The Hartford 2008 Annual Report Download - page 355

Table of Contents
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
1. Basis of Presentation and Accounting Policies (continued)
Accounting and Financial Statement Presentation of Derivative Instruments and Hedging Activities
Derivative instruments are recognized on the consolidated balance sheets at fair value. As of December 31, 2008 and 2007,
approximately 94% and 89% of derivatives, respectively, based upon notional values, were priced by valuation models,
which utilize independent market data, while the remaining 6% and 11%, respectively, were priced by broker quotations.
The derivatives are valued using mid-market level inputs that are predominantly observable in the market place. Inputs used
to value derivatives include, but are not limited to, interest swap rates, foreign currency forward and spot rates, credit
spreads, interest and equity volatility and equity index levels. The Company performs a monthly analysis on the derivative
valuation which includes both quantitative and qualitative analysis. Examples of procedures performed include, but are not
limited to, review of pricing statistics and trends, back testing recent trades, analyzing changes in the market environment
and monitoring trading volume. This discussion on derivative pricing excludes the GMWB rider and associated reinsurance
contracts as well as the embedded derivatives associated with the GMAB product, which are discussed in Note 4.
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 the variability in cash flows of a forecasted transaction or of
amounts 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 (“net
investment” hedge) or (5) held for other investment and/or risk management purposes, which primarily involve managing
asset or liability related risks which do not qualify for hedge accounting.
Fair-Value Hedges
Changes in the fair value of a derivative that is designated and qualifies as a fair-value hedge, along with the changes in the
fair value of the hedged asset or liability that is attributable to the hedged risk, are recorded in current period earnings with
any differences between the net change in fair value of the derivative and the hedged item representing the hedge
ineffectiveness. Periodic cash flows and accruals of income/expense (“periodic derivative net coupon settlements”) are
recorded in the line item of the consolidated statements of operations in which the cash flows of the hedged item are
recorded.
Cash-Flow Hedges
Changes in the fair value of a derivative that is designated and qualifies as a cash-flow hedge are recorded in AOCI and are
reclassified into earnings when the variability of the cash flow of the hedged item impacts earnings. Gains and losses on
derivative contracts that are reclassified from AOCI to current period earnings are included in the line item in the
consolidated statements of operations in which the cash flows of the hedged item are recorded. Any hedge ineffectiveness is
recorded immediately in current period earnings as net realized capital gains and losses. Periodic derivative net coupon
settlements are recorded in the line item of the consolidated statements of operations in which the cash flows of the hedged
item are recorded.
Foreign-Currency Hedges
Changes in the fair value of derivatives that are designated and qualify as foreign-currency hedges are recorded in either
current period earnings or AOCI, depending on whether the hedged transaction is a fair-value hedge or a cash-flow hedge,
respectively. Any hedge ineffectiveness is recorded immediately in current period earnings as net realized capital gains and
losses. Periodic derivative net coupon settlements are recorded in the line item of the consolidated statements of operations
in which the cash flows of the hedged item are recorded.
Net Investment in a Foreign Operation Hedges
Changes in fair value of a derivative used as a hedge of a net investment in a foreign operation, to the extent effective as a
hedge, are recorded in the foreign currency translation adjustments account within AOCI. Cumulative changes in fair value
recorded in AOCI are reclassified into earnings upon the sale or complete, or substantially complete, liquidation of the
foreign entity. Any hedge ineffectiveness is recorded immediately in current period earnings as net realized capital gains and
losses. Periodic derivative net coupon settlements are recorded in the line item of the consolidated statements of operations
in which the cash flows of the hedged item are recorded.
F-15
Source: HARTFORD FINANCIAL S, 10-K, February 12, 2009