The Hartford 2008 Annual Report Download - page 298

Table of Contents
Fixed Maturity Investments
Life’s investment portfolios primarily consist of investment grade fixed maturity securities, including corporate bonds, ABS,
CMBS, tax-exempt municipal securities and government bonds. The fair value of Life’s fixed maturities was $45.2 billion
and $52.5 billion at December 31, 2008 and 2007, respectively. The fair value of Life’s fixed maturities and other invested
assets fluctuates depending on the interest rate environment and other general economic conditions. The weighted average
duration of the fixed maturity portfolio was approximately 5.3 and 4.6 years as of December 31, 2008 and 2007,
respectively.
Liabilities
Life’s investment contracts and certain insurance product liabilities, other than non-guaranteed separate accounts, include
asset accumulation vehicles such as fixed annuities, guaranteed investment contracts, other investment and universal
life-type contracts and certain insurance products such as long-term disability.
Asset accumulation vehicles primarily require a fixed rate payment, often for a specified period of time. Product examples
include fixed rate annuities with a market value adjustment feature and fixed rate guaranteed investment contracts. The
duration of these contracts generally range from less than one year to ten years. In addition, certain products such as
universal life contracts and the general account portion of Life’s variable annuity products, credit interest to policyholders
subject to market conditions and minimum interest rate guarantees. The duration of these products is short-term to
intermediate-term.
While interest rate risk associated with many of these products has been reduced through the use of market value adjustment
features and surrender charges, the primary risk associated with these products is that the spread between investment return
and credited rate may not be sufficient to earn targeted returns.
The Company also manages the risk of certain insurance liabilities similar to how it manages the risk associated with
investment type products due to the relative predictability of the aggregate cash flow payment streams. Products in this
category may contain significant actuarial (including mortality and morbidity) pricing and cash flow risks. Product examples
include structured settlement contracts, on-benefit annuities (i.e., the annuitant is currently receiving benefits thereon) and
short-term and long-term disability contracts. The cash outflows associated with these policy liabilities are not interest rate
sensitive but do vary based on the timing and amount of benefit payments. The primary risks associated with these products
are that the benefits will exceed expected actuarial pricing and/or that the actual timing of the cash flows will differ from
those anticipated, resulting in an investment return lower than that assumed in pricing. Average contract duration can range
from less than one year to typically up to fifteen years.
Derivatives
Life utilizes a variety of derivative instruments to mitigate interest rate risk. Interest rate swaps are primarily used to convert
interest receipts or payments to a fixed or variable rate. The use of such swaps enables the Company to customize contract
terms and conditions to customer objectives and satisfies the operation’s asset/liability duration matching policy.
Occasionally, swaps are also used to hedge the variability in the cash flow of a forecasted purchase or sale due to changes in
interest rates.
Interest rate caps and floors, swaptions and option contracts are primarily used to hedge against the risk of liability contract
holder disintermediation in a rising interest rate environment, and to offset the changes in fair value of corresponding
derivatives embedded in certain of the Company’s fixed maturity investments. Interest rate caps are also used to manage the
duration risk in certain portfolios.
At December 31, 2008 and 2007, notional amounts pertaining to derivatives utilized to manage interest rate risk totaled
$17.0 billion and $16.8 billion, respectively ($15.0 billion and $13.1 billion, respectively, related to investments and
$1.9 billion and $3.7 billion, respectively, related to life liabilities). The fair value of these derivatives was $435 and $45 as
of December 31, 2008 and 2007, respectively.
Calculated Interest Rate Sensitivity
The after-tax change in the net economic value of investment contracts (e.g., guaranteed investment contracts) and certain
insurance product liabilities (e.g., short-term and long-term disability contracts), for which the payment rates are fixed at
contract issuance and the investment experience is substantially absorbed by Life, are included in the following table along
with the corresponding invested assets. Also included in this analysis are the interest rate sensitive derivatives used by Life
to hedge its exposure to interest rate risk. Certain financial instruments, such as limited partnerships, have been omitted from
the analysis due to the fact that the investments are accounted for under the equity method and generally lack sensitivity to
interest rate changes. Separate account assets and liabilities and equity securities held for trading and the corresponding
liabilities associated with the variable annuity products sold in Japan are excluded from the analysis because gains and
losses in separate accounts accrue to policyholders. The calculation of the estimated hypothetical change in net economic
Source: HARTFORD FINANCIAL S, 10-K, February 12, 2009