The Hartford 2009 Annual Report Download - page 182

THE HARTFORD FINANCIAL SERVICES GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
F-33
5. Investments and Derivative Instruments (continued)
Significant Derivative Instruments Accounting Policies
Overview
The Company utilizes a variety of derivative instruments, including swaps, caps, floors, forwards, futures and options through one of
four Company-approved objectives: to hedge risk arising from interest rate, equity market, credit spread and issuer default, price or
currency exchange rate risk or volatility; to manage liquidity; to control transaction costs; or to enter into replication transactions.
Interest rate, volatility, dividend, credit default and index swaps involve the periodic exchange of cash flows with other parties, at
specified intervals, calculated using agreed upon rates or other financial variables 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.
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 interest rate or falls below the floor strike interest 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 that specify a rate of interest or currency exchange rate to be paid or received
on an obligation beginning on a future start date and are typically settled in cash.
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 or cash, 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.
Foreign currency swaps exchange an initial principal amount in two currencies, agreeing to re-exchange the currencies at a future date,
at an agreed upon exchange rate. There may also be a periodic exchange of payments at specified intervals calculated using the agreed
upon rates and exchanged principal amounts.
The Company’ s derivative transactions are used in strategies permitted under the derivative use plans required by the State of
Connecticut, the State of Illinois and the State of New York insurance departments.
Accounting and Financial Statement Presentation of Derivative Instruments and Hedging Activities
Derivative instruments are recognized on the Consolidated Balance Sheets at fair value. For balance sheet presentation purposes, the
Company offsets the fair value amounts, income accruals, and cash collateral held, related to derivative instruments executed in a legal
entity and with the same counterparty under a master netting agreement, which provides the Company with the legal right of offset.
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 hedge of a net investment in a foreign operation (“net
investment” hedge) or (4) 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, including foreign-currency fair value
hedges, 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, including foreign-currency cash flow
hedges, 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.