The Hartford 2008 Annual Report Download - page 105

Table of Contents
Derivative instruments classified as Level 3 include complex derivatives, primarily consisting of equity options and swaps,
interest rate derivatives which have interest rate optionality, certain credit default swaps, and long-dated interest rate swaps.
These derivative instruments are valued using pricing models which utilize both observable and unobservable inputs and, to
a lesser extent, broker quotations. A derivative instrument that is priced using both observable and unobservable inputs will
be classified as a Level 3 financial instrument in its entirety if the unobservable input is significant in developing the price.
The Company utilizes derivative instruments to manage the risk associated with certain assets and liabilities. However, the
derivative instrument may not be classified with the same fair value hierarchy level as the associated assets and liabilities.
Evaluation of Other-Than-Temporary Impairments on Available-for-Sale Securities
One of the significant estimates related to available-for-sale securities is the evaluation of investments for
other-than-temporary impairments. If a decline in the fair value of an available-for-sale security is judged to be
other-than-temporary, a charge is recorded in net realized capital losses equal to the difference between the fair value and
cost or amortized cost basis of the security. 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. The fair value of the other-than-temporarily impaired investment becomes its new
cost basis. For fixed maturities, the Company accretes the new cost basis to par or to the estimated future cash flows over the
expected remaining life of the security by adjusting the security’s yield.
The evaluation of securities for impairments is a quantitative and qualitative process, which is subject to risks and
uncertainties and is intended to determine whether declines in the fair value of investments should be recognized in current
period earnings. The risks and uncertainties include changes in general economic conditions, the issuer’s financial condition
or future prospects, the effects of changes in interest rates or credit spreads and the expected recovery period. The Company
has a security monitoring process overseen by a committee of investment and accounting professionals (“the committee”)
that identifies securities that, due to certain characteristics, as described below, are subjected to an enhanced analysis on a
quarterly basis. Based on this evaluation, during 2008, the Company concluded $4.0 billion of unrealized losses were
other-than-temporarily impaired and as of December 31, 2008, the Company’s unrealized losses on available-for-sale
securities of $14.6 billion were temporarily impaired.
Securities not subject to Emerging Issues Task Force (“EITF”) Issue No. 99-20, “Recognition of Interest Income and
Impairment on Purchased Beneficial Interests and Beneficial Interests That Continued to Be Held by a Transferor in
Securitized Financial Assets” (“non-EITF Issue No. 99-20 securities”) that are in an unrealized loss position, are reviewed at
least quarterly to determine if an other-than-temporary impairment is present based on certain quantitative and qualitative
factors. The primary factors considered in evaluating whether a decline in value for non-EITF Issue No. 99-20 securities is
other-than-temporary include: (a) the length of time and extent to which the fair value has been less than cost or amortized
cost of the security, (b) the financial condition, credit rating and future prospects of the issuer, (c) whether the debtor is
current on contractually obligated interest and principal payments and (d) the intent and ability of the Company to retain the
investment for a period of time sufficient to allow for recovery.
Through September 30, 2008, for securitized financial assets with contractual cash flows, including those subject to EITF
Issue No. 99-20, the Company periodically updated its best estimate of cash flows over the life of the security. The
Company’s best estimate of cash flows used severe economic recession assumptions due to market uncertainty, similar to
those the Company believed market participants would use. If the fair value of a securitized financial asset was less than its
cost or amortized cost and there has been an adverse change in timing or amount of anticipated future cash flows since the
last revised estimate, an other-than-temporary impairment charge was recognized. The Company also considered its intent
and ability to retain a temporarily depressed security until recovery. Estimating future cash flows is a quantitative and
qualitative process that incorporates information received from third party sources along with certain internal assumptions
and judgments regarding the future performance of the underlying collateral. In addition, projections of expected future cash
flows may change based upon new information regarding the performance of the underlying collateral. Beginning in the
fourth quarter of 2008, the Company implemented FSP No. EITF 99-20-1, “Amendments to the Impairment Guidance of
EITF Issue No. 99-20” (see Note 1 in the Notes to the Consolidated Financial Statements). Upon implementation, the
Company continued to utilize the impairment process described above, however, rather than exclusively relying upon
market participant assumptions, management judgment was also used in assessing the probability that an adverse change in
future cash flows has occurred.
Each quarter, during this analysis, the Company asserts its intent and ability to retain until recovery those securities judged
to be temporarily impaired. Once identified, these securities are systematically restricted from trading unless approved by
the committee. The committee will only authorize the sale of these securities based on predefined criteria that relate to
events that could not have been reasonably foreseen. Examples of the criteria include, but are not limited to, the
deterioration in the issuer’s creditworthiness, a change in regulatory requirements or a major business combination or major
disposition.
Pension and Other Postretirement Benefit Obligations
Source: HARTFORD FINANCIAL S, 10-K, February 12, 2009