The Hartford 2009 Annual Report Download - page 202

THE HARTFORD FINANCIAL SERVICES GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
F-53
7. Deferred Policy Acquisition Costs and Present Value of Future Profits
Life
Accounting Policy
Life capitalizes acquisition costs that vary with and are primarily related to the acquisition of new and renewal insurance contracts.
Life’ s deferred policy acquisition cost (“DAC”) asset, which includes the present value of future profits, related to most universal life-
type contracts (including variable annuities) is amortized over the estimated life of the contracts acquired in proportion to the present
value of estimated gross profits (“EGPs”). EGPs are also used to amortize other assets and liabilities in the Company’ s Consolidated
Balance Sheets, such as, sales inducement assets (“SIA”) and unearned revenue reserves (“URR”). Components of EGPs are used to
determine reserves for universal life type contracts (including variable annuities) with death or other insurance benefits such as
guaranteed minimum death, guaranteed minimum income and universal life secondary guarantee benefits. These benefits are accounted
for and collectively referred to as death and other insurance benefit reserves and are held in addition to the account value liability
representing policyholder funds.
For most contracts, the Company estimates gross profits over 20 years as EGPs emerging subsequent to that timeframe are immaterial.
Products sold in a particular year are aggregated into cohorts. Future gross profits for each cohort are projected over the estimated lives
of the underlying contracts, based on future account value projections for variable annuity and variable universal life products. The
projection of future account values requires the use of certain assumptions including: separate account returns; separate account fund
mix; fees assessed against the contract holder’ s account balance; surrender and lapse rates; interest margin; mortality; and hedging costs.
Prior to the second quarter of 2009, the Company determined EGPs using the mean derived from stochastic scenarios that had been
calibrated to the estimated separate account return. The Company also completed a comprehensive assumption study, in the third
quarter of each year, and revised best estimate assumptions used to estimate future gross profits when the EGPs in the Company’ s
models fell outside of an independently determined reasonable range of EGPs. The Company also considered, on a quarterly basis,
other qualitative factors such as product, regulatory and policyholder behavior trends and would revise EGPs if those trends were
expected to be significant.
Beginning with the second quarter of 2009, the Company now determines EGPs from a single deterministic reversion to mean (“RTM”)
separate account return projection which is an estimation technique commonly used by insurance entities to project future separate
account returns. Through this estimation technique, the Company’ s DAC model is adjusted to reflect actual account values at the end
of each quarter. Through consideration of recent market returns, the Company will unlock, or adjust, projected returns over a future
period so that the account value returns to the long-term expected rate of return, providing that those projected returns do not exceed
certain caps or floors. This DAC Unlock for future separate account returns is determined each quarter.
In the third quarter of each year, the Company completes a comprehensive non-market related policyholder behavior assumption study
and incorporates the results of those studies into its projection of future gross profits. Additionally, throughout the year, the Company
evaluates various aspects of policyholder behavior and periodically revises its policyholder assumptions as credible emerging data
indicates that changes are warranted. Upon completion of an assumption study or evaluation of credible new information, the Company
will revise its assumptions to reflect its current best estimate. These assumption revisions will change the projected account values and
the related EGPs in the DAC, SIA and URR amortization models, as well as, the death and other insurance benefit reserving model.
All assumption changes that affect the estimate of future EGPs including: the update of current account values; the use of the RTM
estimation technique; or policyholder behavior assumptions, are considered an Unlock in the period of revision. An Unlock adjusts the
DAC, SIA, URR and death and other insurance benefit reserve balances in the Consolidated Balance Sheets with an offsetting benefit or
charge in the Consolidated Statements of Operations in the period of the revision. An Unlock that results in an after-tax benefit
generally occurs as a result of actual experience or future expectations of product profitability being favorable compared to previous
estimates. An Unlock that results in an after-tax charge generally occurs as a result of actual experience or future expectations of
product profitability being unfavorable compared to previous estimates.
An “Unlock” revises EGPs to reflect current best estimate assumptions. The Company also tests the aggregate recoverability of DAC
by comparing the existing DAC balance to the present value of future EGPs.