The Hartford 2008 Annual Report Download - page 49

Table of Contents
In addition, in the conduct of our business, there could be scenarios where in order to reduce risks, fulfill our obligations or
to raise incremental liquidity, we would sell assets at a loss for a variety of reasons including the unrealized loss position in
our overall investment portfolio and the lack of liquidity in the credit markets. These scenarios could include selling assets
as the Company reduces its securities lending program.
Declines in equity markets and changes in interest rates and credit spreads can also negatively impact the fair values of each
of our segments. If a significant decline in the fair value of a segment occurred and this resulted in an excess of that
segment’s book value over fair value, the goodwill assigned to that segment might be impaired and could cause the
Company to record a charge to impair a part or all of the related goodwill assets, as occurred in the fourth quarter of 2008
with respect to our Individual Annuity and International reporting units. See impairment of goodwill risk factor for further
information on this risk.
We may be unable to effectively mitigate the impact of equity market volatility arising from obligations under annuity
product guarantees, which may have a material adverse effect on our consolidated results of operations, financial
condition and cash flows.
Some of the products offered by our life businesses, especially variable annuities, offer certain guaranteed benefits which, as
a result of any decline in equity markets would not only result in lower earnings, but may also increase our exposure to
liability for benefit claims. During the course of 2008, as equity markets declined, our liability for guaranteed benefits
significantly increased. We are also subject to equity market volatility related to these benefits, especially the guaranteed
minimum death benefit (“GMDB”), guaranteed minimum withdrawal benefit (“GMWB”), guaranteed minimum
accumulation benefit (“GMAB”) and guaranteed minimum income benefit (“GMIB”) offered with variable annuity
products. As of December 31, 2008, the liability for GMWB and GMAB was $6.6 billion and $0, respectively. The liability
for GMIB and GMDB was a combined $473, net of reinsurance as of December 31, 2008. We use reinsurance structures and
have modified benefit features to mitigate the exposure associated with GMDB. We also use reinsurance in combination
with a modification of benefit features and derivative instruments to minimize the claim exposure and to reduce the
volatility of net income associated with the GMWB liability. However, due to the severe economic conditions in the fourth
quarter of 2008, we have adjusted our risk management program to place greater relative emphasis on the protection of
statutory surplus. This shift in relative emphasis will likely result in greater U.S. GAAP earnings volatility. While we
believe that these and other actions we have taken serve to improve the efficiency by which we manage the risks related to
these benefits, we remain liable for the guaranteed benefits in the event that reinsurers or derivative counterparties are
unable or unwilling to pay, and are subject to the risk that other management procedures prove ineffective or that
unanticipated policyholder behavior, combined with adverse market events, produces economic losses beyond the scope of
the risk management techniques employed, which individually or collectively may have a material adverse effect on our
consolidated results of operations, financial condition and cash flows.
The amount of statutory capital that we have and the amount of statutory capital that we must hold to maintain our
financial strength and credit ratings and meet other requirements can vary significantly from time to time and is sensitive
to a number of factors outside of our control, including equity market, credit market, interest rate and foreign currency
conditions, changes in policyholder behavior and changes in rating agency models.
We conduct the vast majority of our business through licensed insurance company subsidiaries. Accounting standards and
statutory capital and reserve requirements for these entities are prescribed by the applicable insurance regulators and the
National Association of Insurance Commissioners (“NAIC”). Insurance regulators have established regulations that provide
minimum capitalization requirements based on risk-based capital (“RBC”) formulas for both life and property and casualty
companies. The RBC formula for life companies establishes capital requirements relating to insurance, business, asset and
interest rate risks, including equity, interest rate and expense recovery risks associated with variable annuities and group
annuities that contain death benefits or certain living benefits. The RBC formula for property and casualty companies adjusts
statutory surplus levels for certain underwriting, asset, credit and off-balance sheet risks.
In any particular year, statutory surplus amounts and RBC ratios may increase or decrease depending on a variety of factors
– the amount of statutory income or losses generated by our insurance subsidiaries (which itself is sensitive to equity market
and credit market conditions), the amount of additional capital our insurance subsidiaries must hold to support business
growth, changes in equity market levels, the value of certain fixed-income and equity securities in our investment portfolio,
the value of certain derivative instruments, changes in interest rates and foreign currency exchange rates, as well as changes
to the NAIC RBC formulas. 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. 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. Also, in extreme
scenarios of equity market declines, the amount of additional statutory reserves that we are required to hold for our variable
annuity guarantees increases at a greater than linear rate. This reduces the statutory surplus used in calculating our RBC
ratios. When equity markets increase, surplus levels and RBC ratios will generally 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. Due to all of
these factors, projecting statutory capital and the related RBC ratios is complex. During February 2009, our financial
Source: HARTFORD FINANCIAL S, 10-K, February 12, 2009