The Hartford 2008 Annual Report Download - page 380

Table of Contents
THE HARTFORD FINANCIAL SERVICES GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. Fair Value Measurements
The following financial instruments are carried at fair value in the Company’s consolidated financial statements: fixed
maturities, equity securities, short-term investments, freestanding and embedded derivatives, and separate account assets.
These fair value disclosures include information regarding the valuation of the Company’s guaranteed benefits products and
the impact of the adoption of SFAS 157, followed by the fair value measurement and disclosure requirements of SFAS 157
and SFAS No. 107, “Disclosures about Fair Value of Financial Instruments”.
Accounting for Guaranteed Benefits Offered With Variable Annuities
Many of the variable annuity contracts issued by the Company offer various guaranteed minimum death, withdrawal,
income and accumulation benefits. Those benefits are accounted for under SFAS 133 or AICPA Statement of Position
No. 03-1 “Accounting and Reporting by Insurance Enterprises for Certain Nontraditional Long-Duration Contracts and for
Separate Accounts” (“SOP 03-1”). Guaranteed minimum benefits often meet the definition of an embedded derivative under
SFAS 133 as they have notional amounts (the guaranteed balance) and underlyings (the investment fund options), they
require no initial net investment and they have terms that require or permit net settlement. However, certain guaranteed
minimum benefits settle only upon a single insurable event, such as death (guaranteed minimum death benefits or “GMDB”)
or living (life contingent portion of guaranteed minimum withdrawal benefits or “GMWB”), and as such are outside of the
scope of SFAS 133 under the “insurance contract exception”. Other guaranteed minimum benefits require settlement in the
form of a long-term financing transaction, such as is typical with guaranteed minimum income benefits (“GMIB”), and as
such do not meet the net settlement requirement in SFAS 133. Guaranteed minimum benefits that are outside of the scope of
SFAS 133 or do not meet the net settlement requirements of SFAS 133 are accounted for as insurance benefits under SOP
03-1.
Guaranteed Benefits Accounted for at Fair Value Prior to SFAS 157
The non-life-contingent portion of the Company’s GMWBs and guaranteed minimum accumulation benefits (“GMAB”)
meet the definition of an embedded derivative under SFAS 133, and as such are recorded at fair value with changes in fair
value recorded in net realized capital gains (losses) in net income. In bifurcating the embedded derivative, the Company
attributes to the derivative a portion of total fees, in basis points, to be collected from the contract holder (the “Attributed
Fees”). Attributed Fees are set equal to the present value of future claims, in basis points, (excluding margins for risk)
expected to be paid for the guaranteed living benefit embedded derivative at the inception of the contract. The excess of total
fees collected from the contract holder over the Attributed Fees are associated with the host variable annuity contract and are
recorded in fee income. In subsequent valuations, both the present value of future claims expected to be paid and the present
value of Attributed Fees expected to be collected are revalued based on current market conditions and policyholder behavior
assumptions. The difference between each of the two components represents the fair value of the embedded derivative.
GMWBs provide the policyholder with a guaranteed remaining balance (“GRB”) if the account value is reduced to a
contractually specified minimum level, through a combination of market declines and withdrawals. The GRB is generally
equal to premiums less withdrawals. If the GRB exceeds the account value for any policy, the contract is “in-the-money” by
the difference between the GRB and the account value.
During the first quarter of 2007, the Company launched its “3Win” product with both GMAB and GMIB riders attached to
certain Japanese variable annuity contracts. The GMAB provides the policyholder with the GRB if the account value is less
than premiums after an accumulation period, generally 10 years, and if the account value has not dropped below 80% of the
initial deposit, at which point a GMIB must either be exercised or the policyholder can elect to surrender 80% of the initial
deposit without a surrender charge. The GRB is generally equal to premiums less surrenders. During the fourth quarter of
2008, nearly all contract holder account values had dropped below 80% of the initial deposit, at which point the GMIB was
exercised
A GMWB and/or GMAB contract is ‘in the money’ if the contract holder’s guaranteed remaining benefit becomes greater
than the account value. As of December 31, 2008 and December 31, 2007, 88% and 19%, respectively, of all unreinsured
U.S. GMWB ‘in-force’ contracts were ‘in the money’. For U.S. and International GMWB contracts that were ‘in the money’
the Company’s exposure to the guaranteed remaining benefit, after reinsurance, as of December 31, 2008 and December 31,
2007, was $7.7 billion and $146, respectively. For GMAB contracts that were ‘in the money’ the Company’s exposure to the
guaranteed remaining benefit, as of December 31, 2008 and December 31, 2007, was $15 and $38, respectively.
However, the only ways the GMWB contract holder can monetize the excess of the GRB over the account value of the
contract is upon death or if their account value is reduced to a contractually specified minimum level, through a combination
of a series of withdrawals that do not exceed a specific percentage of the premiums paid per year and market declines. If the
account value is reduced to the contractually specified minimum level, the contract holder will receive an annuity equal to
the remaining GRB and for the Company’s “lifetime” GMWB products, payments can continue beyond the GRB. As the
Source: HARTFORD FINANCIAL S, 10-K, February 12, 2009