ITEM 1. BUSINESS OF THE HARTFORD (DOLLAR AMOUNTS IN MILLIONS, EXCEPT FOR 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, 2001, total assets and total stockholders' equity of The Hartford were $181.2 billion and $9.0 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 insurance 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 subsidiaries, which are primarily domiciled in Connecticut, 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 21 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") of Hartford Life, Inc. ("HLI"), the holding company parent of The Hartford's significant life insurance subsidiaries, HLI 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 16 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. Accordingly, 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 ten operating segments. Additionally, all activities related to The HLI Repurchase 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 Latin America and Japan, as well as corporate items not directly allocable to any of its reportable operating segments, principally interest expense.
Property & Casualty, headquartered in Hartford, Connecticut, was reorganized into six reportable operating segments and, effective January 1, 2001, is reported as the North American underwriting segments of Business Insurance, Affinity Personal Lines, Personal Insurance, Specialty Commercial and Reinsurance; and the Other Operations segment, formerly "International and Other Operations".
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.
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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 income protection and estate planning to approximately 750,000 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. 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).
HLI is among the largest consolidated life insurance groups in the United States based on statutory assets as of December 31, 2000. In the past year, Life's total assets under management, which include $16.8 billion of third-party assets invested in the Company's mutual funds, increased 9% to $168.4 billion at December 31, 2001 from $155.1 billion at December 31, 2000. Life generated revenues of $6.5 billion, $6.0 billion and $5.5 billion in 2001, 2000 and 1999, respectively. Additionally Life generated net income of $685, $575 and $467 in 2001, 2000, and 1999, respectively.
CUSTOMER SERVICE, TECHNOLOGY AND ECONOMIES OF SCALE
Life maintains advantageous economies of scale and operating efficiencies due to its continued 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 reduced by nearly half since 1992, declining from 43 basis points to 22 basis points in 2001. 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 2001 Annuity Service Award by DALBAR Inc., a recognized independent financial services research organization, for the sixth consecutive year. The Hartford is the only company to receive this prestigious award in every year of the award's existence. Also, in both 2001 and 2000, 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 the DALBAR award for service of life insurance customers in 2001 and was the only life insurance operation to be recognized with this prestigious award.
RISK MANAGEMENT
Life's product designs, prudent underwriting standards and risk management techniques protect it against disintermediation risk and greater than expected mortality and morbidity experience. As of December 31, 2001, the Company had limited exposure to disintermediation risk on approximately 97% 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, 1996 to December 31, 2001, this segment's assets under management grew to $120.3 billion from $55.3 billion, a five year compounded annual growth rate of 17%. Investment Products generated revenues of $2.5 billion, $2.4 billion and $2.0 billion in 2001, 2000 and 1999, respectively, of which individual annuities accounted for $1.5 billion in 2001 and 2000, and $1.4 billion in 1999. Net income in the Investment Products segment was $463, $424 and $330 in 2001, 2000 and 1999, 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 $10.0 billion, $10.7 billion and $10.9 billion in 2001, 2000 and 1999, respectively. The Hartford was among the largest sellers of individual variable annuities in the United States for 2001, 2000 and 1999 with sales of $9.0 billion, $9.0 billion and $10.3 billion, respectively. In addition, the Company continues to be among the largest sellers of individual variable annuities through banks in the United States.
The Company's total account value related to individual annuity products was $84.2 billion as of December 31, 2001. 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 2000, the Company's total account values related to individual annuity products was $87.2 billion. Of this total account value, $78.2
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billion, or 90%, related to individual variable annuity products and $9.0 billion, or 10%, 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 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 of the Internal Revenue Code of 1986, as amended (referred to as "Section 457"). The Company also provides structured settlement contracts, terminal funding products and other investment products such as guaranteed investment contracts ("GICs").
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%, and helped solidify the Company's strong position in variable annuities.
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. 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 initially from 5% 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 $74.6 billion as of December 31, 2001, 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 94% and 96% of the individual variable annuity account values were held in non-guaranteed separate accounts as of December 31, 2001 and 2000, 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"), Putnam Financial Services, Inc. ("Putnam"), American Funds, MFS Investment Management ("MFS"), Franklin Templeton Group, AIM Investments ("AIM") and Morgan Stanley Investment Advisors, Inc. 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 an industry leader in terms of 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.
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 $9.6 billion and $9.0 billion as of December 31, 2001 and 2000, respectively.
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 21 funds. These funds are managed by Wellington and Hartford Investment Management Company, a wholly-owned subsidiary of The Hartford. The Company has entered into agreements with over 750 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 sales were $5.7 billion, $5.2 billion and $3.3 billion in 2001, 2000 and 1999, respectively.
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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 fixed and variable annuities, 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, 2001, the Company administered over 3,000 Section 457 plans.
Corporate -- The Company sells retirement plan products and services to corporations under Section 401(k) 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, 2001, the Company administered over 2,400 Section 401(k) plans.
Institutional Liabilities -- 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.
Section 529 Plans - The Hartford is introducing 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. In 1996, Congress created a tax-advantaged college savings program (529 Plan) as part of Section 529 of the Internal Revenue Code (the "Code"). The 529 Plan is an investment plan operated by a state, 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. The Hartford believes this is a significant market opportunity and the benefits of investing in 529 plans will be well received by many Americans saving for college.
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 individual annuities to customers is consummated).
The Hartford maintains a distribution network of approximately 1,500 broker-dealers and approximately 500 banks. As of September 30, 2001, the Company was selling products through 24 of the 25 largest retail banks in the United States, including proprietary relationships with 10 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 single premium variable life insurance 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 market.
Competition - -----------
The Investment Products segment competes with numerous other insurance companies as well as certain banks, securities brokerage firms, investment advisors and other financial intermediaries marketing annuities, mutual funds and other retirement-oriented products. The 1999 Gramm-Leach-Bliley Act ("the Financial Services Modernization Act"), which allows affiliations among banks, insurance companies and securities firms, has not precipitated any significant changes in bank ownership of insurance companies. (For additional information, see the Regulatory Matters and Contingencies section of the MD&A.) 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 sells a variety of products including variable life, universal life, interest sensitive whole life and term life insurance primarily to the high end estate and business planning markets. The individual life business acquired from Fortis added significant scale to the Company's Individual Life segment, contributing to the significant increase in life insurance in force. As of December 31, 2001, life insurance in force increased 60% to $120.3 billion, from $75.1 billion as of December 31, 2000 and account values grew 35% to $7.9 billion as of December 31, 2001 from $5.8 billion as of December 31, 2000. Revenues were $890, $640 and $584 in 2001, 2000 and 1999, respectively. Net income in the
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Individual Life segment was $121, $79 and $71 in 2001, 2000 and 1999, respectively.
Principal Products - ------------------
The trend in the individual life industry has been a shift away from traditional products towards variable life (including variable universal life) insurance products, in which The Hartford has been on the leading edge. In 2001, of the Company's new sales of individual life insurance, 82% was variable life and 15% was either universal life or interest sensitive whole life. The Company also sold a small amount of 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, as the case may be, the death benefit or surrender value of the variable life policy may 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, often to fund estate taxes for a married couple. Variable life account values were $4.0 billion and $2.9 billion as of December 31, 2001 and 2000, 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 and $2.1 billion as of December 31, 2001 and 2000, respectively.
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 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, particularly as it pertains to estate and business planning. These individuals are generally employees of The Hartford who are managed through a regional sales office system. The Company has grown this organization rapidly the past few years to over 225 individuals and expects to continue to increase the number of wholesalers in the future. The acquisition of the United States individual life insurance business of Fortis has broadened the Company's reach in the emerging affluent market with the addition of a retail broker-dealer consisting of approximately 2,300 registered representatives.
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 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 and supplementary medical coverages to employers and employer sponsored plans, 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 with one or two year rate guarantees. This allows the Company to adjust the rates or terms of its policies in order to minimize the adverse effect of various market trends. In the disability market, the Company focuses on strong underwriting and claims management to derive a competitive advantage. As of December 31, 2001 and 2000, the Company had group disability reserves of $2.4 billion and $2.0 billion and group life reserves of $706 and $601, respectively. The Group Benefits segment generated revenues of $2.5 billion, $2.2 billion and $2.0 billion in 2001, 2000 and 1999, respectively, of which group disability insurance accounted for $1.1 billion, $939 and $860 and group life insurance accounted for $763, $687 and $654, respectively. Net income in the Group Benefits segment was $106, $90 and $79 in 2001, 2000 and 1999, 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 "small case" 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, reduction of long-term disability claims 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 Hartford has concentrated on a managed disability approach, which emphasizes early claimant intervention in an effort to facilitate a disabled claimant's return to work and thereby contain costs. This approach, coupled with an individualized approach to claim servicing, and an incentive to
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contain costs, leads to an overall reduction in the cost of disability coverage for employers. 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 waivers 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 Medicare supplement insurance, 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 has been the members of the Retired Officers Association, an organization consisting of retired military officers. Congress recently 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 will reduce the Company's premium revenue by approximately $131 in 2002.
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. The Company intends to continue to expand the system over the coming years in areas that have the highest growth potential and also will continue to develop alternative distribution channels to sell its products, such as sales to employers through brokers, consultants and third-party administrators as well as to multiple employer groups through its relationships with trade associations. In keeping with its strategy of developing multiple distribution channels, the Company signed an agreement in January 2001 with Wausau Benefits, Inc., to sell its group life and group disability products.
Competition - -----------
Competitive factors primarily affecting Group Benefits are the variety and quality of products 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, while other major carriers have exited the market.
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 the Health Insurance Portability and Accountability Act of 1996 ("HIPA Act of 1996"), 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. The HIPA Act of 1996 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 $18.0 billion and $15.9 billion as of December 31, 2001 and 2000, respectively. Leveraged COLI account values decreased to $4.3 billion as of December 31, 2001 from $5.0 billion as of December 31, 2000, primarily due to the continuing effects of the HIPA Act of 1996. COLI generated revenues of $719, $767 and $831 in 2001, 2000 and 1999, respectively. COLI generated net income of $37, $34 and $30 in 2001, 2000 and 1999, respectively.
PROPERTY & CASUALTY - -------------------
Property & Casualty provides (1) workers' compensation, property, automobile, liability, marine, agricultural and bond coverages to commercial accounts 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 lines insurers; (3) automobile, homeowners and home-based business coverage to individuals throughout the United States; (4) assumed reinsurance through professional reinsurance brokers covering various property, casualty, specialty and marine classes of business; and (5) insurance related services.
The Hartford has the tenth largest property and casualty insurance operation in the United States based on written premiums for the year ended December 31, 2000 according to A.M. Best. Property & Casualty generated revenues of $8.6 billion, $8.7 billion and $8.0 billion, in 2001, 2000 and 1999, respectively. Written premiums for 2001, 2000 and 1999 were $7.6 billion, $7.0 billion and $6.4 billion, respectively. Additionally, net income (loss) was $(115), $494 and $481 for 2001, 2000 and 1999, respectively. Excluding the impact of the September 11 terrorist attack ("September 11"), Property & Casualty generated $8.7 billion in revenues, $7.7 billion in written premiums and $305 in net income in 2001. Total assets for Property & Casualty were $28.8 billion as of December 31, 2001. (For a discussion of the impact of September 11 and terrorism exposures, see MD&A under Property & Casualty and Capital Resources and Liquidity sections.)
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The Hartford's Property & Casualty operation was reorganized into six reportable operating segments and, effective January 1, 2001, is reported as the North American underwriting segments of Business Insurance, Affinity Personal Lines, Personal Insurance, Specialty Commercial and Reinsurance; and the Other Operations segment, formerly "International and Other Operations". 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 allocable to these segments, such as net investment income, net realized capital gains and losses, other expenses including interest, and income taxes.
BUSINESS INSURANCE
Business Insurance provides standard commercial insurance coverage to small ("Select Customer") and mid-sized ("Key Accounts") commercial businesses throughout the United States. This segment also provides commercial risk management products and services to small and mid-sized members of affinity groups in addition to marine coverage. The segment had written premiums of $2.9 billion, $2.4 billion and $2.2 billion in 2001, 2000 and 1999, respectively, and underwriting losses of $242 ($3 of underwriting income excluding the impact of September 11), $50 and $123 in 2001, 2000 and 1999, 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 to small and mid-sized members of affinity groups.
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 a variety of distribution networks including independent agents as well as wholesalers and direct marketing through trade associations, customers of financial institutions 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.
AFFINITY PERSONAL LINES
Affinity Personal Lines provides insurance coverage to individuals throughout the United States. Affinity Personal Lines is organized to provide customized products and services to the following markets: the membership of AARP through a direct marketing operation; customers of Sears, Roebuck & Co. ("Sears") and Ford Motor Company and Ford Motor Credit Company (collectively, "Ford"); as well as customers of financial institutions through an affinity center. Affinity 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 Affinity Personal Lines with an important competitive advantage. Affinity Personal Lines had written premiums of $1.8 billion, $1.7 billion and $1.5 billion in 2001, 2000 and 1999, respectively. Underwriting income (loss) for 2001, 2000 and 1999 was $(39), ($(36) excluding the impact of September 11), $17 and $19, respectively.
Principal Products - ------------------
Affinity Personal Lines provides 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 - --------------------------
Affinity Personal Lines reaches diverse markets through multiple distribution channels including direct mail, the Internet and advertising in publications. The segment markets directly to the over 34 million members of AARP as well as other affinity groups.
PERSONAL INSURANCE
Personal Insurance provides insurance coverage to individuals throughout the United States. Personal Insurance is organized to provide customized products and services to customers 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 Insurance had written premiums of $1.0 billion, $988 and $943 in 2001, 2000 and 1999, respectively. Underwriting income (loss) for 2001, 2000 and 1999 was $(48) (($42) excluding the impact of September 11), $(15) and $15, respectively.
Principal Products - ------------------
Personal Insurance provides standard and non-standard automobile, homeowners and home-based business coverages to individuals across North America.
Marketing and Distribution - --------------------------
Personal Insurance 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.
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 $989 ($996 excluding the impact of September 11), $1.1 billion and $954 in 2001, 2000 and 1999, respectively, and underwriting losses of $262 ($95 excluding the impact of September 11), $103 and $48 in 2001, 2000 and 1999, respectively.
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Principal Products - ------------------
The Specialty Commercial segment offers a variety of customized insurance products and risk management services in addition to standard commercial insurance including workers' compensation, casualty, automobile and liability coverages to large-sized companies. Specialty Commercial also provides bond, professional liability and agricultural coverages, as well as excess and surplus lines coverages not normally written by standard lines insurers.
Marketing and Distribution - --------------------------
Specialty Commercial provides insurance products and services through its home office located in Hartford, Connecticut and multiple domestic regional and district 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.
REINSURANCE
The Hartford assumed reinsurance worldwide through its thirteen Hartford Reinsurance Company ("HartRe") offices and wrote treaty reinsurance through professional reinsurance brokers covering various property, casualty, specialty and marine classes of business until the fourth quarter of 2001. In October 2001, HartRe announced a centralization of all underwriting and claims operations in Hartford, Connecticut. While exiting most international lines, HartRe will continue to write worldwide catastrophe, Alternative Risk Transfer ("ART") and marine from Hartford. The Reinsurance segment had written premiums of $849 ($918 excluding the impact of September 11), $826 and $703 in 2001, 2000 and 1999, respectively, and underwriting losses of $375 ($149 excluding the impact of September 11), $73 and $48 in 2001, 2000 and 1999, respectively.
Principal Products - ------------------
The Reinsurance segment offers a full range of treaty and facultative reinsurance products including property, casualty, marine and alternative risk transfer which includes non-traditional reinsurance products.
Marketing and Distribution - --------------------------
The Reinsurance segment assumes insurance from other insurers, primarily through reinsurance brokers in the worldwide reinsurance market.
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.
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. In September 2001, The Hartford entered into an agreement to sell The Hartford Insurance Company (Singapore), Ltd. (formerly People's Insurance Company, Ltd. ("Singapore Insurance")). The sale was completed in January 2002.
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 $168, $602 and $661 in 2001, 2000 and 1999, respectively. Net income for 2001, 2000 and 1999 was $10, $28 and $33, respectively.
PROPERTY & CASUALTY COMPETITION
The commercial insurance industry continues to be a highly challenging and competitive environment in which The Hartford competes with other insurance companies, self insurers and other underwriting organizations. This competitive environment is created by price competition, consolidation and globalization of companies, exploration and utilization of alternative distribution techniques and emphasis on cost containment and reduction. Additionally, September 11 has created an ambiguous environment and economic uncertainty as federal backing in the event of future terrorist attacks remains uncertain. In 2001, market conditions in the commercial industry have continued to improve as a result of a firming pricing environment.
The personal lines marketplace continues to remain competitive. Over the past few years, intense price competition, upward trends in loss costs and the significant expense of establishing alternative distribution channels have caused underwriting results to decrease. The personal lines marketplace reported a combined ratio of 111.4 for the first nine months of 2001, according to 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 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. The Hartford's contracts with Ford and Sears join major brands in marketing automobile, homeowners, and home-based business insurance products.
The property and casualty worldwide reinsurance market remains extremely competitive, although the pricing
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environment continued to improve in 2001. As a result of September 11, however, the worldwide reinsurance market has been transformed to an environment of some uncertainty. New capital, dramatic price increases and modifications in contract terms and conditions have contributed to the uncertainty. HartRe's organizational realignment has created a centralized organization aimed at enhancing core functions consistent with the segment's return objectives.
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 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 Reserves section of the MD&A.
PROPERTY & CASUALTY RESERVES
The Hartford establishes reserves to provide for the estimated costs of paying claims made by policyholders or against policyholders. These reserves include estimates for both claims that have been reported and those that have been incurred but not yet reported to The Hartford and include estimates of all expenses associated with processing and settling these claims. This estimation process is based primarily on historical experience and involves a variety of actuarial techniques which analyze trends and other relevant factors. For the year ended December 31, 2001, there were no changes to these reserving assumptions that had a significant impact on the reserves or results of operations.
The Hartford continually reviews the adequacy of its estimated claims and claim adjustment expense reserves on an overall basis. As additional experience and other relevant data become available, reserve levels are adjusted accordingly. Such adjustments are reflected in net income for the period in which they are made. In the judgment of The Hartford's management, all information currently available has been properly considered in establishing the reserves for unpaid claims and claim adjustment expenses.
As a result of September 11, the Company established estimated gross reserves of $1.1 billion and estimated net reserves of $556 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 unknown and unreported policyholder losses and costs incurred in settling claims. Included in net reserves was an estimate of amounts recoverable under the Company's ceded reinsurance programs. As a result of the uncertainties involved in the estimation process, final claims settlement may vary from present estimates.
The Hartford continues to receive claims that assert damages from environmental pollution and related clean-up costs and injuries from asbestos and asbestos-related products. Due to deviations from past experience and a variety of social, economic and legal issues, the Company's ability to estimate the future policy benefits, unpaid claims and claim adjustment expenses is significantly impacted. A study which reviewed and identified environmental and asbestos exposures in the United States was performed in 1996 and is discussed in the Environmental and Asbestos Claims section of the MD&A.
Certain liabilities for unpaid claims, principally for permanently disabled claimants, terminated reinsurance treaties and certain contracts that fund loss run-offs for unrelated parties, have been discounted to present value. The amount of the discount was approximately $429 and $396 as of December 31, 2001 and 2000, respectively, and amortization of the discount had no material effect on net income during 2001, 2000 and 1999.
As of December 31, 2001, property and casualty reserves for claims and claim adjustment expenses reported under Generally Accepted Accounting Principles ("GAAP") exceeded those reported on a statutory basis by $26. The primary differences resulted from the required exclusion from statutory reserves of assumed retroactive reinsurance and the discounting of GAAP-basis workers' compensation reserves at risk free interest rates, which exceeded the required statutory discount rates set by regulators.
There were no significant changes in the mix of the Company's business which have impacted property and casualty claims and claim adjustment expense reserves; nor has the Company completed any significant portfolio loss transfers, structured settlements or other transactions which would change claim payment patterns.
Further discussion on The Hartford's Property & Casualty reserves may be found in the Reserves section of the MD&A.
A reconciliation of liabilities for unpaid claims and claim adjustment expenses is herein referenced from Note 1(h) of Notes to Consolidated Financial Statements. A table depicting the historical development of the liabilities for unpaid claims and claim adjustment expenses follows.
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The following table reconciles the Loss Development Table to the Consolidated Financial Statements:
- ---------------------------------------------------------------------- 2001 2000 1999 - ---------------------------------------------------------------------- Loss Development Table: Gross reserves $ 16,255 $ 15,309 $ 15,284 Exclusion of international subsidiaries -- 106 274 Reinsurance - affiliated parties 423 459 456 - ---------------------------------------------------------------------- Gross reserves per Consolidated Financial Statements (see Note 1 (h)) $ 16,678 $ 15,874 $ 16,014 - ----------------------------------------------------------------------
CEDED REINSURANCE
Consistent with normal industry practice, The Hartford cedes insurance risk to reinsurance companies. For Property & Casualty operations, these reinsurance arrangements 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.
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The ceding of insurance obligations does not discharge the original insurer from its primary liability to the policyholder. The original insurer would remain liable in those situations where the reinsurer is unable to meet the obligations assumed under reinsurance agreements. The Hartford has established strict standards that govern the placement of reinsurance and monitors ceded reinsurance security. Virtually all of The Hartford's property and casualty reinsurance is placed with reinsurers that meet strict financial criteria established by a credit committee.
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, 2001, the maximum amount of life insurance retained on any one life by any one of the life operations was approximately $2.5.
In 2001, the Company did not make any significant changes in the terms under which reinsurance is ceded to other insurers. Also, the Company did not enter into a specific reinsurance transaction that had a material effect on earnings or reserves. However, as a result of September 11, The Hartford established estimated ceded reserves of $569 under existing reinsurance contracts and recorded premium cessions of $91 related to reinstatement and other reinsurance premiums. Also as a result of September 11, the reinsurance market has become an environment of some uncertainty. Specifically, dramatic price increases, changes in contract terms and conditions and program modifications have resulted. As a result, it has become more difficult to get selected types of reinsurance coverage at a reasonable price, particularly terrorism coverage.
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. The investment activities of both the Life and Property & Casualty operations 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 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.
Regulatory requirements applying to property and casualty premium rates vary from state to state, but generally provide that rates shall not be inadequate, excessive or unfairly discriminatory. Rates for many products, including automobile and homeowners insurance, are subject to prior regulatory approval in many states. Ocean marine insurance rates are exempt from rate regulation. Subject to regulatory requirements, management determines the rates charged for its policies. Methods for arriving at rates vary by product, exposure assumed and size of risk.
While premium rates in the property and casualty insurance business are for the most part subject to regulation, such rates are not in most instances uniform for all insurers within a given jurisdiction, or in all jurisdictions. The Hartford is a member of various fire, casualty and surety rating organizations. For some lines of business, The Hartford uses the rates and rating plans which are filed by these organizations in the various states, while for other lines of business it uses loss cost data published by such organizations. The Hartford also uses its own independent rates or otherwise departs from rating organization rates, where appropriate.
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.
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State insurance regulations require property and casualty insurers to participate in assigned risk plans, reinsurance facilities and joint underwriting associations, which are mechanisms to provide risks with various basic or minimum insurance coverage when they are not available in voluntary markets. Such mechanisms are most prevalent for automobile and workers' compensation insurance, but a majority of states also mandate participation in so-called FAIR Plans or Windstorm Plans providing basic property coverage. Additionally, some states mandate such participation in facilities for providing medical malpractice insurance. Participation is based upon the amount of a company's written premiums in a particular state for the classes of insurance involved.
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.
RATINGS
Reference is made to the Capital Resources and Liquidity section of the MD&A under "Ratings".
RISK-BASED CAPITAL
Reference is made to the Capital Resources and Liquidity section of the MD&A under "Risk-based Capital".
LEGISLATIVE INITIATIVES
Reference is made to the Regulatory Matters and Contingencies section of the MD&A under "Legislative Initiatives".
INSOLVENCY FUND
Reference is made to the Regulatory Matters and Contingencies section of the MD&A under "Insolvency Fund".
NAIC CODIFICATION
Reference is made to the Regulatory Matters and Contingencies section of the MD&A under "NAIC Codification".
EMPLOYEES
The Hartford had approximately 27,400 employees as of February 28, 2002.
EXECUTIVE OFFICERS OF THE HARTFORD
Information about the executive officers of The Hartford who are also directors and/or nominees for election as directors is set forth in The Hartford's 2002 Proxy Statement. Set forth below is information about other executive officers of the Company:
JOHN N. GIAMALIS (Senior Vice President and Controller)
Mr. Giamalis, 44, is Senior Vice President and Controller of the Company. Mr. Giamalis joined the Company in January 1997 as Director, Financial Reporting and Analysis. In April 1998, he was appointed to the position of Vice President and Corporate Controller. Prior to joining the Company, Mr. Giamalis held senior financial positions in the insurance and technology industries, including Chief Financial Officer of Intelidata Technologies Corp. from March 1995 to December 1996. He also held various public accounting positions, including senior manager with responsibility for insurance, securities and middle market clients at Deloitte & Touche LLP. Mr. Giamalis is a member of the American Institute and the Connecticut Society of Certified Public Accountants.
DAVID M. JOHNSON (Executive Vice President and Chief Financial Officer)
Mr. Johnson, 41, has held the position of Executive Vice President and Chief Financial Officer of the Company since May 1, 2001. Prior to joining the Company, Mr. Johnson was Senior Executive Vice President and Chief Financial Officer of Cendant Corporation since November 1998 and Managing Director, Investment Banking Division, at Merrill Lynch, Pierce, Fenner and Smith, where he worked with major clients in a variety of industries including insurance, airlines and technology, as well as leveraged buyout funds, since 1986.
RANDALL I. KIVIAT (Group Senior Vice President of Human Resources)
Mr. Kiviat, 51, has held the position of Group Senior Vice President of Human Resources for the Company since June 1999. Since joining the Company in 1982, he has held positions of increasing responsibility, including Director of Payroll and Director of Employee Benefits. He was appointed Vice President of Human Resources Services in April 1998.
EDWARD L. MORGAN, JR. (Group Senior Vice President, Corporate Relations)
Mr. Morgan, 58, has held the position of Group Senior Vice President, Corporate Relations, of the Company since April 1998. Previously, he was Senior Vice President, Corporate Relations and Government Affairs since December 1995. Mr. Morgan also has held the position of Senior Vice President, Corporate Relations of Hartford Fire since 1993.
NEAL S. WOLIN (Executive Vice President and General Counsel)
Mr. Wolin, 40, has held the position of Executive Vice President and General Counsel since joining the Company on March 20, 2001. Previously, Mr. Wolin served as General Counsel of the U.S. Treasury from 1999 to January 2001. In that capacity, he headed Treasury's legal division, composed of 2,000 lawyers providing services to all of Treasury's offices and bureaus, including the Internal Revenue Service, Customs, Secret Service, Public Debt, the Office of Thrift Supervision, the Financial Management Service, the U.S. Mint and the Bureau of Engraving and Printing. Mr. Wolin served as the Deputy General Counsel of the Department of the Treasury from 1995 to 1999. Prior to joining the Treasury Department, he served in the White House, first as the Executive Assistant to the National Security Advisor and then as the Deputy Legal Advisor to the National Security Council. Mr. Wolin joined the U.S. Government in 1991 as special assistant to the Directors of Central Intelligence, William H. Webster, Robert M. Gates and
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R. James Woolsey. Mr. Wolin served on the President's Advisory Commission on Holocaust Assets in the United States from 1999 to 2000.
DAVID M. ZNAMIEROWSKI (Group Senior Vice President and Chief Investment Officer)
Mr. Znamierowski, 41, was appointed Group Senior Vice President and Chief Investment Officer of the Company and President of Hartford Investment Management Company ("HIMCO"), a wholly-owned subsidiary of the Company, effective November 5, 2001. Previously, he was Senior Vice President and Chief Investment Officer for the Company's life operations since May 1999, Vice President since September 1998 and Vice President, Investment Strategy since February 1997. Prior to joining the Company in April 1996, Mr. Znamierowski held a variety of positions in the investment industry, including portfolio manager and Vice President of Investment Strategy and Policy for Aetna Life & Casualty Company from 1991 to April 1996 and Vice President of Corporate Finance for Salomon Brothers, Inc. since 1986. Mr. Znamierowski is a member of the Board of Governors of the Investment Company Institute and of the policy-making investment committee of the American Council of Life Insurance. He also serves as a director and President of each of The Hartford-sponsored mutual funds.
ITEM 2.
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 1.6 million square feet. In addition, The Hartford leases approximately 6.4 million square feet throughout the United States and 32 thousand square feet in other countries. All of the properties owned or leased are used by one or more of all ten 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.
ITEM 3. LEGAL PROCEEDINGS
The Hartford is or may become involved in various legal actions, some of which involve claims for substantial amounts. In the opinion of management, the ultimate liability with respect to such actual and potential lawsuits, after consideration of provisions made for potential losses and costs of defense, is not expected to be material to the consolidated financial condition, results of operations or cash flows of The Hartford.
The Hartford is involved in claims litigation arising in the ordinary course of business and accounts for such activity through the establishment of policy reserves. As further discussed in the MD&A under the Environmental and Asbestos Claims section, The Hartford continues to receive environmental and asbestos claims which involve significant uncertainty regarding policy coverage issues. With respect to these claims, The Hartford continually reviews its overall reserve levels, methodologies and reinsurance coverage.
ITEM 4.
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 the fiscal year covered by this report.
PART II
ITEM 5.
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. - ----------------------------------------------------------------------------- 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
Common Stock Price High $52.75 $64.00 $73.75 $79.31 Low 29.38 44.25 56.38 65.44 Dividends Declared 0.24 0.24 0.24 0.25 - -----------------------------------------------------------------------------
As of February 28, 2002, the Company had approximately 120,000 shareholders. The closing price of The Hartford's common stock on the NYSE on February 28, 2002 was $67.00.
On October 18, 2001, The Hartford's Board of Directors declared a quarterly dividend of $0.26 per share payable on January 2, 2002 to shareholders of record as of December 3, 2001. 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".
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ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
Outlined in the table below are United States Industry Combined Ratios for each of the five years ended December 31:
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ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (DOLLAR AMOUNTS IN MILLIONS, EXCEPT 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, 2001, compared with December 31, 2000, and its results of operations for the three years ended December 31, 2001, 2000 and 1999. This discussion should be read in conjunction with the Consolidated Financial Statements and related Notes beginning on page.
Certain of the statements contained herein or in Part I of the Company's Form 10-K (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 uncertain nature of damage theories and loss amounts and the development of additional facts related to the September 11 terrorist attack ("September 11"); the response of reinsurance companies under reinsurance contracts, the impact of increasing reinsurance rates, and the 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 difficulty in predicting the Company's potential exposure for environmental and asbestos claims and related litigation; 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 - --------------------------------------------------------------------------------
Consolidated Results of Operations: Operating Summary 17 Life 20 Investment Products 21 Individual Life 23 Group Benefits 24 Corporate Owned Life Insurance (COLI) 25 Property & Casualty 26 Business Insurance 27 Affinity Personal Lines 28 Personal Insurance 29 Specialty Commercial 30 Reinsurance 31 Other Operations 32 Deferred Acquisition Costs 33 Reserves 33 Environmental and Asbestos Claims 34 Investments 35 Capital Markets Risk Management 38 Capital Resources and Liquidity 48 Regulatory Matters and Contingencies 52 Effect of Inflation 52 Accounting Standards 52
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- -------------------------------------------------------------------------------- CONSOLIDATED RESULTS OF OPERATIONS: OPERATING SUMMARY - --------------------------------------------------------------------------------
The Hartford defines "operating income" (defined in previous years as "core earnings") as after-tax operational results excluding, as applicable, net realized capital gains and losses, extraordinary items, the cumulative effect of accounting changes and certain other items. Operating income is an internal 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
2001 COMPARED TO 2000 -- Revenues increased $444, or 3%. Included in revenues in 2001 was a $91 reduction in North American Property & Casualty premiums, resulting from additional reinsurance cessions related to September 11. Also included in revenues were net realized capital losses of $236 in 2001 and net realized capital gains of $145 in 2000. These capital gains and losses related primarily to the sales of international subsidiaries and other than temporary impairments on securities. Excluding the effects of both September 11 and the net realized capital gains and losses, revenues increased $916, or 6%. The increase was related to continued new business growth in Group Benefits, 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 underwriting 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%. Included in the Company's operating income for the year ended December 31, 2001, were $440 of losses, after-tax and net of reinsurance, related to September 11 and a $130 tax benefit at Hartford Life, Inc. ("HLI"), primarily the result of the favorable treatment of
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certain tax matters related to separate account investment activity during the 1996-2000 tax years. Excluding the effects of September 11 and HLI tax benefit, operating income increased $72, or 7%. The increase reflected favorable operating performance in the Company's Business Insurance, Individual Life, Investment Products and Group Benefits segments, partially offset by higher loss costs in the Company's Affinity Personal Lines and Personal Insurance segments as well as adverse loss development in the Reinsurance segment.
2000 COMPARED TO 1999 -- Revenues increased $1.2 billion, or 9%, primarily as a result of strong growth in fee income in the Investment Products and Individual Life segments, along with premium growth in the Group Benefits segment and in all North American Property & Casualty underwriting segments.
Operating income increased $125, or 15%, due to double-digit earnings growth across all segments in Life partially offset by a decline in Property & Casualty, primarily due to adverse loss development in Reinsurance, increased automobile losses in the Personal Insurance segment, expenses related to the Business Insurance field office and claim reorganizations and deteriorating underwriting results from discontinued operations (public entity ("PENCO"), Canada, Farm and Industrial Risk Insurance pool ("IRI").
SIGNIFICANT ACCOUNTING POLICIES
For information on the Company's significant accounting policies, see the Deferred Acquisition Costs, Reserves and Investments sections and Note 1 of Notes to Consolidated Financial Statements.
NET REALIZED CAPITAL GAINS AND LOSSES
See "Investment Results" in the Investments section.
INCOME TAXES
The effective tax expense (benefit) rate for 2001, 2000 and 1999 was (55)%, 28% and 23%, respectively. Excluding the impacts of September 11 and the HLI federal tax benefits of $130 and $24 in 2001 and 2000, respectively, the effective tax rate for 2001 was 17% compared with 29% and 23%, respectively, for 2000 and 1999. Excluding the impact of September 11 and the HLI federal tax benefits, the decrease in the effective tax rate for 2001 was primarily due to an increase in the proportionate share of tax-exempt net investment income to total pre-tax income for 2001 compared to 2000 and taxes related to the gain on the sale of Zwolsche Algemeene N.V. ("Zwolsche") in 2000. The increase in the effective tax rate for 2000, excluding the $24 tax benefit at HLI, was primarily due to taxes related to the gain on the sale of Zwolsche. (For a further discussion on the sale of Zwolsche, see the Other Operations section and Note 18(b) of Notes to the Consolidated Financial Statements.)
Tax-exempt interest earned on invested assets was the principal cause of effective rates lower than the 35% United States statutory rate in all years. Income taxes paid (received) in 2001, 2000 and 1999 were $(52), $95 and $41, respectively. (See Note 14 of Notes to Consolidated Financial Statements for further information.)
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%. (For additional information, see the Capital Resources and Liquidity section under "Acquisitions" and Note 16 of Notes to Consolidated Financial Statements.)
PER COMMON SHARE
The following table represents per common share data and return on equity for the past three years:
2001 2000 1999 - ------------------------------------------------------------------- Basic earnings per share $2.13 $4.42 $3.83 Diluted earnings per share $2.10 $4.34 $3.79 Weighted average common shares outstanding 237.7 220.6 224.9 Weighted average common shares outstanding and dilutive potential common shares 241.4 224.4 227.5 Return on equity excluding September 11 and Life tax benefit [1] 10.5% 15.4% 15.3% Return on equity [1] 6.6% 15.4% 15.3% - ------------------------------------------------------------------- [1] Calculated by dividing net income by average equity excluding unrealized gain (loss), after-tax.
SEGMENT RESULTS
The Hartford is organized into two major operations: Life and Property & Casualty. Within these operations, The Hartford conducts business principally in ten operating segments. Additionally, all activities related to The HLI Repurchase 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 Latin America and Japan, as well as corporate items not directly allocable to any of its reportable operating segments, principally interest expense.
Property & Casualty was reorganized into six reportable operating segments and, effective January 1, 2001, is reported as the North American underwriting segments of Business Insurance, Affinity Personal Lines, Personal Insurance, Specialty Commercial and Reinsurance; and the Other Operations segment, formerly "International and Other Operations".
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, which includes the combined underwriting results of the North American underwriting segments along with income and expense items not directly allocable to these segments, such as
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net investment income. 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 net realized capital gains and losses through net invested income utilizing the duration of the segment's investment portfolios.
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.
The following is a summary of operating income and net income.
An analysis of the operating results summarized above is included on the following pages. Reserves, Environmental and Asbestos Claims, and Investments are discussed in separate sections.
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- -------------------------------------------------------------------------------- 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 and 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.
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 Latin America and Japan, and corporate items not directly allocable 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 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 the Capital Resources and Liquidity section
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under "Acquisitions" and Note 16 of Notes to Consolidated Financial Statements.)
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.
Operating income increased $168, or 27%, led by the Individual Life and Group Benefits segments where operating 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 charge 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, operating income increased $90, or 15%, for the year ended December 31, 2001, as each of the Company's operating segments experienced growth from a year ago.
2000 COMPARED TO 1999 -- Revenues increased $454, or 8%, primarily related to the growth across each of Life's primary operating segments, particularly the Investment Products and Group Benefits segments, where revenues increased $339, or 17%, and $183, or 9%, respectively. The revenue growth in the Investment Products segment was primarily due to higher fee income in the individual annuity and retail mutual fund operations as related average assets under management in 2000 were higher than 1999. The Group Benefits segment experienced higher earned premiums due to strong sales and persistency. The Individual Life segment also contributed to the revenue increase as a result of strong sales and favorable persistency. Partially offsetting the growth in revenues was the decrease in COLI revenues primarily related to the declining block of leveraged COLI business.
Benefits, claims and expenses increased $352, or 7%, primarily related to the growth in Life's principal operating segments described above.
Operating income increased $165, or 35%, led by the Investment Products segment, where operating income increased $94, or 28%. Additionally, operating income related to each of the remaining three operating segments increased 10% or more. As discussed above, Life also recorded benefits of $32 in 2000 related to favorable tax items. Excluding these tax items, operating income increased $133, or 28%.
- -------------------------------------------------------------------------------- INVESTMENT PRODUCTS - --------------------------------------------------------------------------------
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.
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
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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 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.
Operating 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.
2000 COMPARED TO 1999 -- Revenues increased $339, or 17%, primarily due to higher fee income in the individual annuity and retail mutual fund operations. Fee income generated by individual annuities increased $227, or 20%, while related average account values grew $8.2 billion, or 10%, to $88.1 billion. The growth in average account values was due, in part, to strong sales of $10.7 billion in 2000, and the significant equity market performance in 1999, partially offset by surrenders. Although average individual annuity account values in 2000 were higher than 1999, account values at December 31, 2000 declined $1.7 billion, or 2%, as compared to December 31, 1999, as strong sales were not sufficient to offset surrenders and the impact of the retreating equity markets. In addition, fee income from other investment products increased $99, or 54%, primarily driven by the Company's retail mutual fund operation, where related assets under management increased $4.0 billion, or 63%. This substantial increase in the retail mutual fund operation was due to sales of $5.2 billion in 2000, which was partially offset by redemptions.
Due to the continued growth in this segment, particularly the individual annuity and retail mutual fund operations, total benefits, claims and expenses increased $229, or 15%. This increase was driven by amortization of deferred policy acquisition costs and operating expenses, which grew $86, or 20%, and $43, or 15%, respectively, primarily related to growth in the individual annuity operation. Additionally, non-deferred commissions increased $83, or 59%, principally related to growth in the retail mutual fund operation.
Operating income increased $94, or 28%, primarily due to the growth in revenues discussed above. Additionally, the Investment Products segment continued to maintain its profit margins related to its primary businesses, thus contributing to the segment's earnings growth. In particular, its individual annuity operation's operating expenses as a percentage of average individual annuity account values remained consistent with the prior year at 21 basis points.
OUTLOOK
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. This trend is not expected to subside, particularly in light of the Gramm-Leach-Bliley Act of 1999 ("the Financial Services Modernization Act"), which permits affiliations among banks, insurance companies and securities firms.
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 is introducing 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. SMART 529 will allow investors to choose from a wide variety of investment portfolios to match their risk preference to help accumulate savings for college. The SMART 529 product complements Hartford Life'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. The Hartford believes this is a significant market opportunity and the benefits of investing in 529 plans will be well received by many Americans saving for college.
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- -------------------------------------------------------------------------------- INDIVIDUAL LIFE - --------------------------------------------------------------------------------
The Individual Life segment sells a variety of life insurance products, including variable life, universal life, interest sensitive whole life and term life insurance primarily to the high end estate and business planning markets. 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.
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 a year ago. 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.
Operating 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, operating income increased $45, or 57%, primarily due to the growth factors described above.
2000 COMPARED TO 1999 -- Revenues increased $56, or 10%, resulting primarily from fee income associated with the growing block of variable life insurance. Fee income increased $59, or 15%, as variable life account values increased $352, or 14%, and variable life insurance in force increased $9.6 billion, or 40%.
Benefits, claims and expenses increased $47, or 10%, primarily due to a $16, or 6%, increase in benefits, claims and claim adjustment expenses and a $16, or 12%, increase in amortization of deferred policy acquisition costs mostly associated with the growth in this segment's variable business. Additionally, insurance operating costs and other expenses increased $15, or 17%, directly associated with the growth in this segment as previously described.
Operating income increased $8, or 11%, primarily due to higher fee income as mortality experience (death claims as a percentage of net amount at risk) was consistent with prior year.
OUTLOOK
Management believes that the Company's strong market position will provide opportunities for growth in this segment as individuals increasingly focus on estate planning. 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.
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- -------------------------------------------------------------------------------- GROUP BENEFITS - --------------------------------------------------------------------------------
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.
2001 COMPARED TO 2000 -- Revenues in the Group Benefits segment increased $300, or 14%, driven primarily by growth in 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, $85, or 19%, higher than the prior year. 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 ratios (defined as benefits and claims and claim adjustment expenses as a percentage of premiums and other considerations) have remained relatively consistent with the comparable prior year periods. 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.
Operating 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, operating income increased $18, or 20%. 2000 COMPARED TO 1999 -- Revenues increased $183, or 9%, driven primarily by growth in fully insured premiums, excluding buyouts, which increased $182, or 10%, principally due to favorable persistency of the in force block of business, as well as new sales. Also contributing to the revenue growth was an increase in net investment income of $31, or 16%.
Total benefits, claims and expenses increased $171, or 9%, primarily due to higher benefits, claims and claim adjustment expenses which, excluding buyouts, increased $168, or 12%, directly related to revenue growth in this segment. The segment's combined ratio (ratio of total benefits, claims and expenses as a percentage of earned premiums and other) was consistent with the prior year.
Operating income increased $11, or 14%, primarily driven by the increased revenues described above.
OUTLOOK
As employers continue to offer benefit plans in order to attract and retain valued employees, management expects that the need for group life and group disability insurance will continue to expand and believes the Company is well positioned to take advantage of this growth potential.
The Group Benefits segment offered Medicare supplement insurance to members of several retired military officer associations. Federal legislation effective in the fourth quarter of 2001, now provides retired military officers age 65 and older with full medical insurance paid for by the government, eliminating the need for Medicare supplement insurance. This legislation will reduce Group Benefits premium revenues by approximately $131 in 2002.
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- -------------------------------------------------------------------------------- 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 beneficiary under the policy. Until the Health Insurance Portability and Accountability Act of 1996 ("HIPA Act of 1996"), 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. The HIPA Act of 1996 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.
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.
Operating 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, operating income increased $5, or 15%.
2000 COMPARED TO 1999 -- Revenues in the COLI segment decreased $64, or 8%, primarily due to a decline in net investment income of $65, or 15%. This decline was principally due to the leveraged COLI block of business, as related account values decreased $751, or 13%, as a result of the continued downsizing caused by the HIPA Act of 1996.
Total benefits, claims and expenses decreased $70, or 9%, primarily due to the factor described above.
Operating income increased $4, or 13%, principally due to the variable COLI business where related account values increased $3.6 billion, or 29%, as well as earnings associated with a block of leveraged COLI business recaptured in 1998.
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 is expected to decline over the long run. COLI is subject to a changing legislative and regulatory environment that could have a material adverse effect on its business.
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- -------------------------------------------------------------------------------- PROPERTY & CASUALTY - --------------------------------------------------------------------------------
As discussed above, Property & Casualty was reorganized into six reportable operating segments and, effective January 1, 2001, is reported as the North American underwriting segments of Business Insurance, Affinity Personal Lines, Personal Insurance, Specialty Commercial and Reinsurance; and the Other Operations segment. 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 allocable to these segments, such as net investment income, net realized capital gains and losses, other expenses including interest and income taxes.
The following is a summary of Property & Casualty operating income, after-tax. Operating income excludes net realized capital gains and losses, restructuring charges, extraordinary items and the cumulative effect of accounting changes.
Underwriting results are discussed in each of the Business Insurance, Affinity Personal Lines, Personal Insurance, Specialty Commercial and Reinsurance segment sections. Net investment income and net realized capital gains and losses are
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discussed in the Investments section. (For a further discussion of September 11, see Capital Resources and Liquidity section and Note 2 of Notes to Consolidated Financial Statements.)
2001 COMPARED TO 2000 -- Operating income decreased $443 as compared with 2000. Excluding the $420 impact of September 11, operating income 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.
2000 COMPARED TO 1999 -- Operating income decreased $27, or 6%, primarily due to adverse loss development in Reinsurance, expenses related to the Business Insurance field office and claim reorganizations, deteriorating underwriting results from discontinued operations (PENCO, Canada, Farm and IRI) and increased automobile losses in the Personal Insurance segment. Partially offsetting this decrease was a reduction in property catastrophe losses and improvement in Business Insurance mid-market results.
- -------------------------------------------------------------------------------- BUSINESS INSURANCE - --------------------------------------------------------------------------------
Business Insurance provides workers' compensation, property, automobile and liability coverages to small ("Select Customer") and mid-sized ("Key Accounts") commercial businesses primarily throughout the United States. This segment also provides commercial risk management products and services to small and mid-sized members of affinity groups in addition to marine coverage.
2001 COMPARED TO 2000 -- Written premiums increased $481, or 20%, driven by strong growth in Select Customer and Key Accounts. Select Customer increased $209, or 19%, as a result of pricing increases, strong premium renewal retention and the success of product, marketing, technology and service growth initiatives. The increase in Key Accounts of $195, or 19%, was attributable primarily to significant pricing increases and improved premium renewal retention as well as strong new business growth.
Excluding the impact of September 11, underwriting results improved $53, with a corresponding 2.8 point decrease in the combined ratio. The improvement for the year 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 current year benefits of the 2000 field office reorganization and reorganization costs in 2000 not recurring in 2001.
2000 COMPARED TO 1999 -- Written premiums increased $178, or 8%, primarily as a result of strong growth in Select Customer, up $171, or 19%. Enhanced product offerings, targeted geographic strategies and new business growth coupled with mid-single digit price increases were the primary drivers of the Select Customer growth. This increase was slightly offset by a 2% decrease in Key Accounts. The decline in mid-market premiums reflected the effective execution of the Company's underwriting initiatives, although significant price increases partially mitigated this decrease.
Underwriting results improved $73, or 5.0 combined ratio points, primarily the result of reduced loss ratios due to the effective execution of pricing actions and lower catastrophe losses. A decrease in the expense ratio, despite field and claim reorganization costs, also contributed to the lower combined ratio.
OUTLOOK
Firming market conditions in the standard commercial sector are expected to continue in 2002, although price competition within many markets of the commercial industry will remain a challenge. Additionally, September 11 has created an ambiguous environment and economic uncertainty as federal backing in the event of future terrorist attacks remains uncertain. Uncertainties in the reinsurance market also may impact the segment's ability to obtain adequate reinsurance coverage for certain exposures at a reasonable price. Management expects significant growth in small commercial businesses will continue to be achieved, in part, due to continued strategic actions being implemented. This includes providing a complete product solution for the small commercial coverage needs of the
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segment's 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, alliances and policyholders. Continued pricing and underwriting actions in the middle market business should continue to have a positive impact on overall profitability in 2002.
- -------------------------------------------------------------------------------- AFFINITY PERSONAL LINES - --------------------------------------------------------------------------------
Affinity Personal Lines provides automobile, homeowners and home-based business coverages to individuals across the United States. Affinity Personal Lines is organized to provide customized products and services to the following markets: the membership of AARP through a direct marketing operation; customers of Sears, Roebuck & Co. ("Sears") and Ford Motor Company and Ford Motor Credit Company (collectively, "Ford") as well as customers of financial institutions through an affinity center. Affinity 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.
2001 COMPARED TO 2000 -- Written premiums increased $180, or 11%, driven by growth in both the AARP program and Affinity business unit. AARP increased primarily as a result of strong new business growth and continued steady premium renewal retention. The improvement in the Affinity business unit continues to reflect increased new business from the Ford and Sears accounts.
Excluding the impact of September 11, underwriting results decreased $53, with a corresponding 2.8 point increase 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 slightly as compared to the prior year, primarily as a result of prudent expense management.
2000 COMPARED TO 1999 -- Written premiums increased $132, or 9%, due primarily to policy count growth and improved renewal retention in the AARP program as well as growth in the Affinity business unit resulting from increased business from the Ford and Sears accounts.
Underwriting results decreased $2, with a slight improvement in the combined ratio. The decrease in underwriting results was primarily due to increased automobile losses, partially offset by strong improvement in the AARP homeowners line. The combined ratio improvement was primarily attributable to a decrease in the expense ratio, reflecting productivity gains from prior initiatives.
OUTLOOK
The personal lines industry is struggling to regain its momentum towards profitability as rising loss costs resulting from inflation in both medical and automobile repair costs have adversely impacted results. In addition, September 11 will likely have negative short-term implications to the industry as a result of lower investment yields and higher reinsurance rates. More severe catastrophes could also impact future results. Management does believe, however, that with increased rate activity, the personal lines industry will be positioned for recovery.
During the fourth quarter of 2001, The Hartford's exclusive licensing arrangement with AARP to offer personal insurance products to the over 34 million AARP members was renewed through January 1, 2010. This agreement provides the segment with an important competitive advantage. Favorable "baby boom" demographics as well as initiatives implemented to further strengthen the AARP relationship are expected to increase membership during this period.
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- -------------------------------------------------------------------------------- PERSONAL INSURANCE - --------------------------------------------------------------------------------
Personal Insurance provides automobile, homeowners and home-based business coverages to individuals across the United States. Personal Insurance is organized to provide products and services to individuals who prefer local agent involvement through a network of independent agents in the standard personal lines market and through Omni Insurance Group ("Omni"), in the non-standard automobile market.
2001 COMPARED TO 2000 -- Written premiums increased $33, or 3%, primarily due to premium growth in the standard automobile and homeowners lines as a result of pricing increases and strong premium renewal retention. Premium declines in non-standard auto reflect decreased policy counts, the result of significant price increases to address loss cost issues.
Excluding the impact of September 11, underwriting results decreased $27, with a corresponding 2.6 point increase in the combined ratio. Increased automobile losses in both standard and non-standard adversely impacted the underwriting results and combined ratios. In addition, higher losses and increased litigation costs resulted in an increase in the loss adjustment expense ratio. Partially offsetting the combined ratio increase was improvement in the expense ratio, primarily due to lower commissions and prudent expense management.
2000 COMPARED TO 1999 -- Written premiums increased $45, or 5%, due primarily to policy count growth and improved renewal retention in the standard automobile and homeowners' lines. Non-standard automobile written premiums through Omni decreased for the year as a result of an expected consumer reaction to rate increases in certain states.
Underwriting results decreased $30, with a corresponding 1.9 point increase in the combined ratio. The decrease in underwriting results and related increase in the combined ratio were primarily due to increased standard and non-standard automobile losses. Partially offsetting this decrease was an improvement in the homeowners line of business. A 1.4 point decrease in the expense ratio for the year reflected the continued trend of productivity gains from prior initiatives.
OUTLOOK
The personal lines industry is struggling to regain its momentum towards profitability as rising loss costs resulting from inflation in both medical and automobile repair costs have adversely impacted results. In addition, September 11 will likely have negative short-term implications to the industry in the form of lower investment yields and higher reinsurance rates. More severe catastrophes could also impact future results. Management does believe, however, that with increased rate activity, the personal lines industry will be positioned for recovery.
Strategic actions being taken by the Personal Insurance segment include unprofitable agency closures in the standard lines and a continued shift in state mix away from poor loss performing states in non-standard automobile. Additionally, further investments in technology, continued efforts to reduce expenses and improve the product line, ease of doing business and customer service capability will position Personal Insurance to take advantage of future market conditions.
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- -------------------------------------------------------------------------------- SPECIALTY COMMERCIAL - --------------------------------------------------------------------------------
Specialty Commercial provides insurance through retailers and wholesalers to large commercial clients and insureds requiring a variety of specialized coverages. The segment's results also include the professional liability and bond lines as well as First State Management Group, a leading underwriter of excess and surplus lines business produced primarily through wholesale brokers. Agricultural and livestock products are also included in the property line of business in Specialty Commercial.
2001 COMPARED TO 2000 -- Written premiums decreased $84, 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.
Excluding the impact of September 11, underwriting results improved $8, with a 1.2 point 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 was 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 commission ratio 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.
2000 COMPARED TO 1999 -- Written premiums increased $126, or 13%, primarily due to the purchase of Reliance's in force, new and renewal financial products business as well as the majority of the excess and surplus lines in 2000, which resulted in $108 of additional written premiums for the year. Higher written premiums in the casualty line of business also contributed to the increase.
Underwriting results decreased $55, impacting the combined ratio by 2.0 points, primarily the result of increased losses and loss adjustment expenses in the property and bond lines of business as well as in PENCO and Canada. The combined ratio was adversely impacted by the higher loss ratios. The increase in the combined ratio was partially offset by a decrease in the expense ratio.
OUTLOOK
Firming market conditions in the specialty commercial sector are expected to continue in 2002. However, September 11 has created an ambiguous environment and economic uncertainty as federal backing in the event of future terrorist attacks remains uncertain. Uncertainties in the reinsurance market also may impact the segment's ability to obtain adequate reinsurance coverage for certain exposures at a reasonable price. Strong property pricing should be even stronger in 2002 as a result of September 11. New capital is flowing into the industry as a result of a hardening market, thereby increasing capacity. Management believes, however, that strategic actions being taken which include providing innovative new products as well as expanding product lines; expanding non-traditional distribution alternatives; and further leveraging underwriting discipline and capabilities will position the segment to capitalize on a continued improving marketplace.
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- -------------------------------------------------------------------------------- REINSURANCE - --------------------------------------------------------------------------------
The Hartford assumed reinsurance worldwide through its thirteen Hartford Reinsurance Company ("HartRe") offices and wrote treaty reinsurance through professional reinsurance brokers covering various property, casualty, specialty and marine classes of business until the fourth quarter of 2001. In October 2001, HartRe announced a centralization of all underwriting and claims operations in Hartford, Connecticut and an exit from all international lines except catastrophe, Alternative Risk Transfer ("ART") and marine. The exited international lines contributed $101 of written premiums in 2001.
2001 COMPARED TO 2000 -- Written premiums increased $92, or 11%, primarily due to growth in ART written premiums, driven primarily by a significant first quarter ART transaction. The achievement of double-digit pricing increases in traditional reinsurance was offset by underwriting discipline to maintain profitability targets.
Excluding the impact of September 11, underwriting results decreased $76, with a corresponding 7.2 point increase in the combined ratio. The decrease in underwriting results and corresponding increase in the combined ratio were primarily attributable to continued adverse loss development on prior underwriting years.
2000 COMPARED TO 1999 -- Reinsurance written premiums increased $123, or 17%, primarily due to successful pricing increases in a firming pricing environment, as well as growth in new casualty programs business, and continued execution of new business development strategies in the ART line.
Underwriting results decreased $25, with a corresponding 1.7 point increase in the combined ratio. This decrease was primarily due to adverse prior underwriting years loss development, partially offset by lower property catastrophe losses.
OUTLOOK
As a result of September 11, the reinsurance market has been transformed to an environment of some uncertainty. Net new capital, price increases and modifications in contract terms and conditions have contributed to the uncertainty. The property and casualty worldwide reinsurance market remains extremely competitive, although the pricing environment continued to improve in 2001. It is anticipated by management that rates and terms will continue to improve in 2002. HartRe's organizational realignment has created a centralized organization aimed at enhancing core functions consistent with the segment's return objectives. HartRe will be established as a specialized worldwide property catastrophe underwriting practice, blending technical underwriting expertise and state-of-the-art catastrophe modeling and risk portfolio analysis.
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- -------------------------------------------------------------------------------- OTHER OPERATIONS - --------------------------------------------------------------------------------
The Other Operations segment, formerly International and Other Operations, consists of certain property and casualty insurance operations of The Hartford which have discontinued 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, Ltd, located in the United Kingdom. The main focus of these operations is the proper disposition of claims, resolving disputes and collecting reinsurance proceeds related largely to business underwritten and reinsured prior to 1985. Also included in Other Operations are the Company's international property and casualty businesses.
During the fourth quarter 2001, the Company finalized a new management structure within its Other Operations segment that consolidates the management and claims handling responsibility of the Company's environmental and asbestos exposures. In addition, the Company consolidated its environmental and asbestos reserves into one legal entity within Other Operations. The transaction was accomplished through the use of an intercompany reinsurance agreement, and resulted in $602 of reserves, primarily related to environmental and asbestos exposures from 1986 and prior, being ceded from the Specialty Commercial segment to Other Operations. There was no impact to the Company's consolidated financial condition or results of operations as a result of this transaction.
The Other Operations segment results include activity for the Company's international property and casualty businesses up until their dates of sale as discussed below. Products offered by these companies included property and casualty products in both personal and commercial lines as well as life insurance products and services designed to meet the needs of local customers. The sale of all of The Hartford's property and casualty international businesses continued the Company's strategic shift in its international operations to emphasize growth opportunities in asset accumulation business.
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 which was reported in the 2001 investment results of North American.
On December 22, 2000, The Hartford completed the sale of Zwolsche 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 which was reported in the 2000 investment results of North American.
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.
2000 COMPARED TO 1999 -- Revenues were down $59, or 9%, primarily due to lower earned premiums at Zwolsche. Operating income was down $5, or 23%, primarily due to a higher calendar year loss ratio in automobile business in Hartford Seguros and unfavorable foreign exchange impacts.
OUTLOOK
Except for the uncertainties related to dispute resolution, reinsurance collection and those discussed in the Environmental and Asbestos Claims section, management does not anticipate the future financial performance of Other Operations to have a material effect on the future operating results of the Company.
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- -------------------------------------------------------------------------------- DEFERRED ACQUISITION COSTS - --------------------------------------------------------------------------------
Management is required to make estimates and assumptions that affect the reported amounts of 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. One of the significant estimates made includes those used in determining deferred policy acquisition costs. Although some variability is inherent in these estimates, management believes the amounts provided are adequate.
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.
Deferred policy acquisition costs 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 expected gross profits from investment, mortality and expense margins and surrender charges. Actual gross profits can vary from management's estimates, resulting in increases or decreases in the rate of amortization. Management periodically reviews these estimates and evaluates the recoverability of the deferred acquisition cost asset. When appropriate, management revises its assumptions on the estimated gross profits of these contracts and the cumulative amortization for the books of business are re-estimated and adjusted by a cumulative charge or credit to income. The average rate of assumed future investment yield used in estimating expected gross profits related to variable annuity and variable life business was 9% at December 31, 2001 and for all other products including fixed annuities and other universal life type contracts the average assumed investment yield ranged from 5.0% - 8.5%.
Deferred policy acquisition costs related to traditional policies are amortized over the premium paying period of the related policies in proportion to the ratio of the present value of annual expected premium income to the present value of total expected premium income. Adjustments are made each year to recognize actual experience as compared to assumed experience for the current period.
To date, our experience has generally been consistent or favorable to the assumptions used in determining DAC amortization. However, if we were to experience a material adverse deviation in certain critical assumptions, including surrender rates, mortality experience, or investment performance, there could be a negative effect on the Company's reported earnings and stockholders' equity.
PROPERTY & CASUALTY
The Property & Casualty operations also incur costs related to the acquisition of new and renewal insurance policies. These costs include agent and broker commissions, premium taxes and certain other underwriting expenses. These costs are deferred and amortized over policy terms. Estimates of the present value of future revenues, including net investment income and tax benefits, are compared to estimates of the present value of future costs, including amortization of policy acquisition costs, to determine if the deferred acquisition costs are recoverable, and if not, they are charged to expense.
- -------------------------------------------------------------------------------- RESERVES - --------------------------------------------------------------------------------
LIFE
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 death. 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. Certain contracts include provisions whereby a guaranteed 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. The Company records the death benefit costs, net of reinsurance, as they are incurred. 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. 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.
The persistency of The Hartford's annuity and other interest-sensitive life insurance reserves is enhanced by policy restrictions on the withdrawal of funds. Withdrawals in excess of allowable penalty-free amounts are assessed a surrender charge during a penalty period, which is usually at least seven years. Such surrender charge is initially a percentage of either the accumulation value or considerations received, which varies
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by product, and generally decreases gradually during the penalty period. Surrender charges are set at levels to protect The Hartford from loss on early terminations and to reduce the likelihood of policyholders terminating their policies during periods of increasing interest rates, thereby lengthening the effective duration of policy liabilities and improving the Company's ability to maintain profitability on such policies.
PROPERTY & CASUALTY
The Hartford establishes property and casualty reserves to provide for the estimated costs of paying claims made by policyholders or against policyholders. 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. The uncertainties involved with the reserving process have become increasingly unpredictable due to a number of complex factors including social and economic trends and changes in the concepts of legal liability and damage awards. Accordingly, final claim settlements may vary from the present estimates, particularly when those payments may not occur until well into the future.
As a result of September 11, the Company established estimated gross reserves of $1.1 billion and estimated net reserves of $556 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 unknown and unreported policyholder losses and costs incurred in settling claims. Included in net reserves was an estimate of amounts recoverable under the Company's ceded reinsurance programs. As a result of the uncertainties involved in the estimation process, final claims settlement may vary from present estimates.
The Hartford continually reviews the adequacy of its estimated claims and claim adjustment expense reserves on an overall basis. As additional experience and other relevant data become available, reserve levels are adjusted accordingly. Adjustments to previously established reserves, if any, will be reflected in the operating results of the period in which the adjustment is made. For the year ended December 31, 2001, there were no changes to these reserving assumptions that had a significant impact on the reserves or results of operations. In the judgment of management, all information currently available has been properly considered in the reserves established for claims and claim adjustment expenses. For a discussion of environmental and asbestos claims and the uncertainties related to these reserves, refer to the next section.
- -------------------------------------------------------------------------------- ENVIRONMENTAL AND ASBESTOS CLAIMS - --------------------------------------------------------------------------------
The Hartford continues to receive claims that assert damages from environmental exposures and for injuries from asbestos and asbestos-related products, both of which affect the Property & Casualty operation. Environmental claims relate primarily to pollution and related clean-up costs. With regard to these claims, uncertainty exists which impacts the ability of insurers and reinsurers to estimate the ultimate reserves for unpaid losses and related settlement expenses. The Hartford finds that conventional reserving techniques cannot estimate the ultimate cost of these claims because of inadequate development patterns and inconsistent emerging legal doctrine. The majority of environmental claims and many types of asbestos claims differ from any other type of contractual claims because there is almost no agreement or consistent precedent to determine what, if any, coverage exists or which, if any, policy years and insurers or reinsurers may be liable. Further uncertainty arises with environmental claims since claims are often made under policies, the existence of which may be in dispute, the terms of which may have changed over many years, which may or may not provide for legal defense costs, and which may or may not contain environmental exclusion clauses that may be absolute or allow for fortuitous events. Courts in different jurisdictions have reached disparate conclusions on similar issues and in certain situations have broadened the interpretation of policy coverage and liability issues. In light of the extensive claim settlement process for environmental and asbestos claims, which involves comprehensive fact gathering, subject matter expertise and intensive litigation, The Hartford established an environmental claims facility in 1992 to defend itself aggressively against unwarranted claims and to minimize costs.
Within the property and casualty insurance industry in the mid-1990s, progress was made in developing sophisticated, alternative methodologies utilizing company experience and supplemental databases to assess environmental and asbestos liabilities. Consistent with The Hartford's practice of using the best techniques to estimate the Company's environmental and asbestos exposures, a study was initiated in April 1996 based on known cases. The Hartford, utilizing internal staff supplemented by outside legal and actuarial consultants, completed the study in October 1996.
The study included a review of identified environmental and asbestos exposures of North American Property & Casualty, along with the United States exposures of The Hartford's Other Operations segment. The methodology utilized a ground-up analysis of policy, site and exposure level data for a representative sample of The Hartford's claims. The results of the evaluation were extrapolated against the balance of the claim population to estimate the Company's overall exposure for reported claims.
In addition to estimating liabilities on reported environmental and asbestos claims, The Hartford estimated reserves for claims incurred but not reported. The IBNR reserve was estimated using information on reporting patterns of known insureds, characteristics of insureds such as limits exposed, attachment points and number of coverage years involved, third party costs and closed claims.
Included in The Hartford's analysis of environmental and asbestos exposures was a review of applicable reinsurance
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coverage. Reinsurance coverage applicable to the sample was used to estimate the reinsurance coverage that applied to the balance of the reported environmental and asbestos claims and to the IBNR estimates.
An international actuarial firm reviewed The Hartford's approach and concluded that the way the Company studied its exposures, the thoroughness of its analysis and the way The Hartford came to its estimates were reasonable and comprehensive. The Company believes that its methodology continues to be reasonable and comprehensive.
Reserve activity for both reported and unreported environmental and asbestos claims, including reserves for legal defense costs, for the years ended December 31, 2001, 2000 and 1999, was as follows (net of reinsurance):
Actual claim settlements since 1996 have indicated that a smaller proportion of the total environmental and asbestos reserves should have originally been allocated to environmental, with a greater portion allocated to asbestos. As a result, during the fourth quarter of 2001, the Company reclassified $100 of environmental reserves to asbestos.
With the consolidation of The Hartford's environmental and asbestos liabilities into the Other Operations segment, as previously discussed in the Other Operations section, essentially all of the Company's environmental and asbestos reserves are held within Other Operations. The Hartford believes that the environmental and asbestos reserves, reported at December 31, 2001, are a reasonable estimate of the ultimate remaining liability for these claims based upon known facts, current assumptions and The Hartford's methodologies. Future social, economic, legal or legislative developments may alter the original intent of policies and the scope of coverage. The Hartford will continue to evaluate new methodologies and developments, such as the increasing level of asbestos claims being tendered under the comprehensive general liability operations (non-product) section of policies, as they arise in order to supplement the Company's ongoing analysis and review of its environmental and asbestos exposures. These future reviews may result in a change in reserves, impacting The Hartford's results of operations in the period in which the reserve estimates are changed. While the impact of these changes could have a material effect on future results of operations, The Hartford does not expect such changes would have a material effect on its liquidity or financial condition.
- -------------------------------------------------------------------------------- INVESTMENTS - --------------------------------------------------------------------------------
Return on 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 17% and 19% of the Company's consolidated revenues for the years ended December 31, 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 86% and 85% of the fair value of its invested assets as of December 31, 2001 and 2000, 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 3% of the fair value of its invested assets as of December 31, 2001 and 2000. 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 significant decrease in the fair value of any investment that is deemed other than temporary could result in the Company's recognition of a loss in its financial results prior to the actual sale of the investment.
The Hartford's investment portfolios are divided between Life and Property & Casualty. The investment portfolios are
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managed based on the underlying characteristics and nature of each operation's respective liabilities and within established risk parameters. (For a further discussion on 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.
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 following table identifies the invested assets by type held in the general account as of December 31, 2001 and 2000.
During 2001, fixed maturity investments increased $5.1 billion as a result of the Fortis acquisition, increased operating cash flow and an increase in fair value due to a lower interest rate environment. The decrease in policy loans was primarily due to the decrease in leveraged COLI business, partially offset by policy loans acquired as a result of the Fortis acquisition. Policy loans are secured by the cash value of the associated life policy and do not mature in a conventional sense, but expire in conjunction with the related policy liabilities.
The following table identifies, by type, the fixed maturity securities held in the general account as of December 31, 2001 and 2000.
During 2001, corporate and ABS fixed maturity investments increased due to the Fortis acquisition.
As of December 31, 2001 and 2000, approximately 21% and 22%, respectively, of Life's fixed maturities were invested in private placement securities (including 12% and 13% of Rule 144A offerings as of December 31, 2001 and December 31, 2000, 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 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.
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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 previously discussed increase in 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 fixed maturities of $105, including a $37 loss related to securities issued by Enron Corporation. 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.
2000 COMPARED TO 1999 -- Net investment income, excluding policy loan income, increased $113, or 10%. The increase was primarily due to higher yields earned on the investment of cash flow from operations and reinvestment of proceeds from sales and maturities of fixed maturity securities in a higher interest rate environment. Policy loan income decreased $83, or 21%, due to the decrease in leveraged COLI business.
Net realized capital losses increased $83 primarily as a result of portfolio rebalancing in a higher interest rate environment.
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 following table identifies the invested assets by type held as of December 31, 2001 and 2000.
During 2001, fixed maturity investments increased slightly, as a result of an increase in operating and financing cash flow and an increase in fair value due to a lower interest rate environment, partially offset by a decline in fixed maturities due to sales of international subsidiaries.
The following table identifies, by type, the fixed maturity securities held as of December 31, 2001 and 2000.
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During 2001, corporate fixed maturities increased primarily due to a reallocation from municipal tax-exempts, resulting from a strategy to invest in this sector during a period of wide credit spreads.
INVESTMENT RESULTS
The following table below summarizes Property & Casualty's investment results.
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 of $61 on fixed maturities, including a $16 loss related to securities issued by Enron Corporation, and $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.
2000 COMPARED TO 1999 -- Both before- and after-tax net investment income and yields were relatively flat compared to the prior year.
Net realized capital gains increased by $195 for 2000 primarily as a result of the $242 before-tax gain recognized on the sale of Zwolsche, partially offset by net realized capital losses in the investment portfolio.
CORPORATE
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 investment's carrying values is reported in Corporate's net investment income. The total amount of before-tax amortization for the years ended December 31, 2001 and 2000 was $18 and $10, respectively. Also reported in Corporate as of December 31, 2001 and 2000 are $3 and $5, respectively, of fixed maturity security investments.
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 $104.6 billion and $104.3 billion as of December 31, 2001 and 2000, respectively, wherein the policyholder assumes substantially all the risk and reward; and guaranteed separate accounts totaling $10.1 billion and $9.8 billion as of December 31, 2001 and 2000, 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.
- -------------------------------------------------------------------------------- CAPITAL MARKETS RISK MANAGEMENT - --------------------------------------------------------------------------------
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 separate and distinct risk management units supporting Life 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
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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.
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 interval.
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 Hartford is not exposed to any credit concentration risk of a single issuer greater than 10% of the Company's stockholders' equity.
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.
LIFE
As of December 31, 2001 and 2000, over 96% and 97%, respectively, of the fixed maturity portfolio was invested in securities rated investment grade (BBB and above). During 2001, the percentage of BBB rated fixed maturity investments increased due to the Fortis acquisition and the continued active management of the general account portfolios.
PROPERTY & CASUALTY
As of December 31, 2001 and 2000, over 94% and 95%, respectively, of the fixed maturity portfolio was invested in securities rated investment grade. During 2001, the percentage of BBB rated fixed maturity investments increased primarily due to the continued active management of the general account portfolios.
MARKET RISK
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.
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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 2001 resulted in a significant increase in the unrealized appreciation of the fixed maturity security portfolio from 2000. However, The Hartford's asset allocation and its exposure to market risk as of December 31, 2001 have not changed materially from its position at December 31, 2000.
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.
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 three Company approved objectives: to hedge risk arising from interest rate, price or currency exchange rate volatility; to manage liquidity; or to control transaction costs. The Company does not make a market or trade derivatives for the express purpose of earning trading profits.
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.
The Company uses derivative instruments in its management of market risk consistent with four risk management strategies: hedging anticipated transactions, hedging liability instruments, hedging invested assets and hedging portfolios of assets and/or liabilities. (For additional information on these strategies along with tables reflecting outstanding derivative instruments, see the Life and Property & Casualty discussions below.)
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 for both general and guaranteed separate accounts at December 31, 2001 and 2000 totaled $11.2 billion and $8.8 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 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, 2001. Comparative totals are included as of December 31, 2000.
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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, 2001 and 2000, 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.
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The table below provides information as of December 31, 2001 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, 2000.
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. As an end-user of derivatives, 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, 2001, notional amounts pertaining to derivatives totaled $9.9 billion ($8.2 billion related to insurance investments and $1.7 billion related to life insurance liabilities). Notional amounts pertaining to derivatives totaled $8.5 billion at December 31, 2000 ($6.5 billion related to insurance investments and $2.0 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 characteristics equivalent to the associated liabilities or anticipated investments. The notional amounts of anticipatory hedges as of December 31, 2001 and 2000 were $320 and $144, 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
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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, 2001 and 2000 were $1.7 billion and $2.0 billion, respectively.
Asset Hedging -- To meet the various policyholder obligations and to provide cost-effective, prudent investment risk diversification, the Company may combine two or more financial instruments to achieve the investment characteristics of a fixed maturity security or that match an associated liability. The use of derivative instruments in this regard effectively transfers unwanted investment risks or attributes to others. The selection of the appropriate derivative instruments depends on the investment risk, the liquidity and efficiency of the market, and the asset and liability characteristics. The notional amounts of asset hedges as of December 31, 2001 and 2000 were $6.8 billion and $5.4 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, 2001 and 2000 were $1.1 and $1.0 billion, respectively.
The following tables provide information as of December 31, 2001 with comparative totals for December 31, 2000 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.
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Currency Exchange Risk - ----------------------
As of December 31, 2001, Life had immaterial currency exposures resulting from its international operations.
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.
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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, 2001 are reflected in the table below by expected maturity year. Comparative totals are included for December 31, 2000.
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 are shown in the following table.
Change in Net Economic Value 2001 2000 ------------------------------------------ Basis point shift - 100 + 100 - 100 + 100 - ---------------------------------------------------------------------- Amount $ 6 $ (31) $ (15) $ (27) Percent of liability value 0.03% (0.16)% (0.09)% (0.16)% ======================================================================
These fixed liabilities represented about 61% and 60% of Life's general and guaranteed separate account liabilities at December 31, 2001 and 2000, 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 and 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.
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, 2001 and 2000 of $1.3 billion and $318, 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, 2001, are reflected in the following table. Comparative totals are included as of December 31, 2000. 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, 2001 and 2000, 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
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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.
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The following table provides information as of December 31, 2001 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, 2000. The weighted average rates are based on spot rates as of December 31, 2001 and 2000.
Property & Casualty uses option contracts to hedge fixed maturity investments that totaled $252 in notional value and $1 in carrying value as of December 31, 2001. There were no option contracts in use as of December 31, 2000.
The table below provides information as of December 31, 2001 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, 2000.
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, 2001 and 2000, grouped by major market type.
2001 2000 ------------------------------------------- FAIR VALUE PERCENT FAIR VALUE PERCENT - -------------------------------------------------------------------- EQUITY SECURITIES Domestic Large cap $ 393 42.7% $ 521 58.9% Midcap/small cap 342 37.1% 179 20.2% Foreign EAFE [1]/ Canadian 184 20.0% 185 20.9% Emerging 2 0.2% -- -- - -------------------------------------------------------------------- TOTAL $ 921 100.0% $ 885 100.0% ==================================================================== [1] Europe, Australia, Far East countries index.
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Currency Exchange Risk - ----------------------
As of December 31, 2001, Property & Casualty had immaterial currency exposures resulting from its international operations.
Currency exchange risk also exists with respect to investments in foreign equity securities. Forward foreign contracts with a notional amount of $7 and $8 were used to manage this risk at December 31, 2001 and 2000, respectively.
CORPORATE
Interest Rate Risk - ------------------
The primary exposure to interest rate risk in Corporate relates to the debt issued in connection with The HLI Repurchase. Corporate also has $3 in fixed maturity security investments that represent an immaterial interest rate exposure.
The table below provides information as of December 31, 2001 on Corporate's debt obligations and reflects principal cash flows and related weighted average interest rates by maturity year.
- -------------------------------------------------------------------------------- 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 and borrow funds at competitive rates to meet operating and growth needs. The capital structure of The Hartford as of December 31, 2001 and 2000 consisted of debt and equity, and as of December 31, 1999 also consisted of minority interest, summarized as follows:
CONTRACTUAL OBLIGATION AND COMMITMENTS
The following table identifies the Company's contractual obligations by payment due period.
In addition to the contractual obligations above, The Hartford had certain unfunded commitments at December 31, 2001 to fund limited partnership investments totaling $375. These capital commitments can be called by the partnerships during
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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.
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.
HLI Repurchase
On June 27, 2000, The Hartford acquired all of the outstanding shares of HLI that it did not already own. The HLI Repurchase was recorded as a purchase transaction.
Purchase consideration for the transaction was as follows:
Issuance of: - ------------ Common stock from treasury (7.25 million shares @ $54.90 per share) $ 398 Long-term notes: $250 7.75% notes due June 15, 2005 244 $275 7.90% notes due June 15, 2010 272 Commercial paper 400 - ----------------------------------------------------------------------- Consideration raised 1,314 Other, including conversion of HLI employee stock options and restricted shares 102 - ----------------------------------------------------------------------- Total consideration $ 1,416 - -----------------------------------------------------------------------
For a further discussion of the HLI Repurchase, see Note 16 of Notes to Consolidated Financial Statements.
CAPITALIZATION
The Hartford's total capitalization, excluding unrealized gain (loss) on securities and other, net of tax, increased by $2.0 billion as of December 31, 2001 compared to December 31, 2000. This change was primarily the result of earnings and financing activities related to Fortis and September 11, partially offset by dividends declared.
The Hartford's total capitalization, excluding unrealized gain (loss) on securities and other, net of tax, increased by $1.3 billion as of December 31, 2000 compared to December 31, 1999. This change was primarily the result of earnings and financing activities related to The HLI Repurchase, partially offset by dividends declared and the effect of treasury stock acquired in the first quarter of 2000.
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, 2001, HLI had $1.0 billion remaining on its shelf.
On November 9, 2000, The Hartford filed with the Securities and Exchange Commission a shelf registration statement and a prospectus, as amended on January 31, 2001, for the potential offering and sale of up to $2.6 billion in debt and equity securities. As of December 31, 2001, The Hartford had $1.1 billion remaining on its shelf.
For a further discussion of the shelf registration statements, see Note 6 of Notes to Consolidated Financial Statements.
DEBT
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, 2001, the Company had $299 of outstanding borrowings under the program.
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, 2001, there were no outstanding borrowings under the facility.
HLI has a commercial paper program which allows it to borrow up to a maximum amount of $250 in short-term commercial paper notes. As of December 31, 2001, HLI had no outstanding borrowings under the program.
As of December 31, 2001, HLI maintained a $250 five-year revolving credit facility comprised of four participatory banks. As of December 31, 2001, 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.
On June 16, 2000, The Hartford issued and sold $525 of unsecured redeemable long-term debt. On June 23, 2000, The Hartford issued $400 of commercial paper. Proceeds from the debt issuances were used to partially fund The HLI Repurchase. The Company used proceeds from the sale of Zwolsche to pay off the $400 of commercial paper on December 29, 2000.
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For additional information regarding debt, see Note 6 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.
For a further discussion of Company Obligated Mandatorily Redeemable Preferred Securities of Subsidiary Trusts Holding Solely Junior Subordinated Debentures, see Note 7 of Notes to Consolidated Financial Statements.
STOCKHOLDERS' EQUITY
Issuance of common stock - 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.
Issuance of common stock from treasury - On June 8, 2000, The Hartford issued 7.25 million shares of common stock in a block trade to Goldman, Sachs & Co. for $398. The shares were issued out of treasury. The Hartford used the net proceeds from the issuance of the shares to partially fund The HLI Repurchase.
Dividends - The Hartford declared $242 and paid $235 in dividends to shareholders in 2001, declared $214 and paid $210 in 2000 and declared $209 and paid $207 in 1999.
On October 18, 2001, The Hartford's Board of Directors declared a quarterly dividend of $0.26 per share payable on January 2, 2002 to shareholders of record as of December 3, 2001. The dividend represented a 4% increase from the prior quarter.
Treasury Stock - In October 1999, The Hartford's Board of Directors authorized the repurchase of up to $1.0 billion of the Company's outstanding common stock. This repurchase authorization was effective in November 1999 and covers a three-year period. On the first two trading days following September 11, The Hartford repurchased 0.1 million shares of its common stock in the open market at a total cost of $7. These were the Company's only repurchases in 2001. Since the inception of the 1999 repurchase program, The Hartford has repurchased 6.1 million shares at a total cost of $250. Certain of these repurchased shares have been reissued pursuant to certain stock-based benefit plans.
Unrealized Gain (Loss) and Other - Unrealized gain (loss) on securities and other, net of tax, increased by $172 as of December 31, 2001 compared to December 31, 2000. The change resulted primarily from the impact of decreased interest rates on the fixed maturity portfolio and the net gain on cash-flow hedging instruments.
For additional information on stockholders' equity, see Note 8 of Notes to Consolidated Financial Statements.
RATINGS
The following table summarizes The Hartford's significant United States member companies' financial ratings from the major independent rating organizations as of February 28, 2002.
- -------------------------------------------------------------------- A.M. STANDARD BEST FITCH & POOR'S MOODY'S - -------------------------------------------------------------------- Insurance 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 A-1 P-1 Hartford Capital I quarterly income preferred securities [1] a- A BBB+ A3 Hartford Capital III trust originated preferred securities [1] a- A BBB+ A3 Hartford Life, Inc.: Senior debt a+ A+ A A2 Commercial paper -- A-1 P-1 Hartford Life, Inc.: Capital I and II trust preferred securities [1] a- A BBB+ A3 - -------------------------------------------------------------------- [1] In 2001, Moody's Investor Service recalibrated its rating scale for preferred stock and subordinated bonds to increase comparability of credit risk assessments across sectors of fixed income markets globally. The recalibration represents a change in Moody's overall rating system for preferred stocks and subordinated bonds but not a change in its risk assessment of an issuer's fundamental credit quality. The Company's preferred securities ratings were changed from A2 to A3 as a result of the recalibration.
Ratings are an important factor in establishing the competitive position of an insurance company such as The Hartford. 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.
As a result of September 11 and subsequent reviews by major independent rating agencies, all insurance financial strength and debt ratings of The Hartford were reaffirmed. However, negative outlooks were placed upon the debt ratings of the Company by Moody's and the property and casualty financial strength rating by Standard & Poor's. All other ratings were reaffirmed with stable outlooks.
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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, debt securities and borrowings from its credit facility. 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 restricted 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 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, 2001, the maximum amount of statutory dividends which may be paid to The Hartford Financial Services Group, Inc. from its insurance subsidiaries in 2002, without prior regulatory approval, is $577.
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.)
FUTURE TERRORISM EXPOSURES
The September 11 terrorist attack had a significant impact on The Hartford and the insurance industry as a whole. Since that time, The Hartford has taken steps to limit future exposure to terrorist acts. These steps include attaching terrorist exclusions to our policies wherever possible and identifying and managing concentrated exposures by location and dividing the exposures into terrorism risk classes. The Hartford and the industry continue to support the development of Federal legislation to provide a federal insurance program, which would help share in potential losses from terrorism. However, in the absence of a federally backed capital resource or availability of adequate reinsurance coverage and despite the steps already taken to limit exposure, The Hartford may not have the capacity to cover future large-scale terrorist acts such as nuclear, chemical or biological attacks. In addition, losses related to future terrorist attacks could negatively impact the Company's financial strength and debt ratings. As a result, any losses related to future terrorist attacks could have a material impact to the liquidity, financial condition and results of operation of The Hartford.
CASH FLOW
- -------------------------------------------------------------------- 2001 2000 1999 - -------------------------------------------------------------------- Net cash provided by operating activities $ 2,303 $ 2,435 $ 954 Net cash provided by (used for) investing activities $ (5,536) $ (2,164) $ 2,216 Net cash provided by (used for) financing activities $ 3,365 $ (208) $ (3,104) Cash - end of year $ 353 $ 227 $ 182 ====================================================================
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. Cash flows from operating activities were comparable with prior year.
2000 COMPARED TO 1999 -- The increase in operating cash flow was primarily the result of growth in Life business, along with favorable underwriting cash flows in Property & Casualty. The decrease in cash used for financing activities was attributable to net financing for The HLI Repurchase as well as a lower level of disbursements for investment type contracts related to the leveraged block of COLI business. The financing activities, along with the increase in cash provided by operating activities, accounted for the change in cash from investing activities.
Operating cash flows in each of the last three years have been more than adequate to meet liquidity requirements.
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, 2001, each of The Hartford's insurance subsidiaries within Life and Property & Casualty had more than sufficient capital to meet the NAIC's RBC requirements.
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- -------------------------------------------------------------------------------- REGULATORY MATTERS AND CONTINGENCIES - --------------------------------------------------------------------------------
LEGISLATIVE INITIATIVES
The business of insurance is primarily regulated by the states and is also affected by a range of legislative developments at the state and federal levels. Passage in November 1999 of the Financial Services Modernization Act, which permits affiliations among banks, insurance companies and securities firms, may have competitive, operational and other implications for the Company. Among other provisions, the measure includes privacy protections requiring all financial service providers to disclose their privacy policies and restrict the sharing of personal information for marketing purposes. Various states are considering even more restrictive privacy measures that could potentially affect the Company's operations.
Enactment of the Financial Services Modernization Act at the federal level has also focused renewed attention on state regulation of insurance. Elements of the insurance industry are involved in a countrywide initiative to streamline regulatory procedures, either through the modification of rate and form filing requirements or Congressional adoption of optional federal charter legislation.
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 products, as well as changes in individual income tax rates and the estate tax, a number of which 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. It is too early to determine the future disposition of any of these proposals. Therefore, the potential impact to the Company's financial condition or results of operations cannot be reasonably estimated at this time.
Congress is expected to continue considering terrorism insurance backstop legislation and proposals to moderate the business community's asbestos exposure. Both have the potential to reduce claim exposures; however, enactment of such legislation may not occur in the current Congress. Proposed legislation to reduce abusive class-action lawsuits would also have a beneficial impact, but prospects for near-term enactment are likewise uncertain. So-called "patient protection" legislation introduced in Congress and passed in many states includes provisions permitting lawsuits against health maintenance organizations ("HMOs") for denial of coverage. Although the Company is not a health insurer or health care provider, passage of such legislation could affect medical claim costs to the extent that HMOs were constrained from actively managing care.
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 $6 in 2001, $2 in 2000 and $4 in 1999.
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. As of December 31, 2001, the impact of applying the new guidance resulted in a benefit of approximately $400 in statutory surplus.
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 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. During the first quarter of 1999, the Company modified its existing, exclusive contract with one such third party, Putnam Mutual Funds Corp. ("Putnam") to eliminate the exclusivity provision which allowed both parties to pursue new market opportunities. Putnam is contractually obligated to support and service the related annuity in force block of business and to market, support and service new business. However, there can be no assurance that this contract modification will not adversely impact the Company's ability to distribute Putnam related products.
OTHER
For further information on other contingencies, see Note 15 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.
- -------------------------------------------------------------------------------- ACCOUNTING STANDARDS - --------------------------------------------------------------------------------
For a discussion of accounting standards, see Note 1 of Notes to Consolidated Financial Statements.
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ITEM 7A.
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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Index to Consolidated Financial Statements and Schedules elsewhere herein.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEM 10.
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 2002 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 last fiscal year covered by this Form 10-K under the caption "Item 1. Election of Directors - Directors and Nominees" and "Stock Ownership of Directors, Executive Officers and Certain Shareholders - Compliance with Section 16(a) of the Securities Exchange Act of 1934" and is incorporated herein by reference. Additional information required by Item 10 regarding The Hartford's executive officers is set forth in Item 1 of this Form 10-K under the caption "Executive Officers of The Hartford" and is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information called for by Item 11 is set forth in the Proxy Statement under the captions "Compensation of Executive Officers" and "The Board of Directors and its Committees - Directors' Compensation" and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information called for by Item 12 is set forth in the Proxy Statement under the caption "Stock Ownership of Directors, Executive Officers and Certain Shareholders" and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information called for by Item 13 is set forth in the Proxy Statement under the caption "Certain Relationships and Related Transactions" and is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
(a) Documents filed as a part of this report: 1. CONSOLIDATED FINANCIAL STATEMENTS. See Index to Consolidated Financial Statements elsewhere herein. 2. CONSOLIDATED FINANCIAL STATEMENT SCHEDULES. See Index to Consolidated Financial Statement Schedules elsewhere herein. 3. EXHIBITS. See Exhibit Index elsewhere herein. (b) Reports on Form 8-K - The Hartford has filed 3 reports on Form 8-K during the quarter ended December 31, 2001. (c) See Item 14(a)(3). (d) See Item 14(a)(2).
Shareholders may receive, without charge, a copy of the documents filed with the Securities and Exchange Commission as exhibits to this report by submitting a written request to the Investor Relations Department at the following address: The Hartford Financial Services Group, Inc. 690 Asylum Avenue, Hartford, CT 06115 or by calling (888) 322-8444.
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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
Page(s) Report of Management Report of Independent Public Accountants Consolidated Statements of Income for the three years ended December 31, 2001 Consolidated Balance Sheets as of December 31, 2001 and 2000 Consolidated Statements of Changes in Stockholders' Equity for the three years ended December 31, 2001 -6 Consolidated Statements of Cash Flows for the three years ended December 31, 2001 Notes to Consolidated Financial Statements -35 Summary of Investments - Other Than Investments in Affiliates S-1 Condensed Financial Information of The Hartford Financial Services Group, Inc. S-2-3 Supplementary Insurance Information S-4 Reinsurance S-5 Valuation and Qualifying Accounts S-6 Supplemental Information Concerning Property and Casualty Insurance Operations S-6
REPORT OF MANAGEMENT
The management of The Hartford Financial Services Group, Inc. and its subsidiaries ("The Hartford") is responsible for the preparation and integrity of information contained in the accompanying consolidated financial statements and other sections of the Annual Report. The financial statements are prepared in accordance with accounting principles generally accepted in the United States and, where necessary, include amounts that are based on management's informed judgments and estimates. Management believes these statements present fairly The Hartford's financial position and results of operations, and that any other information contained in the Annual Report is consistent with the financial statements.
Management has made available The Hartford's financial records and related data to Arthur Andersen LLP, independent public accountants, in order for them to perform an audit of The Hartford's consolidated financial statements. Their report appears on page.
An essential element in meeting management's financial responsibilities is The Hartford's system of internal controls. These controls, which include accounting controls and the internal auditing program, are designed to provide reasonable assurance that assets are safeguarded, and transactions are properly authorized, executed and recorded. The controls, which are documented and communicated to employees in the form of written codes of conduct and policies and procedures, provide for careful selection of personnel and for appropriate division of responsibility. Management continually monitors for compliance, while The Hartford's internal auditors independently assess the effectiveness of the controls and make recommendations for improvement. Also, Arthur Andersen LLP took into consideration The Hartford's system of internal controls in determining the nature, timing and extent of their audit tests.
Another important element is management's recognition of its responsibility for fostering a strong, ethical climate, thereby ensuring that The Hartford's affairs are transacted according to the highest standards of personal and professional conduct. The Hartford has a long-standing reputation of integrity in business conduct and utilizes communication and education to create and fortify a strong compliance culture.
The Audit Committee of the Board of Directors of The Hartford, composed of independent directors, meets periodically with the external and internal auditors to evaluate the effectiveness of work performed by them in discharging their respective responsibilities and to ensure their independence and free access to the Committee.
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE HARTFORD FINANCIAL SERVICES GROUP, INC.:
We have audited the accompanying Consolidated Balance Sheets of The Hartford Financial Services Group, Inc. (a Delaware corporation) and its subsidiaries as of December 31, 2001 and 2000, and the related Consolidated Statements of Income, Changes in Stockholders' Equity and Cash Flows for each of the three years in the period ended December 31, 2001. These consolidated financial statements and the schedules referred to below are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of The Hartford Financial Services Group, Inc. and its subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States.
As explained in Note 1(b) to the financial statements, effective January 1, 2001, the Company changed its method of accounting for derivatives and hedging activities. Effective April 1, 2001, the Company changed its method of accounting for recognition of interest income and impairment on purchased and retained beneficial interests in securitized financial assets.
Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedules listed in the Index to Consolidated Financial Statements and Schedules are presented for the purpose of complying with the Securities and Exchange Commission's rules and are not part of the basic financial statements. These schedules have been subjected to the auditing procedures applied in the audits of the basic financial statements and, in our opinion, fairly state in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Hartford, Connecticut January 28, 2002
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
SEE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.
THE HARTFORD FINANCIAL SERVICES GROUP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLAR AMOUNTS IN MILLIONS, EXCEPT PER SHARE DATA, UNLESS OTHERWISE STATED)
1. SIGNIFICANT ACCOUNTING POLICIES
(A) BASIS OF PRESENTATION
The Hartford Financial Services Group, Inc. and its consolidated subsidiaries ("The Hartford" or the "Company") provide investment products, life and property and casualty insurance to both individual and commercial customers in the United States and internationally.
On April 2, 2001, The Hartford acquired the U.S. individual life insurance, annuity and mutual fund businesses of Fortis, Inc. (operating as "Fortis Financial Group", or "Fortis"). The acquisition was accounted for as a purchase transaction and, as such, the revenues and expenses generated by this business from April 2, 2001 forward are included in the Company's Consolidated Statements of Income. (For further discussion of the Fortis Acquisition, see Note 18(a).)
On December 22, 2000, The Hartford completed the sale of its Netherlands-based Zwolsche Algemeene N.V. ("Zwolsche") subsidiary to Assurances Generales de France, a subsidiary of Allianz AG. For purposes of these financial statements, Zwolsche's operating results are included in The Hartford's Consolidated Statements of Income through the date of sale.
On June 27, 2000, The Hartford acquired all of the outstanding shares of Hartford Life, Inc. ("HLI") that it did not already own ("The HLI Repurchase"). The accompanying consolidated financial statements reflect the minority interest in HLI of approximately 19% prior to the acquisition date. (For a further discussion of The HLI Repurchase, see Note 16.)
The consolidated financial statements have been prepared on the basis of accounting principles generally accepted in the United States which differ materially from the accounting prescribed by various insurance regulatory authorities. All material intercompany transactions and balances between The Hartford, its subsidiaries and affiliates have been eliminated.
The preparation of financial statements, in conformity with accounting principles generally accepted in the United States, 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 most significant estimates include those used in determining deferred policy acquisition costs, the liability for future policy benefits, unpaid claims and claim adjustment expenses and investment values. Although some variability is inherent in these estimates, management believes the amounts provided are adequate.
Certain reclassifications have been made to prior year financial information to conform to the current year classification of transactions and accounts.
(B) ADOPTION OF NEW ACCOUNTING STANDARDS
Effective September 2001, the Company adopted Emerging Issues Task Force ("EITF") Issue 01-10, "Accounting for the Impact of the Terrorist Attacks of September 11, 2001". Under the consensus, costs related to the terrorist act should be reported as part of income from continuing operations and not as an extraordinary item. The Company has recognized and classified all direct and indirect costs associated with the attack of September 11 in accordance with the consensus. (For discussion of the impact of the September 11 terrorist attack ("September 11"), see Note 2.)
Effective April 1, 2001, the Company adopted EITF Issue 99-20, "Recognition of Interest Income and Impairment on Purchased and Retained Beneficial Interests in Securitized Financial Assets". Under the consensus, investors in certain asset-backed securities are required to record changes in their estimated yield on a prospective basis and to evaluate these securities for an other than temporary decline in value. If the fair value of the asset-backed security has declined below its carrying amount and the decline is determined to be other than temporary, the security is written down to fair value. Upon adoption of EITF Issue 99-20, the Company recorded an $11 charge in net income as a net of tax cumulative effect of accounting change.
Effective January 1, 2001, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities", as amended by SFAS Nos. 137 and 138. The standard requires, among other things, that all derivatives be carried on the balance sheet at fair value. The standard also specifies hedge accounting criteria under which a derivative can qualify for special accounting. In order to receive special accounting, the derivative instrument must qualify as a hedge of either the fair value or the variability of the cash flow of a qualified asset or liability, or forecasted transaction. Special accounting for qualifying hedges provides for matching the timing of gain or loss recognition on the hedging instrument with the recognition of the corresponding changes in value of the hedged item. The Company's policy prior to adopting SFAS No. 133 was to carry its derivative instruments on the balance sheet in a manner similar to the hedged item(s).
Upon adoption of SFAS No. 133, the Company recorded a $23 charge in net income as a net of tax cumulative effect of accounting change. The transition adjustment was primarily comprised of gains and losses on derivatives that had been previously deferred and not adjusted to the carrying amount of the hedged item. Also included in the transition adjustment were gains and losses related to recognizing at fair value all derivatives that are designated as fair-value hedging instruments offset by the difference between the book values and fair values of related hedged items attributable to the hedged risks. The entire transition amount was previously recorded in Accumulated Other Comprehensive Income ("OCI") - Unrealized Gain/Loss on Securities in accordance with SFAS No. 115. Gains and losses on derivatives that were previously deferred as adjustments to the carrying amount of hedged items were not affected by the implementation of SFAS No. 133.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(B) ADOPTION OF NEW ACCOUNTING STANDARDS (CONTINUED)
Upon adoption, the Company also reclassified $24, net of tax, to Accumulated OCI - - Gain on Cash-Flow Hedging Instruments from Accumulated OCI - Unrealized Gain/Loss on Securities. This reclassification reflects the January 1, 2001 net unrealized gain for all derivatives that are designated as cash-flow hedging instruments. (For further discussion of the Company's derivative-related accounting policies, see Note 1(e).)
In September 2000, the Financial Accounting Standards Board ("FASB") issued SFAS No. 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities - a Replacement of FASB Statement No. 125". SFAS No. 140 revises the accounting for securitizations, other financial asset transfers and collateral arrangements. SFAS No. 140 was effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. For recognition and disclosure of collateral and for additional disclosures related to securitization transactions, SFAS No. 140 was effective for the Company's December 31, 2000 financial statements. Adoption of SFAS No. 140 did not have a material impact on the Company's financial condition or results of operations.
In March 2000, the FASB issued Interpretation No. 44, "Accounting for Certain Transactions Involving Stock Compensation - an Interpretation of Accounting Principles Board ("APB") Opinion No. 25" ("FIN 44"). FIN 44 clarifies the application of APB Opinion No. 25 regarding the definition of employee, the criteria for determining a non-compensatory plan, the accounting for changes to the terms of a previously fixed stock option or award, the accounting for an exchange of stock compensation awards in a business combination, and other stock compensation related issues. FIN 44 became effective July 1, 2000, with respect to new awards, modifications to outstanding awards, and changes in grantee status that occur on or after that date. The adoption of FIN 44 did not have a material impact on the Company's financial condition or results of operations.
Effective January 1, 2000, The Hartford adopted Statement of Position ("SOP") No. 98-7, "Accounting for Insurance and Reinsurance Contracts That Do Not Transfer Insurance Risk". This SOP provides guidance on the method of accounting for insurance and reinsurance contracts that do not transfer insurance risk, defined in the SOP as the deposit method. Adoption of this SOP did not have a material impact on the Company's financial condition or results of operations.
In December 1999, the staff of the Securities and Exchange Commission ("SEC") issued Staff Accounting Bulletin No. 101, "Revenue Recognition in Financial Statements" ("SAB 101"). SAB 101 provides that if registrants have not applied the accounting therein, they should implement the SAB and report a change in accounting principle. SAB 101, as subsequently amended, became effective for the Company in the fourth quarter of 2000. The adoption of SAB 101 did not have a material impact on the Company's financial condition or results of operations.
Effective January 1, 1999, The Hartford adopted SOP No. 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use". This SOP provides guidance on accounting for costs of internal use software and in determining whether software is for internal use. The SOP defines internal use software as software that is acquired, internally developed, or modified solely to meet internal needs and identifies stages of software development and accounting for the related costs incurred during the stages. Adoption of this SOP did not have a material impact on the Company's financial condition or results of operations.
Effective January 1, 1999, The Hartford adopted SOP No. 97-3, "Accounting by Insurance and Other Enterprises for Insurance-Related Assessments". This SOP addresses accounting by insurance and other enterprises for assessments related to insurance activities including recognition, measurement and disclosure of guaranty fund or other assessments. Adoption of this SOP did not have a material impact on the Company's financial condition or results of operations.
The Hartford's cash flows were not impacted by adopting these changes in accounting principles.
(C) FUTURE ADOPTION OF NEW ACCOUNTING STANDARDS
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets". SFAS No. 144 establishes an accounting model for long-lived assets to be disposed of by sale by requiring those long-lived assets be measured at the lower of carrying amount or fair value less cost to sell, whether reported in continuing operations or in discontinued operations. The provisions of Statement 144 are effective for financial statements issued for fiscal years beginning after December 15, 2001. Adoption of SFAS No. 144 will not have a material impact on the Company's financial condition or results of operations.
In June 2001, the FASB issued SFAS No. 141, "Business Combinations". SFAS No. 141 eliminates the pooling-of-interests method of accounting for business combinations requiring all business combinations to be accounted for under the purchase method. Accordingly, net assets acquired are recorded at fair value with any excess of cost over net assets assigned to goodwill.
SFAS No. 141 also requires that certain intangible assets acquired in a business combination be recognized apart from goodwill. The provisions of SFAS No. 141 apply to all business combinations initiated after June 30, 2001. Use of the pooling-of-interests method of accounting for those transactions is prohibited. Adoption of SFAS No. 141 will not have a material impact on the Company's financial condition or results of operations.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible Assets". Under SFAS No. 142, amortization of goodwill is precluded; however, its fair value is periodically (at least annually) reviewed and tested for impairment. Goodwill must be tested for impairment in the year of adoption, including an initial test performed within six months of adoption. If the initial test indicates a potential impairment, then a more detailed analysis to determine the extent of impairment must be completed by the end of the year of adoption.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(C) FUTURE ADOPTION OF NEW ACCOUNTING STANDARDS (CONTINUED)
SFAS No. 142 requires that useful lives for intangibles other than goodwill be reassessed and remaining amortization periods be adjusted accordingly. The reassessment must be completed prior to the end of the first quarter of 2002.
All provisions of SFAS No. 142 will be applied beginning January 1, 2002 to goodwill and other intangible assets. Goodwill amortization totaled $52, after-tax, in 2001. Application of the non-amortization provisions of the statement is expected to result in an increase in net income of $56, after-tax, in 2002. The Company is in the process of assessing the impacts from the implementation of the other provisions of SFAS No. 142.
(D) INVESTMENTS
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" in accordance with 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 reflected in stockholders' equity as a component of accumulated other comprehensive income. Policy loans are carried at outstanding balance which approximates fair value. Other investments consist primarily of limited partnership investments which are accounted for by the equity method, except in instances in which the Company's interest is so minor that it exercises virtually no influence over operating and financial policies. In such instances, the Company applies the cost method of accounting. 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.
Net realized capital gains and losses on security transactions associated with the Company's immediate participation guaranteed contracts are recorded and offset by amounts owed to policyholders and were $(1), $(9) and $2 for the years ended December 31, 2001, 2000 and 1999, respectively. Under the terms of the contracts, the net realized capital gains and losses will be credited to policyholders in future years as they are entitled to receive them. Net realized capital gains and losses, after deducting the life and pension policyholders' share, are reported as a component of revenues and are determined on a specific identification basis.
The Company's accounting policy for impairment recognition requires other than temporary impairment charges to be recorded when it is determined that the Company is unable to recover its cost basis in an investment. Impairment charges on investments are included in net realized capital gains and losses. Factors considered in evaluating whether a decline in value 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 conditions and near-term prospects of the issuer, and (c) the intent and ability of the Company to retain the investment for a period of time sufficient to allow for any anticipated recovery. In addition, 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 cost or 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.
(E) DERIVATIVE INSTRUMENTS
Overview - -------- The Company utilizes a variety of derivative instruments, including swaps, caps, floors, forwards and exchange traded futures and options, in order to achieve one of three Company approved objectives: to hedge risk arising from interest rate, price or currency exchange rate volatility; to manage liquidity; or to control transaction costs. The Company is considered an "end-user" of derivative instruments and as such does not make a market or trade in these instruments for the express purpose of earning trading profits. (For a description of derivative instruments utilized by the Company, see the Capital Markets Risk Management section of Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") under Derivative Instruments.)
Accounting and Financial Statement Presentation of Derivative Instruments and - -------------------------------------------------------------------------------- Hedging Activities - ------------------
Effective January 1, 2001, and in accordance with SFAS No. 133, all derivatives are recognized on the balance sheet at their fair value. On the date the derivative contract is entered into, the Company designates the derivative as (1) a hedge of the fair value of a recognized asset or liability ("fair value" hedge), (2) a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability ("cash flow" hedge), (3) a foreign-currency, fair value or cash-flow hedge ("foreign-currency" hedge), (4) a hedge of a net investment in a foreign operation, or (5) held for other risk management activities, which primarily involve managing asset or liability related risks which do not qualify for hedge accounting under SFAS No. 133. Changes in the fair value of a derivative that is designated and qualifies as a fair-value hedge, along with the gain or loss on the hedged asset or liability that is attributable to the hedged risk, are recorded in current period earnings as net realized capital gains and losses. Changes in the fair value of a derivative that is designated and qualifies as a cash-flow hedge are recorded in OCI and are reclassified into earnings when earnings are impacted by the variability of the cash flow of the hedged item. Changes in the fair value of derivatives that are designated and qualify as foreign-currency hedges are recorded in either current period earnings or OCI, depending on whether the hedge transaction is a fair value hedge or a cash-flow hedge. If, however, a derivative is used as a hedge of a net investment in a foreign operation, its changes in fair value, to the extent effective as a hedge, are recorded in the cumulative translation adjustments account within stockholders' equity. Changes in the fair value of derivative instruments held for other risk management purposes are reported in current period earnings as net realized capital gains and losses.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(E) DERIVATIVE INSTRUMENTS (CONTINUED)
Accounting and Financial Statement Presentation of Derivative Instruments and - -------------------------------------------------------------------------------- Hedging Activities (continued) - ------------------------------
As of December 31, 2001, the Company carried $138 of derivative assets in other investments and $208 of derivative liabilities in other liabilities.
Hedge Documentation and Effectiveness Testing - ---------------------------------------------
At hedge inception, the Company formally documents all relationships between hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking each hedge transaction. In connection with the implementation of SFAS No. 133, the Company designated anew all existing hedge relationships. The documentation process includes linking all derivatives that are designated as fair value, cash flow or foreign-currency hedges to specific assets and liabilities on the balance sheet or to specific forecasted transactions. The Company also formally assesses, both at the hedge's inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. At inception, and on a quarterly basis, the change in value of the hedging instrument and the change in value of the hedged item are measured to assess the validity of maintaining special hedge accounting. Hedging relationships are considered highly effective if the changes in the fair value or discounted cash flows of the hedging instrument are within a ratio of 80-120% of the inverse changes in the fair value or discounted cash flows of the hedged item. High effectiveness is calculated using a cumulative approach. If it is determined that a derivative is no longer highly effective as a hedge, the Company discontinues hedge accounting prospectively, as discussed below under discontinuance of hedge accounting.
Credit Risk - ----------- The Company's derivatives counterparty exposure policy establishes market-based credit limits, favors long-term financial stability and creditworthiness, and typically requires credit enhancement/credit risk reducing agreements. By using derivative instruments, the Company is exposed to credit risk which is measured as the amount owed to the Company based on current market conditions and potential payment obligations between the Company and its counterparties. When the fair value of a derivative contract is positive, this indicates that the counterparty owes the Company, and, therefore, exposes the Company to credit risk. 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 also minimizes the credit risk in derivative instruments by entering into transactions with high quality counterparties that are reviewed periodically by the Company's internal compliance unit, reviewed frequently by senior management and reported to the Company's Finance Committee. The Company also maintains a policy of requiring that all derivative contracts be governed by an International Swaps and Derivatives Association Master Agreement which is structured by legal entity and by counterparty and permits right of offset.
Embedded Derivatives - -------------------- The Company occasionally purchases or issues financial instruments that contain a derivative instrument that is embedded in the financial instrument. When it is determined that (1) the embedded derivative possesses economic characteristics that are not clearly and closely related to the economic characteristics of the host contract, and (2) a separate instrument with the same terms would qualify as a derivative instrument, the embedded derivative is separated from the host contract, carried at fair value, and designated as a fair value, cash flow, or foreign-currency hedge, or as held for other risk management purposes. However, in cases where (1) the host contract is measured at fair value, with changes in fair value reported in current earnings or (2) the Company is unable to reliably identify and measure an embedded derivative for separation from its host contract, the contract is not designated as a hedging instrument. The entire contract is carried on the balance sheet at fair value with changes in fair value recorded as net realized capital gains and losses.
Discontinuance of Hedge Accounting - ---------------------------------- The Company discontinues hedge accounting prospectively when (1) it is determined that the derivative is no longer highly effective in offsetting changes in the fair value or cash flows of a hedged item; (2) the derivative is dedesignated as a hedge instrument, because it is unlikely that a forecasted transaction will occur; or (3) the derivative expires or is sold, terminated, or exercised. When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective fair-value hedge, the derivative continues to be carried at fair value on the balance sheet with changes in its fair value recognized in current period earnings. The changes in the fair value of the hedged asset or liability are no longer recorded in earnings. When hedge accounting is discontinued because the Company becomes aware that it is probable that a forecasted transaction will not occur, the derivative continues to be carried on the balance sheet at its fair value, and gains and losses that were accumulated in OCI are recognized immediately in earnings. In all other situations in which hedge accounting is discontinued on a cash-flow hedge, including those where the derivative is sold, terminated or exercised, amounts previously deferred in OCI are amortized into earnings when earnings are impacted by the variability of the cash flow of the hedged item.
SFAS No. 133 Categorization of the Company's Hedging Activities - --------------------------------------------------------------- Cash-Flow Hedges
General
For the year ended December 31, 2001, the Company's gross gains and losses representing the total ineffectiveness of all cash-flow hedges essentially offset, with the net impact reported as net realized capital gains and losses. All components of each derivative's gain or loss are included in the assessment of hedge effectiveness.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(E) DERIVATIVE INSTRUMENTS (CONTINUED)
SFAS No. 133 Categorization of the Company's Hedging Activities (continued) - ---------------------------------------------------------------------------
Cash-Flow Hedges (continued)
General (continued)
Gains and losses on derivative contracts that are reclassified from OCI to current period earnings are included in the line item in the statement of income in which the hedged item is recorded. As of December 31, 2001, $2 of after-tax deferred net gains on derivative instruments accumulated in OCI are expected to be reclassified to earnings during the next twelve months. This expectation is based on the anticipated interest payments on hedged investments in fixed maturity securities that will occur over the next twelve months, at which time the Company will recognize the deferred net gains/losses as an adjustment to interest income over the term of the investment cash flows. The maximum term over which the Company is hedging its exposure to the variability of future cash flows (for all forecasted transactions, excluding interest payments on variable-rate debt) is twelve months. As of December 31, 2001, the Company held $2.6 billion in derivative notional value related to strategies categorized as cash- flow hedges. There were no reclassifications from OCI to earnings resulting from the discontinuance of cash-flow hedges during the year ended December 31, 2001.
Specific Strategies
The Company's primary use of cash-flow hedging is to use interest-rate swaps as an "asset hedging" strategy, in order to convert interest receipts on floating-rate fixed maturity investments to fixed rates. When multiple assets are designated in a hedging relationship under SFAS No. 133, a homogeneity test is performed to ensure that the assets react similarly to changes in market conditions. To satisfy this requirement, at inception of the hedge, fixed maturity investments with identical variable rates are grouped together (for example: 1-month LIBOR or 3-month LIBOR, not both).
The Company enters into "receive fixed/pay variable" interest rate swaps to hedge the variability in the first LIBOR-based interest payments received on each pool of eligible variable rate fixed maturity investments. Effectiveness is measured by comparing the present value of the variable rate pay side of the swaps to the present value of the first anticipated variable rate interest receipts on the hedged fixed maturity investments. At December 31, 2001, the Company held $2.0 billion in derivative notional value related to this strategy. The Company also uses cash-flow hedges, in its anticipated purchase of fixed maturity investments.
Fair-Value Hedges
General
For the year ended December 31, 2001, the Company's gross gains and losses representing the total ineffectiveness of all fair-value hedges essentially offset, with the net impact reported as net realized capital gains and losses. All components of each derivative's gain or loss are included in the assessment of hedge effectiveness. As of December 31, 2001, the Company held $899 in derivative notional value related to strategies categorized as fair-value hedges.
Specific Strategies
During 2001, the Company entered an interest rate swap as an economic hedge of a portion of its Trust Preferred Securities issued. The interest rate swap agreement was structured to exactly offset the terms and conditions of the hedged trust preferred securities (i.e. notional value, call provisions, maturity date, and payment dates) and has been designated as a hedge of the benchmark interest rate (i.e. LIBOR). The calculation of ineffectiveness involves a comparison of the present value of the cumulative change in the expected future cash flows on the interest rate swap and the present value of the cumulative change in the expected future cash flows on the hedged trust preferred securities. If hedge ineffectiveness exists, it is recorded as net realized capital gain or loss. At December 31, 2001, the Company held $500 in derivative notional value related to this strategy.
The Company purchases interest rate caps and sells interest rate floor contracts in an "asset hedging" strategy utilized to offset corresponding interest rate caps and floors that exist in certain of its variable-rate fixed maturity investments. The standalone interest rate cap and floor contracts are structured to exactly offset those embedded in the hedged investment. The calculation of ineffectiveness involves a comparison of the present value of the cumulative change in the expected future cash flows on the interest rate cap/floor and the present value of the cumulative change in the expected future interest cash flows that are hedged on the fixed maturity investment. If hedge ineffectiveness exists, it is recorded as net realized capital gain or loss. All hedges involving variable rate bonds with embedded interest rate caps and floors are perfectly matched with respect to notional values, payment dates, maturity, index, and the hedge relationship does not contain any other basis differences. No component of the hedging instruments fair value is excluded from the determination of effectiveness. At December 31, 2001, the Company held $200 in derivative notional value related to this strategy.
The Company enters into swaption arrangements in an "asset hedging" strategy utilized to offset the change in the fair value of call options embedded in certain of its investments in municipal fixed maturity investments. The swaptions give the Company the option to enter into a "receive fixed" swap. The swaption's exercise dates coincide with the municipal fixed maturity's call dates, and the receive side of the swaps closely matches the coupon rate on the original municipal fixed maturity investment. The purpose of the swaptions is to ensure a fixed return over the original term to maturity. Should the municipal fixed maturity investment be called, the swaptions would be either settled in cash or exercised. The proceeds from the call are used to purchase a variable rate fixed maturity investment. If the bonds are not called, the swaptions expire worthless. Each swaption contract hedges multiple fixed maturity investments containing embedded call options. These fixed maturity investments are subdivided into portfolio hedges. In accordance with SFAS No. 133, a stress test is performed at the inception of the hedge to prove the homogeneity of each portfolio (with regard to the risk being hedged) and thereby
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(E) DERIVATIVE INSTRUMENTS (CONTINUED)
SFAS No. 133 Categorization of the Company's Hedging Activities (continued) - ---------------------------------------------------------------------------
Fair-Value Hedges (continued)
Specific Strategies (continued)
qualify that hedge for special hedge accounting treatment. Correlation calculations are performed at various interest rate levels comparing the total change in the aggregate value of the embedded calls in the hedged portfolio to the change in value of the embedded call in each individual fixed maturity investment in the portfolio. The correlation statistic for homogeneity must be within a range of 0.85 to 1.00. The calculation of ineffectiveness involves a comparison of the cumulative change in fair value of the embedded call option with the cumulative change in fair value of the swaption. Ineffectiveness is reported as net realized capital gains and losses. No component of the hedging instruments' fair value is excluded from the determination of effectiveness. At December 31, 2001, the Company held $133 in derivative notional value related to this strategy.
Other Risk Management Activities
General
The Company's other risk management activities relate to strategies used to meet the following Company-approved objectives; to hedge risk arising from interest rate, price or currency exchange rate volatility; to manage liquidity; or to control transaction costs. For the year ended December 31, 2001, the Company recognized an after-tax net loss of $23 (reported as net realized capital losses in the statement of income), which represented the total change in value for other derivative-based strategies which do not qualify for hedge accounting under SFAS No. 133. As of December 31, 2001, the Company held $4.6 billion in derivative notional value related to strategies categorized as Other Risk Management Activities.
Specific Strategies
The Company issues liability contracts in which policyholders have the option to surrender their policies at book value and that guarantee a minimum credited rate of interest. Typical products with these features include Whole Life, Universal Life and Repetitive Premium Variable Annuities. The Company uses interest rate cap and swaption contracts as an economic hedge, classified for internal purposes as a "liability hedge", thereby mitigating the Company's loss in a rising interest rate environment. The Company is exposed to the situation where interest rates rise and the Company is not able to raise its credited rates to competitive yields. The policyholder can then surrender at book value while the underlying bond portfolio may be at a loss. The increase in yield in a rising interest rate environment due to the interest rate cap and swaption contracts may be used to raise credited rates, increasing the Company's competitiveness and reducing the policyholder's incentive to surrender. In accordance with Company policy, the amount of notional value will not exceed the book value of the liabilities being hedged and the term of the derivative contract will not exceed the average maturity of the liabilities. As of December 31, 2001, the Company held $516 in derivative notional value related to this strategy.
When terminating certain hedging relationships, the Company will enter a derivative contract with terms and conditions that directly offset the original contract, thereby offsetting its changes in value from that date forward. The Company de-designates the original contract and records the changes in value of both the original contract and the new offsetting contract through net realized capital gains and losses. At December 31, 2001, the Company held $2.0 billion in derivative notional value related to this strategy.
Periodically, the Company enters into swap agreements that have cash flows based upon the results of a referenced index or asset pool. These arrangements are entered into to modify portfolio duration or to increase diversification while controlling transaction costs. At December 31, 2001, the Company held $687 in derivative notional value related to this strategy.
The Company will issue an option in an "asset hedging" strategy utilized to monetize the option embedded in certain of its fixed maturity investments. The Company will receive a premium for issuing the freestanding option. The structure is designed such that the fixed maturity investment and freestanding option have identical expected lives, typically 3-5 years. At December 31, 2001, the Company held $1.2 billion in derivative notional value related to this strategy.
(F) SEPARATE ACCOUNTS
The Company maintains separate account assets and liabilities which are reported at fair value. Separate account assets are segregated from other investments, and investment income and gains and losses accrue directly to the policyholders. Separate accounts reflect two categories of risk assumption: non- guaranteed separate accounts, wherein the policyholder assumes the investment risk, and guaranteed separate accounts, wherein the Company contractually guarantees either a minimum return or the account value to the policyholder.
(G) 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.
Deferred policy acquisition costs 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 expected gross profits from investment mortality and expense margins and surrender charges. Actual gross profits can vary from management's estimates, resulting in increases or decreases in the rate of amortization. Management periodically reviews these estimates and evaluates the recoverability of the deferred acquisition cost asset. When appropriate, management revises its assumptions on the estimated gross profits of these contracts and the cumulative amortization for the books of business are re-estimated and adjusted by a cumulative charge or credit to income. The average rate of assumed future investment yield used in estimating expected gross profits related to variable annuity and
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(G) DEFERRED POLICY ACQUISITION COSTS (CONTINUED)
variable life business was 9% at December 31, 2001 and for all other products including fixed annuities and other universal life type contracts the average assumed investment yield ranged from 5.0% - 8.5%.
Deferred policy acquisition costs related to traditional policies are amortized over the premium paying period of the related policies in proportion to the ratio of the present value of annual expected premium income to the present value of total expected premium income. Adjustments are made each year to recognize actual experience as compared to assumed experience for the current period.
PROPERTY & CASUALTY - Policy acquisition costs, representing commissions, premium taxes and certain other underwriting expenses, are deferred and amortized over policy terms. Estimates of the present value of future revenues, including net investment income and tax benefits, are compared to estimates of the present value of future costs, including amortization of policy acquisition costs, to determine if the deferred acquisition costs are recoverable and, if not, they are charged to expense.
(H) FUTURE POLICY BENEFITS, UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES
LIFE - Liabilities for future policy benefits are computed by the net level premium method using interest assumptions ranging from 3% to 11% and withdrawal and mortality assumptions appropriate at the time the policies were issued. Claim reserves, which are the result of sales of group long-term and short-term disability, stop loss, and Medicare supplement, are stated at amounts determined by estimates on individual cases and estimates of unreported claims based on past experience.
The following table displays the development of the claim reserves (included in future policy benefits in the Consolidated Balance Sheets) resulting primarily from group disability products.
For the years ended December 31, ---------------------------------- 2001 2000 1999 - ------------------------------------------------------------------- BEGINNING CLAIM RESERVES-GROSS $2,384 $2,128 $1,938 Reinsurance recoverables 177 125 125 - ------------------------------------------------------------------- BEGINNING CLAIM RESERVES-NET 2,207 2,003 1,813 - ------------------------------------------------------------------- INCURRED EXPENSES RELATED TO Current year 1,272 1,093 1,013 Prior years (15) (11) (33) - ------------------------------------------------------------------- TOTAL INCURRED 1,257 1,082 980 - ------------------------------------------------------------------- PAID EXPENSES RELATED TO Current year 439 410 360 Prior years 525 468 430 - ------------------------------------------------------------------- TOTAL PAID 964 878 790 - ------------------------------------------------------------------- ENDING CLAIM RESERVES-NET 2,500 2,207 2,003 Reinsurance recoverables 264 177 125 - ------------------------------------------------------------------- ENDING CLAIM RESERVES-GROSS $2,764 $2,384 $2,128 ===================================================================
PROPERTY & CASUALTY - The Hartford establishes reserves to provide for the estimated costs of paying claims made by policyholders or against policyholders. 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. Certain liabilities for unpaid claims, principally for permanently disabled claimants, terminated reinsurance treaties and certain contracts that fund loss run-offs for unrelated parties, have been discounted to present value using an average interest rate of 5.1% in 2001 and 5.7% in 2000. At December 31, 2001 and 2000, such discounted reserves totaled $719 and $716, respectively (net of discounts of $429 and $396, respectively). Amortization of the discount did not have a material effect on net income during 2001, 2000 and 1999, respectively. A reconciliation of liabilities for unpaid claims and claim adjustment expenses follows:
For the years ended December 31, --------------------------------- 2001 2000 1999 - ------------------------------------------------------------------- BEGINNING LIABILITIES FOR UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES-GROSS $15,874 $16,014 $16,449 Reinsurance recoverables 3,452 3,271 3,286 - ------------------------------------------------------------------- BEGINNING LIABILITIES FOR UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES-NET 12,422 12,743 13,163 - ------------------------------------------------------------------- ADD PROVISION FOR UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES Current year 5,992 5,170 4,953 Prior years [1] 143 27 (171) - ------------------------------------------------------------------- TOTAL PROVISION FOR UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES 6,135 5,197 4,782 - ------------------------------------------------------------------- LESS PAYMENTS Current year 2,349 2,265 2,137 Prior years 3,243 3,069 3,024 - ------------------------------------------------------------------- TOTAL PAYMENTS 5,592 5,334 5,161 - ------------------------------------------------------------------- Foreign currency translation (3) (26) (41) Reserves resulting from acquisitions -- -- -- Other [2] (102) (158) -- - ------------------------------------------------------------------- ENDING LIABILITIES FOR UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES-NET 12,860 12,422 12,743 Reinsurance recoverables 3,818 3,452 3,271 - ------------------------------------------------------------------- ENDING LIABILITIES FOR UNPAID CLAIMS AND CLAIM ADJUSTMENT EXPENSES-GROSS $16,678 $15,874 $16,014 =================================================================== [1] Excludes the effects of foreign exchange adjustments. [2] Includes $101 in 2001 and $161 in 2000 related to the sale of international subsidiaries.
The Company has an exposure to catastrophic losses, both natural and man made, which can be caused by significant events including hurricanes, severe winter storms, earthquakes, windstorms, fires and terrorist acts. The frequency and severity of catastrophic losses are unpredictable, and the exposure to a catastrophe is a function of both the total amount insured in an area affected by the event and the severity of the event. Catastrophes generally impact limited geographic areas; however, certain events may produce significant damage in heavily populated areas. The Company generally seeks to reduce its exposure to catastrophic losses through individual risk selection and the purchase of catastrophe reinsurance.
(I) OTHER POLICYHOLDER FUNDS AND BENEFITS PAYABLE
Other policyholder funds and benefits payable include reserves for investment contracts without life contingencies, corporate
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(I) OTHER POLICYHOLDER FUNDS AND BENEFITS PAYABLE (CONTINUED)
owned life insurance and universal life insurance contracts. Of the amounts included in this item, $18.8 billion and $15.6 billion, as of December 31, 2001 and 2000, respectively, represent policyholder obligations. The liability for policy benefits for universal life-type contracts 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.
(J) REVENUE RECOGNITION
LIFE - For investment and universal life-type contracts, the amounts collected from policyholders are considered deposits and are not included in revenue. Fee income for investment and universal life-type contracts consists of policy charges for policy administration, cost of insurance charges and surrender charges assessed against policyholders' account balances and are recognized in the period in which services are provided. Traditional life and the majority of the Company's accident and health products are long duration contracts, and premiums are recognized as revenue when due from policyholders. Retrospective and contingent commissions and other related expenses are incurred and recorded in the same period that the retrospective premiums are recorded or other contract provisions are met.
PROPERTY & CASUALTY - Property and casualty insurance premiums are earned principally on a pro rata basis over the lives of the policies and include accruals for ultimate premium revenue anticipated under auditable and retrospectively rated policies. Unearned premiums represent the portion of premiums written applicable to the unexpired terms of policies in force. Unearned premiums also include estimated and unbilled premium adjustments. Other revenue consists primarily of revenues associated with the Company's servicing businesses. Retrospective and contingent commissions and other related expenses are incurred and recorded in the same period that the retrospective premiums are recorded or other contract provisions are met.
(K) FOREIGN CURRENCY TRANSLATION
Foreign currency translation gains and losses are reflected in stockholders' equity as a component of accumulated other comprehensive income. Balance sheet accounts are translated at the exchange rates in effect at each year end and income statement accounts are translated at the average rates of exchange prevailing during the year. The national currencies of the international operations are generally their functional currencies.
(L) DIVIDENDS TO POLICYHOLDERS
Policyholder dividends are accrued using an estimate of the amount to be paid based on underlying contractual obligations under policies and applicable state laws. If limitations exist on the amount of net income from participating life insurance contracts that may be distributed to stockholders, the policyholders' share of net income on those contracts that cannot be distributed is excluded from stockholders' equity by a charge to operations and a credit to a liability.
LIFE - Participating life insurance in force accounted for 8%, 17% and 20% as of December 31, 2001, 2000 and 1999, respectively, of total life insurance in force. Dividends to policyholders were $68, $67 and $104 for the years ended December 31, 2001, 2000 and 1999, respectively. There were no additional amounts of income allocated to participating policyholders.
PROPERTY & CASUALTY - Net written premiums for participating property and casualty insurance policies represented 9%, 9% and 11% of total net written premiums for the years ended December 31, 2001, 2000 and 1999, respectively. Dividends to policyholders were $38, $33 and $40 for the years ended December 31, 2001, 2000 and 1999, respectively.
(M) MUTUAL FUNDS
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 21 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 and related investment returns are not reflected in the Company's consolidated financial statements since they are not assets, liabilities and operations of the Company.
2. SEPTEMBER 11, 2001
As a result of the September 11 terrorist attack, the Company recorded in 2001 an estimated before-tax loss amounting to $678, net of reinsurance: $647 related to property and casualty operations and $31 related to life operations. The Property & Casualty loss included a $1.1 billion gross reserve addition and cessions under reinsurance contracts of $569. Also included in the Property & Casualty loss was $91 of reinstatement and other reinsurance premiums. The property-casualty portion of the 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 unknown and unreported policyholder losses and costs incurred in settling claims. Also included was an estimate of amounts recoverable under the Company's ceded reinsurance programs, including the cost of additional reinsurance premiums. As a result of the uncertainties involved in the estimation process, final claims settlement may vary from present estimates.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. INVESTMENTS AND DERIVATIVE INSTRUMENTS (CONTINUED)
The amortized cost and estimated fair value of fixed maturity investments at December 31, 2001 by estimated maturity year are shown below. Expected maturities differ from contractual maturities due to call or prepayment provisions. Asset-backed securities, including mortgage-backed securities and collateralized mortgage obligations, are distributed to maturity year based on the Company's estimates of the rate of future prepayments of principal over the remaining lives of the securities. These estimates are developed using prepayment speeds provided in broker consensus data. Such estimates are derived from prepayment speeds experienced at the interest rate levels projected for the applicable underlying collateral. Actual prepayment experience may vary from these estimates.
- ------------------------------------------------------------------ Amortized MATURITY Cost Fair Value - ------------------------------------------------------------------ One year or less $ 4,324 $ 4,352 Over one year through five years 10,980 11,218 Over five years through ten years 11,352 11,644 Over ten years 12,498 12,832 - ------------------------------------------------------------------ TOTAL $ 39,154 $ 40,046 ==================================================================
(F) SALES OF FIXED MATURITY AND EQUITY SECURITY INVESTMENTS
For the years ended December 31, ----------------------------------- 2001 2000 1999 - ---------------------------------------------------------------------- SALE OF FIXED MATURITIES Sale proceeds $ 8,714 $ 9,606 $ 9,761 Gross gains 202 187 245 Gross losses (82) (429) (311) SALE OF EQUITY SECURITIES Sale proceeds $ 803 $ 1,306 $ 1,317 Gross gains 135 258 124 Gross losses (139) (110) (19) ======================================================================
(G) CONCENTRATION OF CREDIT RISK
The Hartford is not exposed to any credit concentration risk of a single issuer greater than 10% of the Company's stockholders' equity.
(H) DERIVATIVE INSTRUMENTS
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 (excluding guaranteed separate accounts) totaled $8.0 billion at December 31, 2001 and $5.3 billion at December 31, 2000.
The Company uses derivative instruments in its management of market risk consistent with four risk management strategies: hedging anticipated transactions, hedging liability instruments, hedging invested assets and hedging portfolios of assets and/or liabilities.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENTS AND DERIVATIVE INSTRUMENTS (CONTINUED)
(H) DERIVATIVE INSTRUMENTS (CONTINUED)
A reconciliation between notional amounts as of December 31, 2001 and 2000 by derivative type and strategy is as follows:
(I) COLLATERAL ARRANGEMENTS
The Hartford entered into various collateral arrangements which require both the pledging and accepting of collateral in connection with its derivative instruments and repurchase agreements. As of December 31, 2001 and 2000, collateral pledged has not been separately reported in the Consolidated Balance Sheet. The classification and carrying amounts of collateral pledged at December 31, 2001 and 2000 were as follows:
ASSETS 2001 2000 - ------------------------------------------------------------------------------ U.S. Gov't and Gov't agencies and authorities (guaranteed and sponsored) $ 1 $ 3 U.S. Gov't and Gov't agencies and authorities (guaranteed and sponsored - asset backed) 53 31 - ------------------------------------------------------------------------------ TOTAL $ 54 $ 34 - ------------------------------------------------------------------------------
At December 31, 2001 and 2000, The Hartford had accepted collateral consisting of cash and U.S. Government securities with a fair value of $161 and $252, respectively. At December 31, 2001 and 2000, only cash collateral of $108 and $31, respectively, was recorded on the balance sheet in fixed maturities and other liabilities. While The Hartford is permitted by contract to sell or repledge the noncash collateral, none of the collateral has been sold or repledged at December 31, 2001 and 2000. As of December 31, 2001 and 2000 all collateral accepted was held in separate custodial accounts.
4. FAIR VALUE OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosure about Fair Value of Financial Instruments", requires disclosure of fair value information of financial instruments. For certain financial instruments where quoted market prices are not available, other independent valuation techniques and assumptions are used. Because considerable judgment is used, these estimates are not necessarily indicative of amounts that could be realized in a current market exchange. SFAS No. 107 excludes certain financial instruments from disclosure, including insurance contracts, other than financial guarantees and investment contracts. The Hartford uses the following methods and assumptions in estimating the fair value of each class of financial instrument.
Fair value for fixed maturities and marketable equity securities approximates those quotations published by applicable stock exchanges or received from other reliable sources.
For policy loans, carrying amounts approximate fair value.
Fair value of limited partnerships and trusts is based on external market valuations from partnership and trust management.
Derivative instruments are reported at fair value based on internally established valuations that are consistent with external valuation models. Other policyholder funds and benefits payable fair value information is determined by estimating future cash flows, discounted at the current market rate.
For short-term debt, carrying amounts approximate fair value.
Fair value for long-term debt and trust preferred securities is based on external valuation using discounted future cash flows at current market interest rates.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)
The carrying amounts and fair values of The Hartford's financial instruments at December 31, 2001 and 2000 were as follows:
2001 2000 ------------------------------------------ Carrying Fair Carrying Fair Amount Value Amount Value - ---------------------------------------------------------------------- ASSETS Fixed maturities $40,046 $40,046 $34,492 $34,492 Equity securities 1,349 1,349 1,056 1,056 Policy loans 3,317 3,317 3,610 3,610 Limited partnerships [1] 1,372 1,372 1,138 1,138 Other investments [2] [3] 605 605 373 374 LIABILITIES Other policyholder funds and benefits payable [4] $16,077 $15,939 $11,985 $11,607 Short-term debt 599 607 235 238 Long-term debt 1,965 2,082 1,862 1,901 Trust preferred securities 1,412 1,429 1,243 1,233 Derivative related liabilities [3] [5] 208 208 -- -- ====================================================================== [1] Included in other investments on the balance sheet. [2] 2001 includes $138 of derivative related assets. [3] Prior year derivative related assets and liabilities were reported along with the items being hedged in accordance with then generally accepted accounting principles. [4] Excludes group accident and health and universal life insurance contracts, including corporate owned life insurance. [5] Included in other liabilities on the balance sheet.
5. SEPARATE ACCOUNTS
The Hartford maintained separate account assets and liabilities totaling $114.7 billion and $114.1 billion at December 31, 2001 and 2000, respectively, which are reported at fair value. Separate account assets, which are segregated from other investments, reflect two categories of risk assumption: non-guaranteed separate accounts totaling $104.6 billion and $104.3 billion at December 31, 2001 and 2000, respectively, wherein the policyholder assumes the investment risk, and guaranteed separate accounts totaling $10.1 billion and $9.8 billion at December 31, 2001 and 2000, respectively, wherein The Hartford contractually guarantees either a minimum return or the account value to the policyholder. Included in the non-guaranteed category were policy loans totaling $575 and $697 at December 31, 2001 and 2000, respectively. Net investment income (including net realized capital gains and losses) and interest credited to policyholders on separate account assets are not reflected in the Consolidated Statements of Income.
Separate account management fees and other revenues included in fee income were $1.3 billion, $1.4 billion and $1.1 billion in 2001, 2000 and 1999, respectively. The guaranteed separate accounts include fixed market value adjusted ("MVA") individual annuities and modified guaranteed life insurance. The average credited interest rate on these contracts was 6.4% and 6.6% at December 31, 2001 and 2000, respectively. The assets that support these liabilities were comprised of $9.8 billion and $9.6 billion in fixed maturities as of December 31, 2001 and 2000, respectively, and $243 and $127 of other investments as of December 31, 2001 and 2000, respectively. The portfolios are segregated from other investments and are managed to minimize liquidity and interest rate risk. In order to minimize the risk of disintermediation associated with early withdrawals, fixed MVA annuity and modified guaranteed life insurance contracts carry a graded surrender charge as well as a market value adjustment. Additional investment risk is hedged using a variety of derivatives which totaled $37 and $3 in net carrying value and $3.2 billion and $3.5 billion in notional amounts as of December 31, 2001 and 2000, respectively.
6. DEBT
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. DEBT (CONTINUED)
(A) SHELF REGISTRATIONS
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. This registration statement includes an aggregate $150 of HLI securities remaining under the shelf registration filed by HLI with the SEC in June 1998. As of December 31, 2001, HLI had $1.0 billion remaining on its shelf.
On November 9, 2000, The Hartford filed with the Securities and Exchange Commission a shelf registration statement and a prospectus, as amended on January 31, 2001, for the potential offering and sale of up to $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 (see Note 7). This registration statement includes an aggregate of $127 of The Hartford securities remaining under a shelf registration statement filed by The Hartford with the Securities and Exchange Commission on October 11, 1995 and subsequently amended on October 2, 1996. The registration statement was declared effective on February 12, 2001. As of December 31, 2001, The Hartford had $1.1 billion remaining on the shelf.
(B) SHORT-TERM DEBT
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. The Hartford's commercial paper ranks equally with its other unsecured and unsubordinated indebtedness. As of December 31, 2001, the Company had $299 of outstanding borrowings under the program.
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, 2001, there were no outstanding borrowings under the facility.
HLI has a commercial paper program which allows it to borrow up to a maximum amount of $250 in short-term commercial paper notes. As of December 31, 2001, HLI had no outstanding borrowings under the program.
As of December 31, 2001, HLI maintained a $250 five-year revolving credit facility comprised of four participatory banks. This facility, which expires in 2003, is available for general corporate purposes and to provide additional support to HLI's commercial paper program. As of December 31, 2001, there were no outstanding borrowings under the facility or commercial paper program.
On June 23, 2000, The Hartford borrowed $400 under its commercial paper program, the proceeds of which were used to partially fund The HLI Repurchase. On December 29, 2000, the Company paid off this borrowing with proceeds received from the sale of Zwolsche (see Note 18(b)).
(C) LONG-TERM DEBT
The Hartford's long-term debt securities are issued by either The Hartford Financial Services Group, Inc. ("HFSG") or HLI and are unsecured obligations of HFSG or HLI and rank on a parity with all other unsecured and unsubordinated indebtedness of HFSG or HLI.
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 from its existing shelf registration. The long-term debt was issued in the form of 7.375% thirty-year senior notes due March 1, 2031. Interest on the notes is payable semi-annually on March 1 and September 1, commencing on September 1, 2001. As previously discussed, HLI used the net proceeds from the issuance of the notes to partially fund the Fortis acquisition. (For further discussion of the Fortis Acquisition, see Note 18(a).)
On June 16, 2000, The Hartford issued and sold $525 of unsecured redeemable long-term debt under its October 11, 1995 shelf. The long-term debt was issued in the form of $250 7.75% five-year notes due June 15, 2005, and $275 7.90% ten-year notes due June 15, 2010. Interest on the notes is payable semi-annually on June 15 and December 15, commencing on December 15, 2000. The Hartford used the net proceeds from the issuance of the common stock and debt to partially fund The HLI Repurchase (see Note 16).
(D) INTEREST EXPENSE
Interest expense incurred related to short-term and long-term debt totaled $179, $150 and $114 for 2001, 2000 and 1999, respectively.
7. COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUSTS HOLDING SOLELY JUNIOR SUBORDINATED DEBENTURES (TRUST PREFERRED SECURITIES)
(A) DESCRIPTION
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. The proceeds from the sale of the Series C Preferred Securities were used to acquire $500 of Junior Subordinated Deferrable Interest Debentures Senior C issued by The Hartford. The Hartford used the proceeds from the sale of such debentures for the redemption of the 8.35% Cumulative Quarterly Income Preferred Securities, Series B of Hartford Capital II.
The Series C Preferred Securities represent undivided beneficial interests in the assets of Hartford Capital III. The Hartford owns all of the common securities of Hartford Capital III. Holders of Series C Preferred Securities are entitled to receive cumulative cash distributions accruing from October 26, 2001, the date of issuance, and payable quarterly in arrears
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUSTS HOLDING SOLELY JUNIOR SUBORDINATED DEBENTURES (TRUST PREFERRED SECURITIES) (CONTINUED)
(A) DESCRIPTION (CONTINUED)
commencing January 2, 2002 at the annual rate of 7.45% of the stated liquidation amount of $25.00 per Series C Preferred Security. The Series C Preferred Securities are subject to mandatory redemption upon repayment of the Series C Junior Subordinated Debentures at maturity or upon earlier redemption. The Hartford has the right to redeem the Hartford Junior Subordinated Debentures (i) at any time, in whole or in part, at a redemption price equal to the accrued and unpaid interest on the Hartford Junior Subordinated Debentures so redeemed to the date fixed for redemption, plus the greater of (a) the principal amount thereof and (b) an amount equal to the interest and principal that would have been payable after the redemption date, discounting that amount on a U.S. Treasury rate basis to present value, or (ii) on or after October 26, 2006, in whole or part, at a redemption price equal to the accrued and unpaid interest on the Hartford Junior Subordinated Debentures so redeemed to the date fixed for redemption plus 100% of the principal amount, or (iii) at any time, in whole, but not in part, upon the occurrence of certain specified events, at a redemption price equal to the accrued and unpaid interest on the Hartford Junior Subordinated Debentures so redeemed to the date fixed for redemption, plus 100% of the principal amount thereof, in each case subject to certain conditions.
The Hartford Junior Subordinated Debentures bear interest at the annual rate of 7.45% of the principal amount, payable quarterly in arrears commencing January 2, 2002, and mature on October 26, 2050. The Hartford Junior Subordinated Debentures are unsecured and rank junior and subordinate in right of payment to all senior debt of The Hartford and are effectively subordinated to all existing and future liabilities of its subsidiaries.
The Hartford has the right to defer payments of interest on the Hartford Junior Subordinated Debentures by extending the interest payment period for up to 20 consecutive quarters for each deferral period, up to the maturity date. During any such period, interest will continue to accrue and The Hartford may not declare or pay any cash dividends or distributions on The Hartford's common stock nor make any principal, interest or premium payments on or repurchase any debt securities that rank pari passu with or junior to the Hartford Junior Subordinated Debentures. In the event of failure to pay interest for 30 consecutive days (subject to the deferral of any due date in the case of an extension period), the Hartford Junior Subordinated Debentures will become due and payable. The Hartford has guaranteed, on a subordinated basis, all of the Hartford Capital III obligations under the Hartford Series C Preferred Securities, including to pay the redemption price and any accumulated and unpaid distributions to the extent of available funds and upon dissolution, winding up or liquidation, but only to the extent that Hartford Capital III has funds to make such payments.
On March 6, 2001, Hartford Life Capital II, a Delaware statutory business trust formed by HLI, issued 8,000,000, 7.625% Trust Preferred Securities, Series B under its June 1998 shelf registration. The proceeds from the sale of the Series B Preferred Securities were used to acquire $200 of 7.625% Series B Junior Subordinated Debentures issued by HLI. HLI used the proceeds from the offering to partially fund the Fortis acquisition.
The Series B Preferred Securities represent undivided beneficial interests in Hartford Life Capital II's assets, which consist solely of the Series B Junior Subordinated Debentures. HLI owns all of the common securities of Hartford Life Capital II. Holders of Series B Preferred Securities are entitled to receive cumulative cash distributions accruing from March 6, 2001, the date of issuance, and payable quarterly in arrears commencing April 15, 2001 at the annual rate of 7.625% of the stated liquidation amount of $25.00 per Series B Preferred Security. The Series B Preferred Securities are subject to mandatory redemption upon repayment of the Series B Junior Subordinated Debentures at maturity or upon earlier redemption. HLI has the right to redeem the Series B Junior Subordinated Debentures on or after March 6, 2006 or earlier upon the occurrence of certain events. Holders of Series B Preferred Securities generally have no voting rights.
The Series B Junior Subordinated Debentures bear interest at the annual rate of 7.625% of the principal amount, payable quarterly in arrears commencing April 15, 2001, and mature on February 15, 2050. The Series B Junior Subordinated Debentures are unsecured and rank junior and subordinate in right of payment to all present and future senior debt of HLI and are effectively subordinated to all existing and future obligations of HLI subsidiaries.
HLI has the right at any time, and from time to time, to defer payments of interest on the Series B Junior Subordinated Debentures for a period not exceeding 20 consecutive quarters up to the debentures' maturity date. During any such period, interest will continue to accrue and HLI may not declare or pay any cash dividends or distributions on, or purchase, HLI's capital stock nor make any principal, interest or premium payments on or repurchase any debt securities that rank equally with or junior to the Series B Junior Subordinated Debentures. HLI will have the right at any time to dissolve the Trust and cause the Series B Junior Subordinated Debentures to be distributed to the holders of the Series B Preferred Securities. HLI has guaranteed, on a subordinated basis, all of the Hartford Life Capital II obligations under the Series B Preferred Securities including payment of the redemption price and any accumulated and unpaid distributions to the extent of available funds and upon dissolution, winding up or liquidation but only to the extent Hartford Life Capital II has funds available to make such payments.
On June 29, 1998, Hartford Life Capital I, a special purpose Delaware trust formed by HLI, issued 10,000,000, 7.2% Trust Preferred Securities, Series A ("Series A Preferred Securities"). The proceeds from the sale of the Series A Preferred Securities were used to acquire $250 of 7.2% Series A Junior Subordinated Deferrable Interest Debentures ("Junior Subordinated Debentures") issued by HLI. HLI used the proceeds from the offering for the retirement of its outstanding commercial paper, for acquisitions and for other general corporate purposes.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUSTS HOLDING SOLELY JUNIOR SUBORDINATED DEBENTURES (TRUST PREFERRED SECURITIES) (CONTINUED)
(A) DESCRIPTION (CONTINUED)
The Series A Preferred Securities represent undivided beneficial interests in Hartford Life Capital I's assets, which consist solely of the Junior Subordinated Debentures. HLI owns all of the beneficial interests represented by Series A Common Securities of Hartford Life Capital I. Holders of Series A Preferred Securities are entitled to receive cumulative cash distributions accruing from June 29, 1998, the date of issuance, and payable quarterly in arrears commencing July 15, 1998 at the annual rate of 7.2% of the stated liquidation amount of $25.00 per Series A Preferred Security. Holders of Series A Preferred Securities generally have no voting rights. The Series A Preferred Securities are subject to mandatory redemption upon repayment of the Junior Subordinated Debentures at maturity or upon earlier redemption.
HLI has the right to redeem the Junior Subordinated Debentures (i) in whole or in part on or after June 30, 2003, or (ii) at any time, in whole only, upon the occurrence of certain specified events. In either case, the redemption price equals the accrued and unpaid interest on the Junior Subordinated Debentures so redeemed to the date fixed for redemption plus the principal amount thereof. In addition, prior to June 30, 2003, HLI shall have the right to redeem the Junior Subordinated Debentures at any time, in whole or in part, at a redemption price equal to the accrued and unpaid interest on the Junior Subordinated Debentures so redeemed to the date fixed for redemption, plus the greater of (a) the principal amount thereof or (b) an amount equal to the present value on the redemption date of the interest payments that would have been paid through June 20, 2003, after discounting that amount on a quarterly basis from the originally scheduled date for payment, and the present value on the redemption date of principal, after discounting that amount on a quarterly basis from June 30, 2003, at a discount rate tied to the interest rate on U.S. Treasury securities maturing on June 30, 2003. The Junior Subordinated Debentures bear interest at the annual rate of 7.2% of the principal amount, payable quarterly in arrears commencing June 29, 1998, and mature on June 30, 2038. The Junior Subordinated Debentures are unsecured and rank junior and subordinate in right of payment to all present and future senior debt of HLI and are effectively subordinated to all existing and future liabilities of its subsidiaries.
HLI has the right at any time, and from time to time, to defer payments of interest on the Junior Subordinated Debentures for a period not exceeding 20 consecutive quarters up to the debentures' maturity date. During any such period, interest will continue to accrue and HLI may not declare or pay any cash dividends or distributions on, or purchase, HLI's capital stock nor make any principal, interest or premium payments on or repurchase any debt securities that rank pari passu with or junior to the Junior Subordinated Debentures. HLI will have the right at any time to dissolve the Trust and cause the Junior Subordinated Debentures to be distributed to the holders of the Series A Preferred Securities and the Series A Common Securities. HLI has guaranteed, on a subordinated basis, all of the Hartford Life Capital I obligations under the Series A Preferred Securities, including payment of the redemption price and any accumulated and unpaid distributions to the extent of available funds and upon dissolution, winding up or liquidation but only to the extent that Hartford Life Capital I has funds to make such payments.
On October 30, 1996, Hartford Capital II, a special purpose Delaware trust formed by The Hartford, issued 20,000,000 Series B, 8.35% Cumulative Quarterly Income Preferred Securities ("Series B Preferred Securities"). The material terms of the Series B Preferred Securities are substantially the same as the Hartford Series A Preferred Securities described above, except for the rate and maturity date. The proceeds from the sale of the Series B Preferred Securities were used to acquire $500 of Junior Subordinated Deferrable Interest Debentures, Series B ("Series B Debentures"), issued by The Hartford. The Series B Debentures bear interest at the annual rate of 8.35% of the principal amount payable quarterly in arrears commencing December 31, 1996, and mature on October 30, 2026. The Hartford used the proceeds from the sale of such debentures for general corporate purposes.
The Series B Preferred Securities were redeemed on December 31, 2001, using the proceeds from the October 2001 Series C Preferred Securities. The Company incurred an $8, after-tax, extraordinary loss related to unamortized issue costs associated with the early extinguishment of the Series B Preferred Securities.
On February 28, 1996, Hartford Capital I, a special purpose Delaware trust formed by The Hartford, issued 20,000,000 Series A, 7.7% Cumulative Quarterly Income Preferred Securities ("Hartford Series A Preferred Securities"). The proceeds from the sale of Hartford Series A Preferred Securities were used to acquire $500 of Junior Subordinated Deferrable Interest Debentures, Series A ("Hartford Junior Subordinated Debentures"), issued by The Hartford. The Hartford used the proceeds from the sale of such debentures for the partial repayment of outstanding commercial paper and short-term bank indebtedness. Hartford Series A Preferred Securities represent undivided beneficial interests in the assets of Hartford Capital I. The Hartford owns all of the beneficial interests represented by Series A Common Securities of Hartford Capital I. Holders of Hartford Series A Preferred Securities are entitled to receive preferential cumulative cash distributions accruing from February 28, 1996 and payable quarterly in arrears commencing March 31, 1996 at the annual rate of 7.7% of the liquidation amount of $25.00 per Hartford Series A Preferred Security. Holders of Hartford Series A Preferred Securities have limited voting rights. The Hartford Series A Preferred Securities are subject to mandatory redemption upon repayment of the Hartford Junior Subordinated Debentures at maturity or their earlier redemption.
The Hartford has the right to redeem the Hartford Junior Subordinated Debentures (i) at any time, in whole or in part, at a redemption price equal to the accrued and unpaid interest on the Hartford Junior Subordinated Debentures so redeemed to the date fixed for redemption, plus the greater of (a) the principal amount thereof and (b) an amount equal to the interest and
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. COMPANY OBLIGATED MANDATORILY REDEEMABLE PREFERRED SECURITIES OF SUBSIDIARY TRUSTS HOLDING SOLELY JUNIOR SUBORDINATED DEBENTURES (TRUST PREFERRED SECURITIES) (CONTINUED)
(A) DESCRIPTION (CONTINUED)
principal that would have been payable after the redemption date, discounting that amount on a U.S. Treasury rate basis to a present value, or (ii) on or after February 28, 2001, in whole or part, at a redemption price equal to the accrued and unpaid interest on the Hartford Junior Subordinated Debentures so redeemed to the date fixed for redemption plus 100% of the principal amount thereof, or (iii) at any time, in whole only, upon the occurrence of certain specified events, at a redemption price equal to the accrued and unpaid interest on the Hartford Junior Subordinated Debentures so redeemed to the date fixed for redemption, plus 100% of the principal amount thereof, in each case subject to certain conditions.
The Hartford Junior Subordinated Debentures bear interest at the annual rate of 7.7% of the principal amount, payable quarterly in arrears commencing March 31, 1996, and mature on February 28, 2016. The Hartford Junior Subordinated Debentures are unsecured and rank junior and subordinate in right of payment to all senior debt of The Hartford and are effectively subordinated to all existing and future liabilities of its subsidiaries.
The Hartford has the right to defer payments of interest on the Hartford Junior Subordinated Debentures by extending the interest payment period for up to 20 consecutive quarters for each deferral period, up to the maturity date. During any such period, interest will continue to accrue and The Hartford may not declare or pay any cash dividends or distributions on The Hartford's common stock nor make any principal, interest or premium payments on or repurchase any debt securities that rank pari passu with or junior to the Hartford Junior Subordinated Debentures. In the event of failure to pay interest for 30 consecutive days (subject to the deferral of any due date in the case of an extension period), the Hartford Junior Subordinated Debentures will become due and payable. The Hartford has guaranteed, on a subordinated basis, all of the Hartford Capital I obligations under the Hartford Series A Preferred Securities, including to pay the redemption price and any accumulated and unpaid distributions to the extent of available funds and upon dissolution, winding up or liquidation, but only to the extent that Hartford Capital I has funds to make such payments.
(B) INTEREST EXPENSE
Interest expense incurred with respect to the Series A Preferred Securities and Series B Preferred Securities totaled approximately $116, $100 and $100 in 2001, 2000 and 1999, respectively.
8. STOCKHOLDERS' EQUITY
(A) COMMON STOCK
On October 22, 2001, The Hartford issued 7.0 million shares of common stock under its current shelf registration to Salomon Smith Barney Inc. at a price of $56.82 per share and received proceeds of $400. The shares were then re-offered by Salomon Smith Barney Inc. to investors. The proceeds from this issuance were used for the replacement of a portion of the reduction in stockholders' equity from the September 11 loss.
On February 16, 2001, The Hartford issued 10 million shares of common stock pursuant to an underwritten offering under its current shelf registration for net proceeds of $615. The proceeds were used to partially fund the Fortis acquisition.
On June 8, 2000, The Hartford issued 7.25 million shares of common stock in a block trade to Goldman, Sachs & Co. for $398. The shares were issued out of treasury. The Hartford used the net proceeds from the issuance of the shares to partially fund The HLI Repurchase (see Note 16).
In October 1999, The Hartford's Board of Directors authorized the repurchase of up to $1.0 billion of the Company's outstanding common stock. This repurchase authorization was effective in November 1999 and covers a three-year period. On the first two trading days following September 11, The Hartford repurchased 0.1 million shares of its common stock in the open market at a total cost of $7. This transaction represented the only repurchases made during 2001. Since the inception of the 1999 repurchase program, The Hartford has repurchased 6.1 million shares at a total cost of $250. Certain of these repurchased shares have been reissued pursuant to certain stock-based benefit plans. Shares repurchased in the open market are carried at cost and reflected as a reduction to stockholders' equity. Treasury shares subsequently reissued are reduced from treasury stock on a weighted average cost basis.
(B) PREFERRED STOCK
The Company has 50,000,000 shares of preferred stock authorized, none of which have been issued. In 1995, the Company approved The Hartford Stockholder Rights Plan, pursuant to which a nonvoting right attaches to each share of common stock. Upon the occurrence of certain triggering events, the right will permit each shareholder to purchase a fraction of a share of the Series A Participating Cumulative Preferred Stock (the "Series A Preferred Stock") of The Hartford. There are 300,000 authorized shares of Series A Preferred Stock. No shares were issued or outstanding at December 31, 2001, 2000 or 1999.
(C) STATUTORY RESULTS For the years ended December 31, -------------------------------- 2001 2000 1999 - --------------------------------------------------------------------- STATUTORY NET INCOME (LOSS) Life operations $ (364) $ 422 $ 245 Property & Casualty operations (223) 779 315 - --------------------------------------------------------------------- TOTAL $ (587) $ 1,201 $ 560 - --------------------------------------------------------------------- STATUTORY SURPLUS Life operations $ 2,991 $ 2,407 $ 2,356 Property & Casualty operations 3,178 3,495 4,678 - --------------------------------------------------------------------- TOTAL $ 6,169 $ 5,902 $ 7,034 =====================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. STOCKHOLDERS' EQUITY (CONTINUED)
(C) STATUTORY RESULTS (CONTINUED)
A significant percentage of the consolidated statutory surplus is permanently reinvested or is subject to various state and foreign government regulatory restrictions or other agreements which limit the payment of dividends without prior approval. As of December 31, 2001, the maximum amount of statutory dividends which may be paid to HFSG from its insurance subsidiaries in 2002, without prior approval, is $577.
The domestic insurance subsidiaries of HFSG prepare their statutory financial statements in accordance with accounting practices prescribed by the applicable state insurance department. Prescribed statutory accounting practices include publications of the National Association of Insurance Commissioners ("NAIC"), as well as state laws, regulations and general administrative rules.
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. As of December 31, 2001, the impact of applying the new guidance resulted in a benefit of approximately $400 in statutory surplus.
9. EARNINGS PER SHARE
Earnings per share amounts have been computed in accordance with the provisions of SFAS No. 128, "Earnings per Share". The following tables present a reconciliation of income and shares used in calculating basic earnings per share to those used in calculating diluted earnings per share.
Basic earnings per share are computed based on the weighted average number of shares outstanding during the year. Diluted earnings per share include the dilutive effect of outstanding options, using the treasury stock method, and also contingently issuable shares. Under the treasury stock method, exercise of options is assumed with the proceeds used to purchase common stock at the average market price for the period. The difference between the number of shares assumed issued and number of shares purchased represents the dilutive shares. Contingently issuable shares are included upon satisfaction of certain conditions related to the contingency.
10. STOCK COMPENSATION PLANS
On May 18, 2000, the shareholders of The Hartford approved The Hartford 2000 Incentive Stock Plan (the "2000 Plan"), which replaced The Hartford 1995 Incentive Stock Plan (the "1995 Plan"). The terms of the 1995 Plan were substantially similar to the terms of the 2000 Plan except that the 1995 Plan had an annual award limit and a higher maximum award limit.
Under the 2000 Plan, awards may be granted in the form of non-qualified or incentive stock options qualifying under Section 422A of the Internal Revenue Code, performance shares or restricted stock, or any combination of the foregoing. In addition, stock appreciation rights may be granted in connection with all or part of any stock options granted under the 2000 Plan. The aggregate number of shares of stock which may be awarded is subject to a maximum limit of 17,211,837 shares applicable to all awards for the ten-year duration of the 2000 Plan.
All options granted have an exercise price equal to the market price of the Company's common stock on the date of grant, and an option's maximum term is ten years. Certain options become exercisable over a three year period commencing one year from the date of grant, while certain other options become exercisable upon the attainment of specified market price appreciation of the Company's common shares or at seven years after the date of grant. For any year, no individual employee may receive an award of options for more than 1,000,000 shares. As of December 31, 2001, The Hartford had not issued any incentive stock options under the 2000 Plan.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. STOCK COMPENSATION PLANS (CONTINUED)
Performance awards of common stock granted under the 2000 Plan become payable upon the attainment of specific performance goals achieved over a period of not less than two nor more than five years, and restricted stock granted is subject to a restriction period. On a cumulative basis, no more than 20% of the aggregate number of shares which may be awarded under the 2000 Plan are available for performance shares and restricted stock awards. Also, the maximum award of performance shares for any individual employee in any year is 200,000 shares.
In 1997, the Company awarded special performance based options and restricted stock to certain key executives under the 1995 Plan. The awards vested only if the Company's stock traded at certain predetermined levels for ten consecutive days by March 1, 2001. Vested options could not be exercised nor restricted shares disposed of until March 1, 2001. As a result of the Company's stock trading at predetermined levels for ten consecutive days, in May 1999 and also in September 2000, the special performance based options and restricted stock vested. As a result, the Company began recognizing compensation expense in May 1999 and continued to recognize expense through March 1, 2001.
In 1996, the Company established The Hartford Employee Stock Purchase Plan ("ESPP"). Under this plan, eligible employees of The Hartford may purchase common stock of the Company at a 15% discount from the lower of the market price at the beginning or end of the quarterly offering period. The Company may sell up to 5,400,000 shares of stock to eligible employees under the ESPP, and 288,118, 241,742 and 255,971 shares were sold in 2001, 2000 and 1999, respectively. The per share weighted average fair value of the discount under the ESPP was $10.11, $14.89 and $9.99 in 2001, 2000 and 1999, respectively. Additionally, during 1997, The Hartford established employee stock purchase plans for certain employees of the Company's international subsidiaries. Under these plans, participants may purchase common stock of The Hartford at a fixed price at the end of a three-year period.
The Company applies APB Opinion No. 25 and related interpretations in accounting for its stock-based compensation plans. Accordingly, in the measurement of compensation expense, the Company utilizes the excess of market price over exercise price on the first date that both the number of shares and award price are known. For the years ended December 31, 2001, 2000 and 1999, compensation expense related to the Company's two stock-based compensation plans was $8, $23 and $16 after-tax, respectively. Had compensation cost for the Company's incentive stock plan and ESPP been determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS No. 123, "Accounting for Stock-Based Compensation", the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated as follows:
2001 2000 1999 - ------------------------------------------------------------------------------- Net income: As reported $ 507 $ 974 $ 862 Pro forma [1] [2] $ 454 $ 937 $ 834 Basic earnings per share: As reported $ 2.13 $ 4.42 $ 3.83 Pro forma [1] [2] $ 1.91 $ 4.25 $ 3.71 Diluted earnings per share: As reported $ 2.10 $ 4.34 $ 3.79 Pro forma [1] [2] $ 1.88 $ 4.18 $ 3.67 =============================================================================== [1] The pro forma disclosures are not representative of the effects on net income and earnings per share in future years. [2] For 2000 and 1999 includes The Hartford's ownership share of compensation costs related to HLI's incentive stock plan and employee stock purchase plan determined in accordance with SFAS No. 123.
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 2001, 2000 and 1999: dividend yield of 1.6% for 2001, 1.5% for 2000 and 2.1% for 1999; expected price variability of 29.1% for 2001, 35.7% for 2000 and 29.0% for 1999; risk-free interest rates of 4.98% for 2001 grants, 6.41% for 2000 grants and 5.08% for 1999 grants; and expected lives of six years for 2001, four years for 2000 and seven years for 1999.
A summary of the status of non-qualified options included in the Company's incentive stock plan as of December 31, 2001, 2000 and 1999 and changes during the years ended December 31, 2001, 2000 and 1999 is presented below:
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. STOCK COMPENSATION PLANS (CONTINUED)
The following table summarizes information about stock options outstanding and exercisable (shares in thousands) at December 31, 2001:
11. PENSION PLANS AND POSTRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFIT PLANS
The following tables set forth a reconciliation of beginning and ending balances of the benefit obligation and fair value of plan assets as well as the funded status of The Hartford's defined benefit pension and postretirement health care and life insurance benefit plans for the years ended December 31, 2001 and 2000. International plans represent an immaterial percentage of total pension assets, liabilities and expense and, for reporting purposes, are combined with domestic plans.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. PENSION PLANS AND POSTRETIREMENT HEALTH CARE AND LIFE INSURANCE BENEFIT PLANS (CONTINUED)
Amounts recognized in the statement of financial position consist of:
Weighted-average assumptions used in the accounting for the plans were:
For measurement purposes, an 8% annual rate of increase in the per capita cost of covered health care benefits was assumed for 2001. The rate was assumed to decrease gradually to 5.0% for 2007 and remain at that level thereafter. Increasing (decreasing) the table of health care trend rates by one percent per year would have the effect of increasing (decreasing) the benefit obligation as of December 31, 2001 by $8 $(8) and the annual net periodic expense for the year then ended by $1 $(1), respectively, for the postretirement health care and life insurance benefit plan.
Total pension cost for the years ended December 31, 2001, 2000 and 1999 include the following components:
The Hartford provides certain health care and life insurance benefits for eligible retired employees. The Hartford's contribution for health care benefits will depend upon the retiree's date of retirement and years of service. In addition, the plan has a defined dollar cap which limits average Company contributions. The Hartford has prefunded a portion of the health care and life insurance obligations through trust funds where such prefunding can be accomplished on a tax effective basis.
Effective January 1, 2001, the Company amended the defined benefit pension plan to add a cash balance benefit formula to apply to all employees with an original hire date on or after January 1, 2001.
12. INVESTMENT AND SAVINGS PLAN
Substantially all U.S. employees are eligible to participate in The Hartford's Investment and Savings Plan under which designated contributions may be invested in common stock of The Hartford or certain other investments. These contributions are matched, up to 3% of compensation, by the Company. In addition, the Company allocates 0.5% of base salary to the plan for each eligible employee. The cost to The Hartford for the above plan was approximately $30, $28 and $26 for 2001, 2000 and 1999, respectively.
13. REINSURANCE
The Hartford cedes insurance to other insurers in order to limit its maximum losses. Such transfer 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 also assumes reinsurance from other insurers. The Hartford evaluates the financial condition of its reinsurers and monitors concentrations of credit risk. As of December 31, 2001, The Hartford had no reinsurance-related concentrations of credit risk greater than 10% of the Company's stockholders' equity.
Life insurance net retained premiums were comprised of the following:
For the years ended December 31, ---------------------------------------- 2001 2000 1999 - --------------------------------------------------------------------- Gross premiums $ 5,070 $ 4,731 $ 4,165 Assumed 232 137 154 Ceded (398) (303) (250) - --------------------------------------------------------------------- NET RETAINED PREMIUMS $ 4,904 $ 4,565 $ 4,069 =====================================================================
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. REINSURANCE (CONTINUED)
The Hartford records a receivable for reinsured benefits paid and the portion of insurance liabilities that are reinsured. The cost of reinsurance related to long-duration contracts is accounted for over the life of the underlying reinsured policies using assumptions consistent with those used to account for the underlying policies. Life insurance recoveries on ceded reinsurance contracts, which reduce death and other benefits, were $392, $225 and $168 for the years ended December 31, 2001, 2000 and 1999, respectively.
The effect of reinsurance on property and casualty premiums written and earned was as follows:
For the years ended December 31, -------------------------------------------- 2001 2000 1999 - -------------------------------------------------------------------- PREMIUMS WRITTEN Direct $ 7,625 $ 7,109 $ 6,464 Assumed 1,035 965 833 Ceded (1,075) (826) (585) - -------------------------------------------------------------------- NET $ 7,585 $ 7,248 $ 6,712 ==================================================================== PREMIUMS EARNED Direct $ 7,230 $ 6,770 $ 6,189 Assumed 1,016 1,001 827 Ceded (980) (795) (528) - -------------------------------------------------------------------- NET $ 7,266 $ 6,976 $ 6,488 ====================================================================
Reinsurance cessions, which reduce claims and claim expenses incurred, were $1.2 billion, $650 and $565 for the years ended December 31, 2001, 2000 and 1999, respectively.
14. INCOME TAX
Deferred tax assets (liabilities) include the following as of December 31:
Prior to the Tax Reform Act of 1984, the Life Insurance Company Income Tax Act of 1959 permitted the deferral from taxation of a portion of statutory income under certain circumstances. In these situations, the deferred income was accumulated in a "Policyholders' Surplus Account" and, based on current tax law, will be taxable in the future only under conditions which management considers to be remote; therefore, no federal income taxes have been provided on the balance in this account, which for tax return purposes was $104 as of December 31, 2001.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. INCOME TAX (CONTINUED)
No additional provision or benefit has been recognized for U.S. taxes on international earnings, as amounts were insignificant at December 31, 2001.
A reconciliation of the tax provision at the U.S. Federal statutory rate to the provision for income taxes is as follows:
15. COMMITMENTS AND CONTINGENCIES
(A) LITIGATION
The Hartford is or may become involved in various legal actions, some of which involve claims for substantial amounts. In the opinion of management, the ultimate liability with respect to such actual and potential lawsuits, after consideration of provisions made for potential losses and costs of defense, is not expected to be material to the consolidated financial condition, results of operations or cash flows of The Hartford.
(B) ENVIRONMENTAL AND ASBESTOS CLAIMS
Historically, The Hartford has found it difficult to estimate ultimate liabilities related to environmental and asbestos claims due to uncertainties surrounding these exposures. Within the property and casualty insurance industry, in the mid-1990s, progress was made in developing sophisticated, alternative methodologies utilizing company experience and supplemental databases to assess environmental and asbestos liabilities. A study which incorporated these methodologies was initiated by The Hartford in April 1996. The study included a review of identified environmental and asbestos exposures of North American Property & Casualty, along with U.S. exposures of The Hartford's Other Operations segment. The methodology utilized a ground-up analysis of policy, site and exposure level data for a representative sample of The Hartford's claims. The results of the evaluation were extrapolated against the balance of the claim population to estimate the Company's overall exposure for reported claims.
In addition to estimating liabilities on reported environmental and asbestos claims, The Hartford estimated reserves for claims incurred but not reported ("IBNR"). The IBNR reserve was estimated using information on reporting patterns of known insureds, characteristics of insureds such as limits exposed, attachment points and number of coverage years involved, third party costs and closed claims.
Included in The Hartford's analysis of environmental and asbestos exposures was a review of applicable reinsurance coverage. Reinsurance coverage applicable to the sample was used to estimate the reinsurance coverage that applied to the balance of the reported environmental and asbestos claims and to the IBNR estimates.
The Hartford reported net environmental and asbestos reserves of $1,270 and $1,483 as of December 31, 2001 and 2000, respectively. The Hartford believes that the environmental and asbestos reserves reported at December 31, 2001 are a reasonable estimate of the ultimate remaining liability for these claims based upon known facts, current assumptions and The Hartford's methodologies. Future social, economic, legal or legislative developments may alter the original intent of policies and the scope of coverage. The Hartford will continue to evaluate new methodologies and developments, such as the increasing level of asbestos claims being tendered under the comprehensive general liability operations (non-product) section of policies, as they arise in order to supplement the Company's ongoing analysis and review of its environmental and asbestos exposures. These future reviews may result in a change in reserves, impacting The Hartford's results of operations in the period in which the reserve estimates are changed. While the impact of these changes could have a material effect on future results of operations, The Hartford does not expect such changes would have a material effect on its liquidity or financial condition.
(C) LEASE COMMITMENTS
Total rental expense on operating leases was $181 in 2001, $179 in 2000 and $183 in 1999. Future minimum lease commitments are as follows:
2002 $ 131 2003 112 2004 98 2005 84 2006 69 Thereafter 194 - ---------------------------------------------------------------------- TOTAL $ 688 - ----------------------------------------------------------------------
(D) TAX MATTERS
The Hartford's federal income tax returns are routinely audited by the Internal Revenue Service ("IRS"). In August 2001, the Company recorded a $130 benefit, primarily the result of the favorable treatment of certain tax matters related to separate account investment activity arising during the 1996-2000 tax years. During 2000, the Company recorded a $24 tax benefit as a result of a settlement with the IRS with respect to certain similar tax matters for the 1993-1995 tax years.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
15. COMMITMENTS AND CONTINGENCIES (CONTINUED)
(D) TAX MATTERS (CONTINUED)
Management believes that adequate provision has been made in the financial statements for any potential assessments that may result from tax examinations and other tax related matters for all open tax years.
(E) UNFUNDED COMMITMENTS
At December 31, 2001, The Hartford has outstanding commitments to fund limited partnership investments totaling $375. 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.
16. TRANSACTIONS WITH AFFILIATES
On December 19, 1995, ITT Corporation ("ITT") distributed all of the outstanding shares of common stock of The Hartford to the shareholders of ITT common stock ("the Distribution"). As a result of the Distribution, The Hartford became an independent, publicly-traded company. Prior to the Distribution, The Hartford had substantial dealings with ITT and its affiliates as described below.
The Distribution Agreement entered into by The Hartford, ITT Destinations, Inc., and ITT Industries, Inc. (the former ITT subsidiaries) addressed the disposition of shared liabilities. A shared liability is defined as a liability arising out of, or related to, business conducted by ITT prior to the Distribution that was not otherwise specifically related to one of the former ITT subsidiaries. Under the Distribution Agreement, responsibility for shared liabilities generally will be borne equally by each of the former ITT subsidiaries (or any successor to each former ITT subsidiary), including related attorney's fees and other out-of-pocket expenses. As of December 31, 2001, accruals had been established for liabilities covered by this agreement.
On June 27, 2000, The Hartford acquired all of the outstanding shares of HLI that it did not already own. The HLI Repurchase has been recorded as a purchase transaction. Consideration totaled $1.4 billion and resulted in recognition of goodwill (excess of the purchase price over the fair value of the net assets acquired) of $862, which was amortized on a straight-line basis until January 1, 2002.
Purchase consideration for the transaction was as follows:
Issuance of: - ------------ Common stock from treasury (7.25 million shares @ $54.90 per share) $ 398 Long-term notes: $250 7.75% notes due June 15, 2005 244 $275 7.90% notes due June 15, 2010 272 Commercial paper 400 - ------------------------------------------------------------------- Consideration raised 1,314 Other, including conversion of HLI employee stock options and restricted shares 102 - ------------------------------------------------------------------- Total consideration $ 1,416 ===================================================================
Purchase accounting for this transaction resulted in adjustments to the cost basis of certain assets and liabilities acquired based on assessments of fair value. These adjustments also include the recognition of an asset representing the present value of estimated net cash flows (present value of the future gross profits to be earned, "PVP") embedded in HLI's existing insurance and investment contracts. The amount of the purchase price allocated to PVP was $801. PVP is amortized to expense in relation to the estimated gross profits on those contracts, and interest is accreted on the unamortized balance. For the years ended December 31, 2001 and 2000, amortization of PVP amounted to $79 and $47, respectively. Amortization of purchase adjustments will not have a significant impact on the Company's ongoing results of operations.
17. SEGMENT INFORMATION
The Hartford is organized into two major operations: Life and Property & Casualty. Within these operations, The Hartford conducts business principally in ten operating segments. Additionally, all activities related to The HLI Repurchase 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"). Investment Products offers individual variable and fixed annuities, mutual funds, retirement plan services and other investment products. Individual Life sells a variety of life insurance products, including variable life, universal life, interest sensitive whole life and term life insurance. Group Benefits sells group insurance products, including 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. COLI primarily offers variable products used by employers to fund non-qualified benefits or other postemployment benefit obligations as well as leveraged COLI. Life also includes in an Other category its international operations, which are primarily located in Latin America and Japan, as well as corporate items not directly allocable to any of its reportable operating segments, principally interest expense.
Property & Casualty was reorganized into six reportable operating segments and, effective January 1, 2001, is reported as the North American underwriting segments of Business Insurance, Affinity Personal Lines, Personal Insurance, Specialty Commercial and Reinsurance; and the Other Operations segment, formerly International and Other Operations.
Business Insurance provides standard commercial insurance coverage to small (Select Customer) and mid-sized (Key Accounts) insureds. This segment also provides commercial risk management products and services to small and mid-sized members of affinity groups in addition to marine coverage. Affinity Personal Lines provides customized products and services to the membership of AARP through a direct marketing operation; and to customers of Sears and Ford as well as customers of financial institutions through an affinity center. Personal Insurance provides automobile, homeowners and
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. SEGMENT INFORMATION (CONTINUED)
home-based business coverages to individuals who prefer local agent involvement through a network of independent agents in the standard personal lines market and through Omni in the non-standard automobile market. Specialty Commercial provides property, bond and professional liability coverages as well as insurance through retailers and wholesalers to large commercial clients and insureds requiring a variety of specialized coverages. The Reinsurance segment assumes reinsurance worldwide and primarily writes treaty reinsurance through professional reinsurance brokers covering various property, casualty, specialty and marine classes of business. In October 2001, The Hartford's reinsurance segment announced a centralization of all underwriting and claims operations in Hartford, Connecticut. While exiting most international lines, HartRe will continue to write worldwide catastrophe, Alternative Risk Transfer ("ART") and marine from Hartford. For further discussion of this restructuring, see Note 18(c) of Notes to Consolidated Financial Statements. The Other Operations segment currently consists of certain property and casualty insurance operations of The Hartford which have discontinued writing new business. The Other Operations segment results also include activity for the Company's international property & casualty businesses up until their dates of sales. For further discussion regarding the sales of international subsidiaries, see Note 18(b).
The measure of profit or loss used by The Hartford's management in evaluating performance is operating income (defined in previous years as "core earnings"), except for its North American underwriting segments, which are evaluated by The Hartford's management primarily based upon underwriting results. "Operating income" is defined as after-tax operational results excluding, as applicable, net realized capital gains and losses, the cumulative effect of accounting changes and certain other items. While not considered segments, the Company also reports and evaluates operating income results for Life, Property & Casualty and North American. North American includes the combined underwriting results of the North American underwriting segments along with income and expense items not directly allocable to these segments, such as net investment income. 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 net realized capital gains and losses through net invested income utilizing the duration of the segment's investment portfolios.
The following tables present revenues and operating income (loss). Underwriting results are presented for the Business Insurance, Affinity Personal Lines, Personal Insurance, Specialty Commercial and Reinsurance segments, while operating income is presented for all other segments, along with Life and Property & Casualty, including North American.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
17. SEGMENT INFORMATION (CONTINUED)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
18. ACQUISITIONS, DISPOSITIONS AND RESTRUCTURING
(A) ACQUISITIONS
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 accounted for as a purchase transaction and, as such, the revenues and expenses generated by this business from April 2, 2001 forward are included in the Company's Consolidated Statement of Income.
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 =======================================================================
The assets and liabilities acquired in this transaction were recorded at values prescribed by applicable purchase accounting rules, which generally represent estimated fair value. In addition, an intangible asset representing the present value of future profits ("PVP") of the acquired business was established in the amount of $605. The PVP is amortized to expense in relation to the estimated gross profits of the underlying insurance contracts, and interest is accreted on the unamortized balance. For the year ended December 31, 2001, amortization of PVP amounted to $66. Goodwill of $553, representing the excess of the purchase price over the amount of net assets (including PVP) acquired, has also been recorded and was amortized on a straight-line basis until January 1, 2002.
On June 27, 2000, The Hartford acquired all of the outstanding shares of HLI that it did not already own. For additional discussion, see Note 16, Transactions with Affiliates.
(B) DISPOSITIONS
In September 2001, The Hartford entered 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 completed in January 2002.
On September 7, 2001, HLI completed the sale of its ownership interest in an Argentine subsidiary, Sudamerica Holding S.A. The Company recorded an after-tax net realized capital loss of $21 related to the sale.
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 an after-tax net realized capital loss of $16.
On December 22, 2000, The Hartford completed the sale of its Netherlands-based Zwolsche subsidiary. The Hartford received $547, before costs of sale, and reported an after-tax net realized capital gain of $69 related to the transaction. Management used a portion of the proceeds from the sale to reduce outstanding commercial paper which was issued to partially fund The HLI Repurchase.
(C) RESTRUCTURING
During the fourth quarter of 2001, the Company approved and implemented plans for restructuring the operations of both HartRe and The Hartford Bank. In October 2001, HartRe announced a restructuring of its entire international and domestic operations, with the purpose of centralizing the underwriting organization in Hartford, Connecticut. Also during the fourth quarter, the Boards of Directors for both The Hartford Bank and The Hartford Financial Services Group, Inc., approved The Hartford Bank's dissolution plan. Both plans will be completed during 2002.
Primarily as a result of these restructuring plans, the Company recorded a fourth quarter pretax charge of approximately $16, which is classified within "Other Expenses" on the 2001 Consolidated Statement of Income. This amount includes $8 in employee-related costs, $5 in occupancy-related costs and the remaining $3 in other restructuring related costs.
The 79 employees terminated under these restructuring plans primarily relate to all levels of the underwriting and claims areas. As of December 31, 2001, the Company has not paid any severance costs. The occupancy-related costs represent the remaining lease liabilities for both the domestic and international offices of HartRe to be closed pursuant to the restructuring plan.
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S-2
S-3
S-4
S-5
S-6
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
By: /s/ John N. Giamalis ------------------------------------ John N. Giamalis Senior Vice President and Controller
Date: March 18, 2002
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated.
SIGNATURE TITLE DATE --------- ----- ---- /S/ RAMANI AYER Chairman, President, Chief March 18, 2002 - ---------------------- Ramani Ayer Executive Officer and Director
/S/ THOMAS A. MARRA Executive Vice President and Director March 18, 2002 - ---------------------- Thomas A. Marra
/S/ DAVID K. ZWIENER Executive Vice President and Director March 18, 2002 - ---------------------- David K. Zwiener
/S/ DAVID M. JOHNSON Executive Vice President March 18, 2002 - ---------------------- David M. Johnson and Chief Financial Officer
/S/ JOHN N. GIAMALIS Senior Vice President March 18, 2002 - ---------------------- John N. Giamalis and Controller
/S/ RAND V. ARASKOG Director March 18, 2002 - ---------------------- Rand V. Araskog
/S/ DINA DUBLON Director March 18, 2002 - ---------------------- Dina Dublon
/S/ DONALD R. FRAHM Director March 18, 2002 - ---------------------- Donald R. Frahm
/S/ EDWARD J. KELLY Director March 18, 2002 - ---------------------- Edward J. Kelly
/S/ PAUL G. KIRK, JR. Director March 18, 2002 - ---------------------- Paul G. Kirk, Jr.
/S/ ROBERT W. SELANDER Director March 18, 2002 - ---------------------- Robert W. Selander
/S/ CHARLES B. STRAUSS Director March 18, 2002 - ---------------------- Charles B. Strauss
/S/ H. PATRICK SWYGERT Director March 18, 2002 - ---------------------- H. Patrick Swygert
/S/ GORDON I. ULMER Director March 18, 2002 - ---------------------- Gordon I. Ulmer
II-1
THE HARTFORD FINANCIAL SERVICES GROUP, INC. FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001 FORM 10-K
EXHIBITS INDEX
The exhibits attached to this Form 10-K are those which are required by Item 601 of Regulation S-K and which have not been previously filed with the Securities and Exchange Commission.
EXHIBIT NO. DESCRIPTION - ----------- -----------
3.01 Amended and Restated Certificate of Incorporation of The Hartford Financial Services Group, Inc. ("The Hartford"), amended effective May 21, 1998, was filed as Exhibit 3.01 to The Hartford's Form 10-Q for the quarterly period ended June 30, 1998 and is incorporated herein by reference.
3.02 Amended By-Laws of The Hartford, amended effective February 18, 1999, were filed as Exhibit 3.02 to The Hartford's Form 10-K for the fiscal year ended December 31, 1998 and are incorporated herein by reference.
4.01 Amended and Restated Certificate of Incorporation and By-Laws of The Hartford (incorporated herein by reference as indicated in Exhibits 3.01 and 3.02, respectively).
4.02 Rights Agreement dated as of November 1, 1995, (the "Rights Agreement"), between The Hartford and The Bank of New York as Rights agent was filed as Exhibit 4.02 to The Hartford's Form 10-K for the fiscal year ended December 31, 1995 and is incorporated herein by reference.
4.03 Form of certificate of the voting powers, preferences and relative participating, optional and other special rights, qualifications, limitations or restrictions of Series A Participating Cumulative Preferred Stock of The Hartford (attached as Exhibit A to the Rights Agreement that is incorporated by reference as Exhibit 4.02 hereto).
4.04 Form of Right Certificate (attached as Exhibit B to the Rights Agreement that is incorporated by reference as Exhibit 4.02 hereto).
4.07 Senior Indenture, dated as of October 20, 1995, between The Hartford and The Chase Manhattan Bank (National Association), as trustee, with respect to The Hartford's 6.375% Notes Due November 1, 2002, 7.30% Debentures Due November 1, 2015 and 6.375% Notes Due November 1, 2008 (incorporated by reference to Exhibit 4.08 to The Hartford's Report on Form 8-K, dated November 15, 1995).
4.08 Forms of The Hartford's 6.375% Notes Due November 1, 2002 and 7.30% Debentures due November 1, 2015 (incorporated by reference to Exhibits 4.09 and 4.10, respectively, of The Hartford's Report on Form 8-K dated November 15, 1995).
4.09 Form of The Hartford's 6.375% Notes due November 1, 2008 was filed as Exhibit 4.09 to The Hartford's Form 10-K for the fiscal year ended December 31, 1998 and is incorporated herein by reference.
4.10 Junior Subordinated Indenture, dated as of February 28, 1996, between The Hartford and Wilmington Trust Company, as trustee, with respect to The Hartford's 7.70% Junior Subordinated Deferrable Interest Debentures, Series A, due February 28, 2016 (the "Junior Debentures") was filed as Exhibit 4.09 to The Hartford's Form 10-K for the fiscal year ended December 31, 1995 and is incorporated herein by reference.
4.11 Supplemental Indenture No. 1, dated as of February 28, 1996, between The Hartford and Wilmington Trust Company, as trustee, with respect to the Junior Debentures, was filed as Exhibit 4.10 to The Hartford's Form 10-K for the fiscal year ended December 31, 1995 and is incorporated herein by reference.
4.12 Form of The Hartford's 7.70% Junior Subordinated Deferrable Interest Debenture, Series A, due February 28, 2016 (included in the Indenture incorporated by reference as Exhibit 4.10 hereto).
4.13 Amended and Restated Trust Agreement, dated as of February 28, 1996, of Hartford Capital I, relating to the 7.70% Cumulative Quarterly Income Preferred Securities, Series A ("Preferred Securities") was filed as Exhibit 4.12 to The Hartford's Form 10-K for the fiscal year ended December 31, 1995 and is incorporated herein by reference.
4.14 Agreement as to Expenses and Liabilities, dated as of February 28, 1996, between The Hartford and Hartford Capital I was filed as Exhibit 4.13 to The Hartford's Form 10-K for the fiscal year ended December 31, 1995 and is incorporated herein by reference.
II-2
EXHIBITS INDEX (CONTINUED)
EXHIBIT NO. - -----------
4.15 Preferred Security Certificate for Hartford Capital I (included as Exhibit E to the Trust Agreement incorporated by reference as Exhibit 4.13 hereto).
4.16 Guarantee Agreement, dated as of February 28, 1996, between The Hartford and Wilmington Trust Company, as trustee, relating to The Hartford's guarantee of the Preferred Securities, was filed as Exhibit 4.15 to The Hartford's Form 10-K for the fiscal year ended December 31, 1995 and is incorporated herein by reference.
4.19 Amended and Restated Trust Agreement, dated as of October 30, 1996, of Hartford Capital II, relating to the 8.35% Cumulative Quarterly Income Preferred Securities, Series B, (the "Series B Preferred Securities") was filed as Exhibit 4.1 to The Hartford's Form 8-K, dated November 4, 1996, and is incorporated herein by reference.
4.20 Agreement as to Expenses and Liabilities, dated as of October 30, 1996, between The Hartford and Hartford Capital II (included as Exhibit D that is incorporated by reference as Exhibit 4.19 hereto).
4.21 Preferred Security Certificate for Hartford Capital II (included as Exhibit E to the Amended and Restated Trust Agreement that is incorporated by reference as Exhibit 4.19 hereto).
4.22 Guarantee Agreement, dated as of October 30, 1996, between The Hartford and Wilmington Trust Company, as trustee, relating to The Hartford's guarantee of the Series B Preferred Securities, was filed as Exhibit 4.21 to The Hartford's Form 10-K for the fiscal year ended December 31, 1996 and is incorporated herein by reference.
4.23 Supplemental Indenture No. 1, dated as of December 27, 2000, to the Senior Indenture between The Hartford and The Chase Manhattan Bank, as trustee, was filed as Exhibit 4.30 to The Hartford's Registration Statement on From S-3 (Registration No. 333-49666) and is incorporated herein by reference.
4.24 Form of The Hartford's 7.75% Senior Notes due June 15, 2005 was filed as Exhibit 4.24 to The Hartford's Form 10-K for the fiscal year ended December 31, 2000 and is incorporated herein by reference.
4.25 Form of The Hartford's 7.90% Senior Notes due June 15, 2010 was filed as Exhibit 4.25 to The Hartford's Form 10-K for the fiscal year ended December 31, 2000 and is incorporated herein by reference.
4.26 Junior Subordinated Indenture, dated October 30, 1996, between ITT Hartford Group, Inc. and Wilmington Trust Company, as trustee, was filed as Exhibit 4.16 to ITT Hartford Group, Inc.'s Form 10-K for the fiscal year ended December 31, 1996 and is incorporated herein by reference.
4.27 Supplemental Indenture, dated as of October 26, 2001, between The Hartford and Wilmington Trust Company, as trustee, to the Junior Subordinated Indenture between The Hartford and Wilmington Trust Company, as trustee. +
4.28 Amended and Restated Trust Agreement, dated as of October 26, 2001, of Hartford Capital III, relating to the 7.45% Trust Originated Preferred Securities, Series C, (the "Series C Preferred Securities"). +
4.29 Agreement as to Expenses and Liabilities, dated as of October 26, 2001, between The Hartford and Hartford Capital III. +
4.30 Preferred Security Certificate for Hartford Capital III. +
4.31 Guarantee Agreement, dated as of October 26, 2001, between The Hartford and Wilmington Trust Company, relating to The Hartford's guarantee of the Series C Preferred Securities. +
10.01 Distribution Agreement among ITT Corporation, ITT Destinations, Inc. and The Hartford was filed as Exhibit 10.01 to The Hartford's Form 10-K for the fiscal year ended December 31, 1995 and is incorporated herein by reference.
10.02 Intellectual Property License Agreement among ITT Corporation, ITT Destinations, Inc. and The Hartford was filed as Exhibit 10.02 to The Hartford's Form 10-K for the fiscal year ended December 31, 1995 and is incorporated herein by reference.
10.03 Tax Allocation Agreement among ITT Corporation, ITT Destinations, Inc. and The Hartford was filed as Exhibit 10.03 to The Hartford's Form 10-K for the fiscal year ended December 31, 1995 and is incorporated herein by reference.
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EXHIBITS INDEX (CONTINUED)
EXHIBIT NO. - -----------
10.04 Form of Trade Name and Service Mark License Agreement between ITT Corporation and The Hartford was filed as Exhibit 10.04 to The Hartford's Form 10-K for the fiscal year ended December 31, 1995 and is incorporated herein by reference.
10.05 License Assignment Agreement among ITT Destinations, Inc., The Hartford and Nutmeg Insurance Company was filed as Exhibit 10.05 to The Hartford's Form 10-K for the fiscal year ended December 31, 1995 and is incorporated herein by reference.
10.06 License Assignment Agreement among ITT Destinations, Inc., Nutmeg Insurance Company and Hartford Fire Insurance Company was filed as Exhibit 10.06 to The Hartford's Form 10-K for the fiscal year ended December 31, 1995 and is incorporated herein by reference.
10.07 Employee Benefit Services and Liability Agreement among ITT Corporation, ITT Destinations, Inc. and The Hartford was filed as Exhibit 10.07 to The Hartford's Form 10-K for the fiscal year ended December 31, 1995 and is incorporated herein by reference.
10.08 Debt allocation agreement, dated as of November 1, 1995, between ITT Corporation and The Hartford, and related Fourth Supplemental Indenture, dated as of November 1, 1995, among ITT Corporation, The Hartford and State Street Bank and Trust Company, as successor trustee, were filed as Exhibit 10.10 to The Hartford's Form 10-K for the fiscal year ended December 31, 1995 and are incorporated herein by reference.
10.09 Five-Year Competitive Advance and Revolving Credit Facility Agreement, dated as of December 20, 1996, among The Hartford, the lenders named therein and The Chase Manhattan Bank as administrative agent was filed as Exhibit 10.11 to The Hartford's Form 10-K for the fiscal year ended December 31, 1996 and is incorporated herein by reference.
10.10 364 Day Competitive Advance and Revolving Credit Facility Agreement, dated as of December 20, 1996, among The Hartford, the lenders named therein and The Chase Manhattan Bank as administrative agent was filed as Exhibit 10.12 to The Hartford's Form 10-K for the fiscal year ended December 31, 1996 and is incorporated herein by reference.
*10.11 Employment Agreement, dated July 1, 1997, between The Hartford and Ramani Ayer was filed as Exhibit 10.01 to The Hartford's Form 10-Q for the quarterly period ended September 30, 1997 and is incorporated herein by reference.
*10.12 Employment Agreement, dated July 1, 1997, between Hartford Life, Inc. ("Hartford Life"), The Hartford and Lowndes A. Smith was filed as Exhibit 10.02 to The Hartford's Form 10-Q for the quarterly period ended September 30, 1997 and is incorporated herein by reference.
*10.13 Employment Agreement, dated July 1, 1997, between The Hartford and David K. Zwiener was filed as Exhibit 10.03 to The Hartford's Form 10-Q for the quarterly period ended September 30, 1997 and is incorporated herein by reference.
*10.14 Employment Agreement, dated July 1, 2000, between The Hartford and Thomas M. Marra was filed as Exhibit 10.1 to The Hartford's Form 10-Q for the quarterly period ended September 30, 2000 and is incorporated herein by reference.
*10.15 Form of Employment Protection Agreement between The Hartford and certain executive officers of The Hartford was filed as Exhibit 10.15 to The Hartford's Form 10-K for the fiscal year ended December 31, 1997 and is incorporated herein by reference.
*10.16 The Hartford 1996 Restricted Stock Plan for Non-Employee Directors, as amended, was filed as Exhibit 10.15 to The Hartford's Form 10-K for the fiscal year ended December 31, 1998 and is incorporated herein by reference.
*10.17 The Hartford 2000 Incentive Stock Plan, as amended. +
*10.18 The Hartford 1996 Deferred Restricted Stock Unit Plan, as amended. +
*10.19 The Hartford 1996 Deferred Compensation Plan, as amended. +
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EXHIBITS INDEX (CONTINUED)
EXHIBIT NO. - -----------
*10.20 The Hartford 1997 Senior Executive Severance Pay Plan I, revised as of October 15, 1998, was filed as Exhibit 10.19 to The Hartford's Form 10-K for the fiscal year ended December 31, 1998 and is incorporated herein by reference.
*10.21 The Hartford Executive Severance Pay Plan, revised as of February 1, 1999, was filed as Exhibit 10.20 to The Hartford's Form 10-K for the fiscal year ended December 31, 1998 and is incorporated herein by reference.
10.22 Master Intercompany Agreement among Hartford Life, The Hartford and with respect to Articles VI and XII, Hartford Fire Insurance Company was filed as Exhibit 10.01 to Hartford Life's Form 10-Q for the quarterly period ended June 30, 1997 and is incorporated herein by reference.
10.23 Tax Sharing Agreement among The Hartford and its subsidiaries, including Hartford Life, was filed as Exhibit 10.02 to Hartford Life's Form 10-Q for the quarterly period ended June 30, 1997 and is incorporated herein by reference.
10.24 Management Agreement between Hartford Life Insurance Company and The Hartford Investment Management Company, was filed as Exhibit 10.03 to Hartford Life's Form 10-Q for the quarterly period ended June 30, 1997 and is incorporated herein by reference.
10.25 Management Agreement among certain subsidiaries of Hartford Life and Hartford Investment Services, Inc., was filed as Exhibit 10.04 to Hartford Life's Form 10-Q for the quarterly period ended June 30, 1997 and is incorporated herein by reference.
10.26 Sublease Agreement between Hartford Fire Insurance Company and Hartford Life was filed as Exhibit 10.05 to Hartford Life's Form 10-Q for the quarterly period ended June 30, 1997 and is incorporated herein by reference.
10.27 Employment Agreement, dated as of March 20, 2001, between The Hartford and Neal Wolin as Executive Vice President and General Counsel was filed as Exhibit 10.1 to The Hartford's Form 10-Q for the quarterly period ended March 31, 2001 and is incorporated herein by reference.
10.28 Employment Agreement, dated as of April 26, 2001, between The Hartford and David M. Johnson as Executive Vice President and Chief Financial Officer was filed as Exhibit 10.2 to The Hartford's Form 10-Q for the quarterly period ended March 31, 2001 and is incorporated herein by reference.
10.29 Amended and Restated Five-Year Competitive Advance and Revolving Credit Facility Agreement, dated as of June 20, 2001, among The Hartford Financial Services Group, Inc., the lenders named therein, and The Chase Manhattan Bank and Bank of America, N.A. as co-administrative agents was filed as Exhibit 10.1 to The Hartford's Form 10-Q for the quarterly period ended June 30, 2001 and is incorporated herein by reference.
12.01 Statement Re: Computation of Ratio of Earnings to Fixed Charges is filed herewith.
21.01 Subsidiaries of The Hartford Financial Services Group, Inc. is filed herewith.
23.01 Consent of Arthur Andersen LLP to the incorporation by reference into The Hartford's Registration Statements on Forms S-8 and Form S-3 of the report of Arthur Andersen LLP contained in this Form 10-K regarding the audited financial statements is filed herewith.
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* Management contract, compensatory plan or arrangement. + Filed with the Securities and Exchange Commission as an exhibit to this report.
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