The Hartford 2008 Annual Report Download - page 323

Table of Contents
Risk-Based Capital
State insurance regulators and the NAIC have adopted risk-based capital requirements for life insurance companies to
evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks. The requirements
provide a means of measuring the minimum amount of statutory surplus appropriate for an insurance company to support its
overall business operations based on its size and risk profile.
A company’s risk-based statutory surplus is calculated by applying factors and performing calculations relating to various
asset, premium, claim, expense and reserve items. Regulators can then measure the adequacy of a company’s statutory
surplus by comparing it to the risk-based capital (“RBC”). Under RBC requirements, regulatory compliance is determined
by the ratio of a company’s total adjusted capital, as defined by the insurance regulators, to its company action level of RBC
(known as the RBC ratio), also as defined by insurance regulators. In addition, the rating agencies view RBC ratios along
with their proprietary models as key factors in making ratings determinations.
Sensitivity
In any particular year, statutory surplus amounts and RBC ratios may increase or decrease depending upon a variety of
factors. The amount of change in the statutory surplus or RBC ratios can vary based on individual factors and may be
compounded in extreme scenarios or if multiple factors occur at the same time. At times the impact of changes in certain
market factors or a combination of multiple factors on RBC ratios can be varied and in some instances counterintuitive.
Factors include:
• In general, as equity market levels decline, our reserves for death and living benefit guarantees associated with variable
annuity contracts increases, sometimes at a greater than linear rate, reducing statutory surplus levels. In addition, as
equity market levels increase, generally surplus levels will increase. RBC ratios will also tend to increase when equity
markets increase. However, as a result of a number of factors and market conditions, including the level of hedging
costs and other risk transfer activities, reserve requirements for death and living benefit guarantees and RBC
requirements could increase resulting in lower RBC ratios.
• As the value of certain fixed-income and equity securities in our investment portfolio decreases, due in part to credit
spread widening, statutory surplus and RBC ratios may decrease.
• As the value of certain derivative instruments that do not get hedge accounting decreases, statutory surplus and RBC
ratios may decrease.
• Life’s exposure to foreign currency exchange risk exists with respect to non-U.S. dollar denominated assets and
liabilities. Assets and liabilities denominated in foreign currencies are accounted for at their U.S. dollar equivalent
values using exchange rates at the balance sheet date. As foreign currency exchange rates strengthen in comparison to
the U.S. dollar, the remeasured value of those non-dollar denominated assets or liabilities will increase causing an
increase or decrease to statutory surplus, respectively.
• Our statutory surplus is also impacted by widening credit spreads as a result of the accounting for the assets and
liabilities in our fixed market value adjusted (“MVA”) annuities. Statutory separate account assets supporting the fixed
MVA annuities are recorded at fair value. In determining the statutory reserve for the fixed MVA annuities, we are
required to use current crediting rates in the U.S. and Japanese LIBOR in Japan. In many capital market scenarios,
current crediting rates in the U.S. are highly correlated with market rates implicit in the fair value of statutory separate
account assets. As a result, the change in statutory reserve from period to period will likely substantially offset the
change in the fair value of the statutory separate account assets. However, in periods of volatile credit markets, such as
we are now experiencing, actual credit spreads on investment assets may increase sharply for certain sub-sectors of the
overall credit market, resulting in statutory separate account asset market value losses. As actual credit spreads are not
fully reflected in the current crediting rates in the U.S. or Japanese LIBOR in Japan, the calculation of statutory
reserves will not substantially offset the change in fair value of the statutory separate account assets resulting in
reductions in statutory surplus and create funding obligations to the statutory separate account.
Most of these factors are outside of the Company’s control. The Company’s financial strength and credit ratings are
significantly influenced by the statutory surplus amounts and RBC ratios of our insurance company subsidiaries. Due to all
of these factors, projecting statutory capital and the related projected RBC ratios is complex. In addition, rating agencies
may implement changes to their internal models that have the effect of increasing or decreasing the amount of statutory
capital we must hold in order to maintain our current ratings.
The Company has reinsured approximately 27% of its risk associated with GMWB and 44% of its risk associated with the
aggregate GMDB exposure. These reinsurance agreements serve to reduce the Company’s exposure to changes in the
statutory reserves and the related capital and RBC ratios associated with changes in the equity markets. The Company also
continues to explore other solutions for mitigating the capital market risk effect on surplus, such as internal and external
reinsurance solutions, migrating towards a more statutory based hedging program, changes in product design, increasing
Source: HARTFORD FINANCIAL S, 10-K, February 12, 2009