The Hartford 2010 Annual Report Download - page 14

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Our exposure to interest rate risk relates primarily to the market price and cash flow variability associated with changes in interest rates.
A rise in interest rates, in the absence of other countervailing changes, will increase the net unrealized loss position of our investment
portfolio and, if long-term interest rates rise dramatically within a six-to-twelve month time period, certain of our wealth management
businesses may be exposed to disintermediation risk. Disintermediation risk refers to the risk that our policyholders may surrender their
contracts in a rising interest rate environment, requiring us to liquidate assets in an unrealized loss position. Although our products have
features such as surrender charges, market-value adjustments and put options on certain retirement plans, we are subject to
disintermediation risk. An increase in interest rates can also impact our tax planning strategies and in particular our ability to utilize tax
benefits to offset certain previously recognized realized capital losses. In a declining rate environment, due to the long-term nature of the
liabilities associated with certain of our life businesses, such as structured settlements and guaranteed benefits on variable annuities,
sustained declines in long-term interest rates may subject us to reinvestment risks, increased hedging costs, spread compression and
capital volatility. Our exposure to credit spreads primarily relates to market price and cash flow variability associated with changes in
credit spreads. If issuer credit spreads widen significantly or retain historically wide levels over an extended period of time, additional
other-than-temporary impairments and increases in the net unrealized loss position of our investment portfolio will likely result. In
addition, losses have also occurred due to the volatility in credit spreads. When credit spreads widen, we incur losses associated with the
credit derivatives where the Company assumes exposure. When credit spreads tighten, we incur losses associated with derivatives where
the Company has purchased credit protection. If credit spreads tighten significantly, the Company’ s net investment income associated
with new purchases of fixed maturities may be reduced. In addition, a reduction in market liquidity can make it difficult to value certain
of our securities when trading becomes less frequent. As such, valuations may include assumptions or estimates that may be more
susceptible to significant period-to-period changes, which could have a material adverse effect on our consolidated results of operations
or financial condition.
Our statutory surplus is also affected by widening credit spreads as a result of the accounting for the assets and liabilities on our fixed
MVA annuities. Statutory separate account assets supporting the fixed MVA annuities are recorded at fair value. In determining the
statutory reserve for the fixed MVA annuities we are required to use current crediting rates in the U.S. and Japanese LIBOR in Japan. In
many capital market scenarios, current crediting rates in the U.S. are highly correlated with market rates implicit in the fair value of
statutory separate account assets. As a result, the change in the statutory reserve from period to period will likely substantially offset the
change in the fair value of the statutory separate account assets. However, in periods of volatile credit markets, actual credit spreads on
investment assets may increase sharply for certain sub-sectors of the overall credit market, resulting in statutory separate account asset
market value losses. As actual credit spreads are not fully reflected in current crediting rates in the U.S. or Japanese LIBOR in Japan, the
calculation of statutory reserves will not substantially offset the change in fair value of the statutory separate account assets resulting in
reductions in statutory surplus. This has resulted and may continue to result in the need to devote significant additional capital to support
the fixed MVA product.
Our primary foreign currency exchange risk is related to certain guaranteed benefits associated with the Japan and U.K. variable
annuities. The strengthening of the yen compared with other currencies will substantially increase our exposure to pay yen denominated
obligations. In addition our foreign currency exchange risk relates to net income from foreign operations, non-U.S. dollar denominated
investments, investments in foreign subsidiaries, and our yen-denominated individual fixed annuity product. In general, the weakening
of foreign currencies versus the U.S. dollar will unfavorably affect net income from foreign operations, the value of non-U.S. dollar
denominated investments, investments in foreign subsidiaries and realized gains or losses on the yen denominated annuity products. A
strengthening of the U.S. dollar compared to foreign currencies will increase our exposure to the U.S. variable annuity guarantee
benefits where policyholders have elected to invest in international funds, generating losses and statutory surplus strain.
Our real estate market exposure includes investments in commercial mortgage-backed securities, residential mortgage-backed securities,
commercial real estate collateralized debt obligations, mortgage and real estate partnerships, and mortgage loans. Significant
deterioration in the real estate market in the past couple of years adversely affected our business and results of operations. Further
deterioration in the real estate market, including increases in property vacancy rates, delinquencies and foreclosures, could have a
negative impact on property values and sources of refinancing resulting in reduced market liquidity and higher risk premiums. This
could result in impairments of real estate backed securities, a reduction in net investment income associated with real estate partnerships,
and increases in our valuation allowance for mortgage loans.
Significant declines in equity prices, changes in U.S. interest rates, changes in credit spreads, inflation, the strengthening or weakening
of foreign currencies against the U.S. dollar, or global real estate market deterioration, individually or in combination, could have a
material adverse effect on our consolidated results of operations, financial condition and liquidity.