The Hartford 2009 Annual Report Download - page 58

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Life Estimated Gross Profits Used in the Valuation and Amortization of Assets and Liabilities Associated with Variable Annuity and
Other Universal Life-Type Contracts
Estimated gross profits (“EGPs”) are used in the amortization of: Life’ s deferred policy acquisition cost (“DAC”) asset, which includes
the present value of future profits; sales inducement assets (“SIA”); and unearned revenue reserves (“URR”). See Note 7 of the Notes
to Consolidated Financial Statements for additional information on DAC. See Note 10 of the Notes to Consolidated Financial
Statements for additional information on SIA. EGPs are also used in the valuation of reserves for death and other insurance benefit
features on variable annuity and universal life-type contracts. See Note 9 of the Notes to Consolidated Financial Statements for
additional information on death and other insurance benefit feature reserves.
The specific breakdown of the most significant EGP based balances as of December 31, 2009 and 2008 are as follows:
Individual Variable
Annuities – U.S.
Individual Variable
Annuities - Japan Individual Life
2009 2008 2009 2008 2009 2008
DAC $ 3,378 $ 4,844 $ 1,566 $ 1,834 $ 2,528 $ 2,931
SIA $ 324 $ 436 $ 28 $ 19 $ 42 $ 36
URR $ 85 $ 109 $ 1 $ — $ 1,185 $ 1,299
Death and Other Insurance Benefit Reserves $ 1,232 $ 867 $ 580 $ 229 $ 76 $ 40
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. Changes in these assumptions and, in addition, changes to other policyholder behavior assumptions such as resets, partial
surrenders, reaction to price increases, and asset allocations causes EGPs to fluctuate which impacts earnings.
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. Under RTM, the expected long term
weighted average rate of return is 7.1% and 5.6% for U.S. and Japan, respectively. The expected long-term equity total rate of return is
9.5% and 8.5% for the U.S. and Japan, respectively, and the expected long-term fixed income rate of return is 6.0% and 4.0% for the
U.S. and Japan, respectively.
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 emerging data indicates that
changes are warranted. In the fourth quarter of 2009, recent market volatility provided the Company additional information regarding
policyholder behavior, related to living benefit lapses, withdrawal rates and GMDB lapses. This information was incorporated into the
Company’ s assumptions used in determining estimated gross profits. Upon completion of an assumption study or evaluation of 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 and policyholder behavior assumptions are considered an Unlock in the period of revision. An Unlock adjusts
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.