rating of an
insurance company. One consideration is the relative level of statutory surplus
necessary to support the business written. Statutory surplus represents the
capital of the insurance company reported in accordance with accounting
practices prescribed by the applicable state insurance department. The table
below sets forth statutory surplus for the Company's insurance companies.
2002 2001
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Life Operations $ 3,019 $ 2,991
Property & Casualty Operations 5,131 4,159
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TOTAL $ 8,150 $ 7,150
==================================================================
On January 28, 2003, following The Hartford's announcement that it is commencing
a comprehensive review of its asbestos loss reserves, A.M. Best Co. placed under
review with negative implications the commercial paper and debt ratings of The
Hartford Financial Services Group, Inc. ("HFSG") and Hartford Life, Inc.
Concurrently, the financial strength ratings of The Hartford's various life and
property and casualty subsidiaries remain unaffected. On December 16, 2002, all
of The
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Hartford's financial strength and debt ratings were affirmed. The under review
status is expected to be completed in conjunction with the Company's completion
of its asbestos reserve study prior to the end of second quarter 2003.
On January 28, 2003, Fitch Ratings placed its fixed income ratings for HFSG and
its insurer financial strength ratings for The Hartford Fire Intercompany Pool
on Rating Watch Negative. Ratings for HFSG's life insurance subsidiaries and
fixed income ratings at the life insurance operation's intermediate holding
company, Hartford Life, Inc., were not impacted by Fitch's rating actions and
remain on stable outlook. Fitch's rating action followed the Company's
announcement that it is commencing a comprehensive review of its asbestos loss
reserves. Fitch anticipates responding to the Rating Watch status upon
completion of the asbestos review or potentially sooner if certain uncertainties
are resolved earlier.
On September 19, 2002, Fitch Ratings lowered the ratings of The Hartford Life
Group as part of a comprehensive industry review of all North American life
insurance company ratings. For The Hartford Life Group, Fitch stated the rating
action was driven primarily by Fitch's opinion that most of the very strong,
publicly owned insurance organizations are more appropriately rated in the `AA'
rating category. Fitch also changed its view on the variable annuity business
and stated that it believes that the associated risks, mainly variable earnings,
are greater than previously considered. Fitch's long-term fixed income ratings
on The Hartford Financial Services Group, Inc. were also lowered, while the
affiliated property and casualty insurer financial strength ratings were
affirmed. The rating outlooks are stable.
On January 28, 2003, Moody's confirmed the ratings of HFSG and its subsidiaries,
including the ratings of Hartford Life, Inc. following the Company's
announcement that it is commencing a comprehensive review of its asbestos loss
reserves. The review is expected to be completed during the second quarter 2003.
In the same action, Moody's changed the outlook on the debt ratings for both the
parent company and HLI to negative from stable and also placed a negative
outlook on the insurance financial strength ratings of members of The Hartford's
property and casualty intercompany pool. The negative outlook reflects the
significant uncertainty surrounding the Company's asbestos liabilities. The
outlook for the insurance financial strength ratings (Aa3) for the life
insurance companies remains stable.
On September 4, 2002, Moody's revised its outlook on The Hartford's debt ratings
to Stable from Negative citing The Hartford's commitment to maintaining its
capital strength in the event of a significant unforeseen loss or adverse
development that would weaken its capital position.
On November 26, 2002, Standard & Poor's removed from CreditWatch its
counterparty credit rating on The Hartford Financial Services Group, Inc. and
related entities and lowered it to `A-' from `A' reflecting concerns about
trends in the retirement and savings sector, the consolidated capitalization of
the Company's insurance operations and the increasingly competitive environment
for spread-based and equity-linked retirement and savings products. At the same
time, Standard & Poor's lowered to AA- from AA the insurance financial strength
ratings of Hartford Fire Intercompany Pool and the life insurance subsidiaries
of HLI.
ACQUISITIONS
Fortis
On April 2, 2001, The Hartford acquired Fortis Financial Group for $1.12 billion
in cash. The Company effected the acquisition through several reinsurance
agreements with subsidiaries of Fortis, Inc. and the purchase of 100% of the
stock of Fortis Advisers, Inc. and Fortis Investors, Inc., wholly-owned
subsidiaries of Fortis, Inc. The acquisition was recorded as a purchase
transaction.
Purchase consideration for the transaction was as follows:
Issuance of:
- ------------
Common stock issuance (10 million shares
@ $64.00 per share), net of transaction costs $ 615
Long-term notes:
$400 7.375% notes due March 1, 2031 400
Trust preferred securities:
$200 7.625% Trust Preferred Securities
(Series B) due February 15, 2050 200
- -----------------------------------------------------------------
Consideration raised $ 1,215
=================================================================
For a further discussion of the Fortis acquisition, see Note 18(a) of Notes to
Consolidated Financial Statements.
EQUITY MARKETS
For a discussion of the potential impact of the equity markets on capital and
liquidity, see the Capital Markets Risk Management section under "Market Risk".
LIQUIDITY REQUIREMENTS
The liquidity requirements of The Hartford have been and will continue to be met
by funds from operations as well as the issuance of commercial paper, common
stock, debt securities and borrowings from its credit facilities. The principal
sources of operating funds are premiums and investment income as well as
maturities and sales of invested assets. The Hartford Financial Services Group,
Inc. is a holding company which receives operating cash flow in the form of
dividends from its subsidiaries, enabling it to service debt, pay dividends on
its common stock and pay certain business expenses.
Dividends to The Hartford Financial Services Group, Inc. from its subsidiaries
are restricted. The payment of dividends by Connecticut-domiciled insurers is
limited under the insurance holding company laws of Connecticut. Under these
laws, the insurance subsidiaries may only make their dividend payments out of
unassigned surplus. These laws require notice to and approval by the state
insurance commissioner for the declaration or payment of any dividend, which,
together with other dividends or distributions made within the preceding twelve
months, exceeds the greater of (i) 10% of the insurer's policyholder surplus as
of December 31 of the preceding year or (ii) net income (or net gain from
operations, if such company is a life insurance company) for the twelve-month
period ending on the thirty-first day of December last preceding, in each case
determined under statutory insurance accounting policies. In addition, if any
dividend of a Connecticut-domiciled insurer
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exceeds the insurer's earned surplus, it requires the prior approval of the
Connecticut Insurance Commissioner.
The insurance holding company laws of the other jurisdictions in which The
Hartford's insurance subsidiaries are incorporated (or deemed commercially
domiciled) generally contain similar (although in certain instances somewhat
more restrictive) limitations on the payment of dividends.
As of December 31, 2002, the maximum amount of statutory dividends which may be
paid to The Hartford Financial Services Group, Inc. from its insurance
subsidiaries in 2003, without prior regulatory approval, is $1.8 billion.
The primary uses of funds are to pay claims, policy benefits, operating expenses
and commissions and to purchase new investments. In addition, The Hartford has a
policy of carrying a significant short-term investment position and accordingly
does not anticipate selling intermediate- and long-term fixed maturity
investments to meet any liquidity needs. (For a discussion of the Company's
investment objectives and strategies, see the Investments and Capital Markets
Risk Management sections.)
TERRORISM RISK INSURANCE ACT OF 2002
On November 26, 2002, President Bush signed the Terrorism Risk Insurance Act of
2002 (the "Act") into law. The Act established a program that will run through
2005 that 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.
The Act created a program under which the federal government will pay 90% of
covered losses after an insurer's losses exceed a deductible determined by a
statutorily prescribed formula, 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
limit, insurers with losses exceeding their deductibles will not be responsible
for additional losses.
The statutory formula for determining a company's deductible for each year is
based on the company's direct commercial earned premiums for the prior calendar
year multiplied by a specified percentage. The specified percentages are 7% for
2003, 10% for 2004 and 15% for 2005. For example, based on The Hartford's 2002
direct commercial earned premiums of $5 billion, The Hartford's 2003 deductible
would be $350.
The Act applies to a significant portion of The Hartford's commercial property
and casualty contracts, but it specifically excludes some of The Hartford's
other insurance business, including crop or livestock insurance, reinsurance and
personal lines business. The Act currently does not apply to group life
insurance contracts but permits the Secretary of the Treasury to extend the
backstop protection to them.
The Act requires all property and casualty insurers, including The Hartford, to
make terrorism insurance coverage available in all of their covered commercial
property and casualty insurance policies (as defined in the Act). The Hartford
will evaluate risks with terrorism exposures by applying its internally
developed underwriting guidelines and control plans. The Hartford does not
anticipate significant increases in premiums due to the Act.
RISK-BASED CAPITAL
The National Association of Insurance Commissioners ("NAIC") has regulations
establishing minimum capitalization requirements based on risk-based capital
("RBC") formulas for both life and property and casualty companies. The
requirements consist of formulas, which identify companies that are
undercapitalized and require specific regulatory actions. The RBC formula for
life companies establishes capital requirements relating to insurance, business,
asset and interest rate risks. RBC is calculated for property and casualty
companies after adjusting capital for certain underwriting, asset, credit and
off-balance sheet risks. As of December 31, 2002, each of The Hartford's
insurance subsidiaries within Life and Property & Casualty had more than
sufficient capital to meet the NAIC's RBC requirements.
CONTINGENCIES
Legal Proceedings - The Hartford is involved in claims litigation arising in the
ordinary course of business, both as a liability insurer defending third-party
claims brought against insureds and as an insurer defending coverage claims
brought against it. The Hartford accounts for such activity through the
establishment of unpaid claim and claim adjustment expense reserves. Subject to
the discussion of the litigation involving MacArthur in Part I, Item 3. Legal
Proceedings and the uncertainties related to asbestos and environmental claims
discussed in the MD&A under the caption "Other Operations," management expects
that the ultimate liability, if any, with respect to such ordinary-course claims
litigation, after consideration of provisions made for potential losses and
costs of defense, will not be material to the consolidated financial condition,
results of operations or cash flows of The Hartford.
The Hartford is also involved in other kinds of legal actions, some of which
assert claims for substantial amounts. These actions include, among others,
putative state and federal class actions seeking certification of a state or
national class. Such putative class actions have alleged, for example,
underpayment of claims or improper underwriting practices in connection with
various kinds of insurance policies, such as personal and commercial automobile,
premises liability and inland marine. The Hartford also is involved in
individual actions in which punitive damages are sought, such as claims alleging
bad faith in the handling of insurance claims. Management expects that the
ultimate liability, if any, with respect to such lawsuits, after consideration
of provisions made for potential losses and costs of defense, will not be
material to the consolidated financial condition of The Hartford. Nonetheless,
given the large or indeterminate amounts sought in certain of these actions, and
the inherent unpredictability of litigation, it is possible that an adverse
outcome in certain matters could, from time to time, have a material adverse
effect on the Company's consolidated results of operations or cash flows in
particular quarterly or annual periods.
Dependence on Certain Third Party Relationships - The Company distributes its
annuity, life and certain property and casualty insurance products through a
variety of distribution channels, including broker-dealers, banks, wholesalers,
its own internal sales force and other third party organizations. The Company
periodically negotiates provisions and renewals of these relationships and there
can be no assurance that such terms
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<PAGE>
will remain acceptable to the Company or such third parties. An interruption in
the Company's continuing relationship with certain of these third parties could
materially affect the Company's ability to market its products.
LEGISLATIVE INITIATIVES
Federal measures which have been previously considered or enacted by Congress
and which, if revisited, could affect the insurance business include tax law
changes pertaining to the tax treatment of insurance companies and life
insurance and annuity products, as well as changes in individual income tax
rates and the estate tax. These changes could have an impact on the relative
desirability of various personal investment vehicles. Legislation to restructure
the Social Security system, expand private pension plans, and create new
retirement savings incentives also may be considered.
The Bush Administration's fiscal year 2004 budget contains several proposals
that could materially affect the Company's business. In particular, there are
proposals that would more fully integrate corporate and individual taxes by
permitting the distribution of nontaxable dividends to shareholders under
certain circumstances. These proposals, if enacted, could have a material effect
on sales of the Company's variable annuities and other retirement savings
products, as well as implications for the Company's shareholders, both with
respect to the amount of taxable dividends received, as well as the price of and
tax basis in their holdings of the Company's common stock. The dividend
exclusion proposal, if enacted, also would reduce the federal tax benefits
currently received by the Company stemming from the dividends received
deduction.
There also are proposals in the federal 2004 budget submitted by President Bush
that would create new investment vehicles with larger annual contribution limits
for individuals to use for savings purposes. Some of these proposed vehicles
would have significant tax advantages, and could have material effects on the
Company's product portfolio. There have also been proposals regarding certain
deferred compensation arrangements that could have negative effects on the
Company's product sales. Prospects for enactment of this legislation in 2003 are
uncertain. Therefore, any potential effect on the Company's financial condition
or results of operations cannot be reasonably estimated at this time.
Congress is likely to consider a number of legal reform proposals this year.
Among them is legislation that would reduce the number and type of national
class actions certified by state judges by updating the federal rules on
diversity jurisdiction. Other proposals that will likely be considered by
Congress this year include those to reform the asbestos litigation environment
by, among other things, implementing medical criteria that must be met by
asbestos claimants or establishing an administrative claims facility to
compensate those with asbestos-related injuries. Prospects for enactment of
these proposals in 2003 are uncertain.
INSOLVENCY FUND
In all states, insurers licensed to transact certain classes of insurance are
required to become members of an insolvency fund. In most states, in the event
of the insolvency of an insurer writing any such class of insurance in the
state, members of the fund are assessed to pay certain claims of the insolvent
insurer. A particular state's fund assesses its members based on their
respective written premiums in the state for the classes of insurance in which
the insolvent insurer is engaged. Assessments are generally limited for any year
to one or two percent of premiums written per year depending on the state. Such
assessments paid by The Hartford approximated $26 in 2002, $6 in 2001 and $2 in
2000.
NAIC CODIFICATION
The NAIC adopted the Codification of Statutory Accounting Principles
("Codification") in March 1998. The effective date for the statutory accounting
guidance was January 1, 2001. Each of The Hartford's domiciliary states has
adopted Codification, and the Company has made the necessary changes in its
statutory reporting required for implementation. The impact of applying the new
guidance resulted in a benefit of approximately $400 in statutory surplus.
OTHER
For further information on other contingencies, see Note 16 of Notes to
Consolidated Financial Statements.
- --------------------------------------------------------------------------------
EFFECT OF INFLATION
- --------------------------------------------------------------------------------
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 The
Hartford during the three most recent fiscal years.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item is set forth in the Capital Markets Risk
Management section of the Management's Discussion and Analysis of Financial
Condition and Results of Operations and is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Index to Consolidated Financial Statements and Schedules elsewhere herein.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE HARTFORD
Certain of the information called for by Item 10 is set forth in the definitive
proxy statement for the 2003 annual meeting of shareholders (the "Proxy
Statement") filed or to be filed by The Hartford with the Securities and
Exchange Commission within 120 days after the end of the fiscal year covered by
this Form 10-K under the caption "Item 1. Election of Directors - Nominees for
Directorships" and "Stock Ownership of Directors, Executive Officers and Certain
Shareholders - Section 16(a) Beneficial Ownership Reporting Compliance" and is
incorporated herein by reference.
EXECUTIVE OFFICERS OF THE HARTFORD
Information about the executive officers of The Hartford who are also nominees
for election as directors is set forth in The Hartford's Proxy Statement. Set
forth below is information about the other executive officers of the Company:
DAVID M. JOHNSON
(Executive Vice President a