The Hartford 2013 Annual Report Download - page 152

THE HARTFORD FINANCIAL SERVICES GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
1. Basis of Presentation and Significant Accounting Policies (continued)
F-16
Deferred Policy Acquisition Costs and Present Value of Future Profits
Deferred policy acquisition costs ("DAC") represent costs that are directly related to the acquisition of new and renewal insurance
contracts and incremental direct costs of contract acquisition that are incurred in transactions with either independent third parties or
employees. Such costs primarily include commissions, premium taxes, costs of policy issuance and underwriting, and certain other
expenses that are directly related to successfully issued contracts.
For property and casualty insurance products and group life, disability and accident contracts, costs are deferred and amortized ratably
over the period the related premiums are earned. Deferred acquisition costs are reviewed to determine if they are recoverable from future
income, and if not, are charged to expense. Anticipated investment income is considered in the determination of the recoverability of
DAC. For the years ended December 31, 2013, 2012 and 2011, no amount of DAC was charged to expense based on the determination
of recoverability.
For life insurance products, the DAC asset, which includes the present value of future profits, related to most universal life-type
contracts (including variable annuities) is amortized over the estimated life of the contracts acquired in proportion to the present value of
estimated gross profits (“EGPs”). EGPs are also used to amortize other assets and liabilities in the Company’s Consolidated Balance
Sheets, such as, sales inducement assets (“SIA”) and unearned revenue reserves (“URR”). Components of EGPs are used to determine
reserves for universal life-type contracts (including variable annuities) with death or other insurance benefits such as guaranteed
minimum death, guaranteed minimum income and universal life secondary guarantee benefits. These benefits are accounted for and
collectively referred to as death and other insurance benefit reserves and are held in addition to the account value liability representing
policyholder funds.
For most life insurance product contracts, the Company estimates gross profits over 20 years as EGPs emerging subsequent to that
timeframe are immaterial. Products sold in a particular year are aggregated into cohorts. Future gross profits for each cohort are
projected over the estimated lives of the underlying contracts, based on future account value projections for variable annuity and variable
universal life products. The projection of future account values requires the use of certain assumptions including: separate account
returns; separate account fund mix; fees assessed against the contract holder’s account balance; surrender and lapse rates; interest
margin; mortality; and the extent and duration of hedging activities and hedging costs.
The Company determines EGPs from a single deterministic reversion to mean (“RTM”) separate account return projection which is an
estimation technique commonly used by insurance entities to project future separate account returns. Through this estimation technique,
the Company’s DAC model is adjusted to reflect actual account values at the end of each quarter. Through consideration of recent
market returns, the Company will unlock, or adjust, projected returns over a future period so that the account value returns to the long-
term expected rate of return, providing that those projected returns do not exceed certain caps or floors. This Unlock for future separate
account returns is determined each quarter.
In the third quarter of each year, the Company completes a comprehensive non-market related policyholder behavior assumption study
and incorporates the results of those studies into its projection of future gross profits. Additionally, throughout the year, the Company
evaluates various aspects of policyholder behavior and periodically revises its policyholder assumptions as credible emerging data
indicates that changes are warranted. The Company will continue to evaluate its assumptions related to policyholder behavior as
initiatives to reduce the size of the variable annuity business are implemented by management. Upon completion of an annual
assumption study or evaluation of credible new information, the Company will revise its assumptions to reflect its current best estimate.
These assumption revisions will change the projected account values and the related EGPs in the DAC, SIA and URR amortization
models, as well as, the death and other insurance benefit reserving models.
All assumption changes that affect the estimate of future EGPs including the update of current account values, the use of the RTM
estimation technique and policyholder behavior assumptions are considered an Unlock in the period of revision. An Unlock adjusts the
DAC, SIA, URR and death and other insurance benefit reserve balances in the Consolidated Balance Sheets with an offsetting benefit or
charge in the Consolidated Statements of Operations in the period of the revision. An Unlock revises EGPs to reflect the Company’s
current best estimate assumptions. The Company also tests the aggregate recoverability of DAC by comparing the existing DAC balance
to the present value of future EGPs. An Unlock that results in an after-tax benefit generally occurs as a result of actual experience or
future expectations of product profitability being favorable compared to previous estimates. An Unlock that results in an after-tax charge
generally occurs as a result of actual experience or future expectations of product profitability being unfavorable compared to previous
estimates.
Income Taxes
The Company recognizes taxes payable or refundable for the current year and deferred taxes for the tax consequences of differences
between the financial reporting and tax basis of assets and liabilities. Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years the temporary differences are expected to reverse.