The Hartford 2008 Annual Report Download - page 294

Table of Contents
Credit Risk
The Company is exposed to credit risk within our investment portfolio and through counterparties. Credit risk relates to the
uncertainty of an obligor’s continued ability to make timely payments in accordance with the contractual terms of the
instrument or contract. The Company manages credit risk through established investment credit policies which address
quality of obligors and counterparties, credit concentration limits, diversification requirements and acceptable risk levels
under expected and stressed scenarios. These policies are reviewed and approved by senior management and by the
Company’s Board of Directors.
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 in derivative instruments by entering into transactions with high quality counterparties
rated A2/A or better, which are monitored and evaluated by the Company’s risk management team and reviewed by senior
management. In addition, the internal compliance unit monitors counterparty credit exposure on a monthly basis to ensure
compliance with Company policies and statutory limitations.
Derivative counterparty credit risk is measured as the amount owed to the Company based upon current market conditions
and potential payment obligations between the Company and 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 derivative instruments exceeds the contractual thresholds. In accordance with industry
standards 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.
The Company has developed credit exposure thresholds which are based upon counterparty ratings. The maximum
uncollateralized threshold for a derivative counterparty for a single legal entity is $10, excluding reinsurance derivatives.
The Company currently transacts derivatives in five legal entities and therefore the maximum combined threshold for a
single counterparty over 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, 2008, the
maximum combined threshold for all counterparties under a single credit support provider over 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 a counterparty’s credit rating.
In addition to counterparty credit risk, the Company enters into credit derivative instruments, including credit default, index
and total return swaps, in which the Company assumes credit risk from or reduces credit risk to a single entity, referenced
index, or asset pool, in exchange for periodic payments. For further information on credit derivatives, see the “Investment
Credit Risk” section.
The Company is also exposed to credit spread risk related to security market price and cash flows associated with changes in
credit spreads. Credit spread widening will reduce the fair value of the investment portfolio and will increase net investment
income on new purchases. This will also result in losses associated with credit based non-qualifying derivatives where the
Company assumes credit exposure. If issuer credit spreads increase significantly or for an extended period of time, it may
result in higher other-than-temporary impairments. Credit spread tightening will reduce net investment income associated
with new purchases of fixed maturities and increase the fair value of the investment portfolio. During 2008, credit spread
widening resulted in a significant increase in the Company’s unrealized losses and other-than-temporary impairments. For
further discussion of sectors most significantly impacted, see the “Investment Credit Risk” section. Also, see “Capital
Resources and Liquidity” for a discussion of the widening of credit spread impacts on the Company’s statutory financial
results as it relates to the accounting and reporting for market value adjusted fixed annuities.
Equity Risk
The Company does not have significant equity risk exposure from invested assets. The Company’s primary exposure to
equity risk relates to the potential for lower earnings associated with certain of the Life’s businesses such as variable
annuities where fee income is earned based upon the fair value of the assets under management. During 2008, Life’s fee
income declined $302 or 6%. In addition, Life offers certain guaranteed benefits, primarily associated with variable annuity
products, which increases the Company’s potential benefit exposure as the equity markets decline. For a further discussion,
see Life Equity Risk in this section of the MD&A.
The Company is also subject to equity risk based upon the assets that support its pension plans. The asset allocation mix is
reviewed on a periodic basis. In order to minimize risk, the pension plans maintain a listing of permissible and prohibited
investments. In addition, the pension plans have certain concentration limits and investment quality requirements imposed
on permissible investment options. For further discussion of equity risk associated with the pension plans, see the Critical
Accounting Estimates section of the MD&A under “Pension and Other Postretirement Benefit Obligations” and Note 17 of
Notes to Consolidated Financial Statements.
Source: HARTFORD FINANCIAL S, 10-K, February 12, 2009