The Hartford 2008 Annual Report Download - page 356

Table of Contents
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
1. Basis of Presentation and Accounting Policies (continued)
Other Investment and/or Risk Management Activities
The Company’s other investment and/or risk management activities primarily relate to strategies used to reduce economic
risk or replicate permitted investments and do not receive hedge accounting treatment. Changes in the fair value, including
periodic derivative net coupon settlements, of derivative instruments held for other investment and/or risk management
purposes are reported in current period earnings as net realized capital gains and losses.
Hedge Documentation and Effectiveness Testing
To qualify for hedge accounting treatment, a derivative must be highly effective in mitigating the designated changes in fair
value or cash flow of the hedged item. At hedge inception, the Company formally documents all relationships between
hedging instruments and hedged items, as well as its risk-management objective and strategy for undertaking each hedge
transaction. The documentation process includes linking derivatives that are designated as fair-value, cash-flow,
foreign-currency or net investment hedges to specific assets or liabilities on the balance sheet or to specific forecasted
transactions and defining the effectiveness and ineffectiveness testing methods to be used. The Company also formally
assesses both at the hedge’s inception and ongoing on a quarterly basis, whether the derivatives that are used in hedging
transactions have been and are expected to continue to be highly effective in offsetting changes in fair values or cash flows
of hedged items. Hedge effectiveness is assessed using qualitative and quantitative methods. Qualitative methods may
include comparison of critical terms of the derivative to the hedged item. Quantitative methods include regression or other
statistical analysis of changes in fair value or cash flows associated with the hedge relationship. Hedge ineffectiveness of the
hedge relationships are measured each reporting period using the “Change in Variable Cash Flows Method”, the “Change in
Fair Value Method”, the “Hypothetical Derivative Method”, or the “Dollar Offset Method”.
Discontinuance of Hedge Accounting
The Company discontinues hedge accounting prospectively when (1) it is determined that the derivative is no longer highly
effective in offsetting changes in the fair value or cash flows of a hedged item; (2) the derivative is dedesignated as a
hedging instrument; or (3) the derivative expires or is sold, terminated or exercised.
When hedge accounting is discontinued because it is determined that the derivative no longer qualifies as an effective
fair-value hedge, the derivative continues to be carried at fair value on the balance sheet with changes in its fair value
recognized in current period earnings.
When hedge accounting is discontinued because the Company becomes aware that it is not probable that the forecasted
transaction will occur, the derivative continues to be carried on the balance sheet at its fair value, and gains and losses that
were accumulated in AOCI are recognized immediately in earnings.
In other situations in which hedge accounting is discontinued on a cash-flow hedge, including those where the derivative is
sold, terminated or exercised, amounts previously deferred in AOCI are reclassified into earnings when earnings are
impacted by the variability of the cash flow of the hedged item.
Embedded Derivatives
The Company purchases and issues financial instruments and products that contain embedded derivative instruments. When
it is determined that (1) the embedded derivative possesses economic characteristics that are not clearly and closely related
to the economic characteristics of the host contract, and (2) a separate instrument with the same terms would qualify as a
derivative instrument, the embedded derivative is bifurcated from the host for measurement purposes. The embedded
derivative, which is reported with the host instrument in the consolidated balance sheets, is carried at fair value with changes
in fair value reported in net realized capital gains and losses.
Credit Risk
The Company’s derivative counterparty exposure policy establishes market-based credit limits, favors long-term financial
stability and creditworthiness and typically requires credit enhancement/credit risk reducing agreements. Credit risk is
measured as the amount owed to the Company based on current market conditions and potential payment obligations
between the Company and its counterparties. For each legal entity, the Company’s credit exposures are generally quantified
daily, netted by counterparty and collateral is pledged to and held by, or on behalf of, the Company to the extent the current
value of derivatives exceeds the contractual thresholds which do not exceed $10, except for reinsurance derivatives. The
Company also 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
Source: HARTFORD FINANCIAL S, 10-K, February 12, 2009