The Hartford 2012 Annual Report Download - page 111

Table of Contents
Derivative Instruments
The Company utilizes a variety of over-the-counter and exchange traded derivative instruments as a part of its overall risk management strategy, as well as to
enter into replication transactions. Derivative instruments are used to manage risk associated with interest rate, equity market, credit spread, issuer default,
price, and currency exchange rate risk or volatility. Replication transactions are used as an economical means to synthetically replicate the characteristics and
performance of assets that would otherwise be permissible investments under the Company’s investment policies. For further information on the Company’s
use of derivatives, see Note 6 of the Notes to Consolidated Financial Statements.
Derivative activities are monitored and evaluated by the Company’s compliance and risk management teams and reviewed by senior management. In addition,
the Company monitors counterparty credit exposure on a monthly basis to ensure compliance with Company policies and statutory limitations. The notional
amounts of derivative contracts represent the basis upon which pay or receive amounts are calculated and are not reflective of credit risk. Downgrades to the
credit ratings of The Hartford’s insurance operating companies may have adverse implications for its use of derivatives including those used to hedge benefit
guarantees of variable annuities. In some cases, downgrades may give derivative counterparties the unilateral contractual right to cancel and settle outstanding
derivative trades or require additional collateral to be posted. In addition, downgrades may result in counterparties becoming unwilling to engage in additional
over-the-counter (“OTC”) derivatives requiring greater collateralization before entering into any new trades. This will restrict the supply of derivative
instruments commonly used to hedge variable annuity guarantees, particularly long-dated equity derivatives and interest rate swaps. Under these
circumstances, the Company’s operating subsidiaries could conduct hedging activity using a combination of cash and exchange-traded instruments, in
addition to using the available OTC derivatives.
The Company uses various derivative counterparties in executing its derivative transactions. The use of counterparties creates credit risk that the counterparty
may not perform in accordance with the terms of the derivative transaction. The Company has developed a derivative counterparty exposure policy which
limits the Company’s exposure to credit risk. The derivative counterparty exposure policy establishes market-based credit limits, favors long-term financial
stability and creditworthiness of the counterparty and typically requires credit enhancement/credit risk reducing agreements. The Company minimizes the
credit risk of derivative instruments by entering into transactions with high quality counterparties primarily rated A or better, which are monitored and
evaluated by the Company’s risk management team and reviewed by senior management. In addition, the Company monitors counterparty credit exposure on
a monthly basis to ensure compliance with Company policies and statutory limitations. The Company also generally requires that derivative contracts, other
than exchange traded contracts, certain forward contracts, and certain embedded and reinsurance derivatives, be governed by an International Swaps and
Derivatives Association Master Agreement, which is structured by legal entity and by counterparty and permits right of offset.
The Company has developed credit exposure thresholds which are based upon counterparty ratings. Credit exposures are measured using the market value of
the derivatives, resulting in amounts owed to the Company by its counterparties or potential payment obligations from the Company to its counterparties.
Credit exposures are generally quantified daily based on the prior business day’s market value and collateral is pledged to and held by, or on behalf of, the
Company to the extent the current value of the derivatives exceed the contractual thresholds. In accordance with industry standard and the contractual
agreements, collateral is typically settled on the next business day. The Company has exposure to credit risk for amounts below the exposure thresholds which
are uncollateralized, as well as for market fluctuations that may occur between contractual settlement periods of collateral movements.
For the company’s domestic derivative programs, the maximum uncollateralized threshold for a derivative counterparty for a single legal entity is $ 10. The
Company currently transacts OTC derivatives in five legal entities that have a threshold greater than zero and therefore the maximum combined threshold for a
single counterparty across all legal entities that use derivatives is $ 50. In addition, the Company may have exposure to multiple counterparties in a single
corporate family due to a common credit support provider. As of December 31, 2012, for the company’s domestic derivative programs, the maximum
combined threshold for all counterparties under a single credit support provider across all legal entities that use derivatives is $ 100. Based on the contractual
terms of the collateral agreements, these thresholds may be immediately reduced due to a downgrade in either party’s credit rating. Beginning in the fourth
quarter of 2011, the Company began hedging its Japan exposures within the legal entity HLIKK. The counterparty credit exposures at HLIKK are generally
managed to be consistent with the maximum uncollateralized threshold of the domestic program. However, for three HLIKK counterparties, the maximum
uncollateralized exposures are higher than $10 . These three counterparties maintain credit ratings of A3 or better and the Company actively monitors their
credit standing. For further discussion, see the Derivative Commitments section of Note 13 of the Notes to Consolidated Financial Statements.
For the year ended December 31, 2012, the Company has incurred no losses on derivative instruments due to counterparty default.
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