The Hartford 2014 Annual Report Download - page 102

Liabilities
The Company has foreign currency exchange risk associated with the yen denominated Japan fixed payout annuities reinsured from HLIKK. The Company
has entered into pay U.S. dollar, receive yen swap contracts to hedge the currency exposure between the U.S. dollar denominated assets and the yen
denominated fixed liability reinsurance payments.
Talcott Resolution previously issued non-U.S. dollar denominated funding agreement liability contracts. The Company hedged the foreign currency risk
associated with these liability contracts with currency rate swaps. At December 31, 2014 and 2013, the derivatives used to hedge foreign currency exchange
risk related to foreign denominated liability contracts had a total notional amount of $94 and a total fair value of $(20) and $(1), respectively.
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Statutory surplus amounts and risk-based capital (“RBC”) ratios may increase or decrease in any period depending upon a variety of factors and may be
compounded in extreme scenarios or if multiple factors occur at the same time. At times the impact of changes in certain market factors or a combination of
multiple factors on RBC ratios can be counterintuitive. Factors include:
• In general, as equity market levels and interest rates decline, the amount and volatility of both our actual potential obligation, as well as the related
statutory surplus and capital margin for death and living benefit guarantees associated with variable annuity contracts can be materially negatively
affected, sometimes at a greater than linear rate. Other market factors that can impact statutory surplus, reserve levels and capital margin include
differences in performance of variable subaccounts relative to indices and/or realized equity and interest rate volatilities. In addition, as equity
market levels increase, generally surplus levels will increase. RBC ratios will also tend to increase when equity markets 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 with rising equity markets, resulting in lower RBC ratios. Non-market factors,
which can also impact the amount and volatility of both our actual potential obligation, as well as the related statutory surplus and capital margin,
include actual and estimated policyholder behavior experience as it pertains to lapsation, partial withdrawals, and mortality.
• As the value of certain fixed-income and equity securities in our investment portfolio decreases, due in part to credit spread widening, statutory
surplus and RBC ratios may decrease.
• As the value of certain derivative instruments that do not qualify for hedge accounting decreases, statutory surplus and RBC ratios may decrease.
• Our statutory surplus is also impacted by widening credit spreads as a result of the accounting for the assets and liabilities in our fixed market value
adjusted ("MVA") annuities. Statutory separate account assets supporting the fixed MVA annuities are recorded at fair value. In determining the
statutory reserve for the fixed MVA annuities, we are required to use current crediting rates in the U.S. In many capital market scenarios, current
crediting rates in the U.S. are highly correlated with market rates implicit in the fair value of statutory separate account assets. As a result, the change
in statutory reserve from period to period will likely substantially offset the change in the fair value of the statutory separate account assets.
However, in periods of volatile credit markets, such as we experienced in 2008 and 2009, actual credit spreads on investment assets may increase
sharply for certain sub-sectors of the overall credit market, resulting in statutory separate account asset market value losses. As actual credit spreads
are not fully reflected in the current crediting rates in the U.S. the calculation of statutory reserves will not substantially offset the change in fair
value of the statutory separate account assets resulting in reductions in statutory surplus. This has resulted and may continue to result in the need to
devote significant additional capital to support the product.
• With respect to our fixed annuity business, sustained low interest rates may result in a reduction in statutory surplus and an increase in NAIC
required capital.
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.
The Company has reinsured approximately 26% of its risk associated with GMWB and 79% of its risk associated with the aggregate GMDB exposure. These
reinsurance agreements serve to reduce the Company’s exposure to changes in the statutory reserves and the related capital and RBC ratios associated with
changes in the capital markets. The Company also continues to explore other solutions for mitigating the capital market risk effect on surplus, such as
external reinsurance solutions, modifications to our hedging program, changes in product design, increasing pricing and expense management.
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