The Hartford 2010 Annual Report Download - page 15

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Our adjustment of our risk management program relating to products we offer with guaranteed benefits to emphasize protection of
statutory surplus will likely result in greater U.S. GAAP volatility in our earnings and potentially material charges to net income in
periods of rising equity market pricing levels.
Some of the products offered by our Wealth Management businesses, especially variable annuities, offer guaranteed benefits which, in
the event of a decline in equity markets, would not only result in lower earnings, but will also increase our exposure to liability for
benefit claims. We are also subject to equity market volatility related to these benefits, including the guaranteed minimum withdrawal
benefit (“GMWB”), guaranteed minimum accumulation benefit (“GMAB”), guaranteed minimum death benefit (“GMDB”) and
guaranteed minimum income benefit (“GMIB”) offered with variable annuity products. We use reinsurance structures and have
modified benefit features to mitigate the exposure associated with GMDB. We also use reinsurance in combination with a modification
of benefit features and derivative instruments to attempt to minimize the claim exposure and to reduce the volatility of net income
associated with the GMWB liability. However, due to the severe economic conditions in the fourth quarter of 2008, we adjusted our risk
management program to place greater relative emphasis on the protection of statutory surplus. This shift in relative emphasis has
resulted in greater U.S. GAAP earnings volatility in 2009 and 2010 and, based upon the types of hedging instruments used, can result in
potentially material charges to net income in periods of rising equity market pricing levels, lower interest rates, rises in implied volatility
and weakening of the yen against other currencies. While we believe that these actions have improved the efficiency of our risk
management related to these benefits, we remain liable for the guaranteed benefits in the event that reinsurers or derivative
counterparties are unable or unwilling to pay. We are also subject to the risk that these management procedures prove ineffective or that
unanticipated policyholder behavior, combined with adverse market events, produces economic losses beyond the scope of the risk
management techniques employed, which individually or collectively may have a material adverse effect on our consolidated results of
operations, financial condition and cash flows.
The amount of statutory capital that we have and the amount of statutory capital that we must hold to maintain our financial
strength and credit ratings and meet other requirements can vary significantly from time to time and is sensitive to a number of
factors outside of our control, including equity market, credit market, interest rate and foreign currency conditions, changes in
policyholder behavior and changes in rating agency models.
We conduct the vast majority of our business through licensed insurance company subsidiaries. Accounting standards and statutory
capital and reserve requirements for these entities are prescribed by the applicable insurance regulators and the National Association of
Insurance Commissioners (“NAIC”). Insurance regulators have established regulations that provide minimum capitalization
requirements based on RBC formulas for both life and property and casualty companies. The RBC formula for life companies
establishes capital requirements relating to insurance, business, asset and interest rate risks, including equity, interest rate and expense
recovery risks associated with variable annuities and group annuities that contain death benefits or certain living benefits. The RBC
formula for property and casualty companies adjusts statutory surplus levels for certain underwriting, asset, credit and off-balance sheet
risks.
In any particular year, statutory surplus amounts and RBC ratios may increase or decrease depending on a variety of factors, including
the amount of statutory income or losses generated by our insurance subsidiaries (which itself is sensitive to equity market and credit
market conditions), the amount of additional capital our insurance subsidiaries must hold to support business growth, changes in equity
market levels, the value of certain fixed-income and equity securities in our investment portfolio, the value of certain derivative
instruments, changes in interest rates and foreign currency exchange rates, the impact of internal reinsurance arrangements, and changes
to the NAIC RBC formulas. Most of these factors are outside of the Company’ s control. The Company’ s financial strength and credit
ratings are significantly influenced by the statutory surplus amounts and RBC ratios of our insurance company subsidiaries. In addition,
rating agencies may implement changes to their internal models that have the effect of increasing the amount of statutory capital we
must hold in order to maintain our current ratings. Also, in extreme scenarios of equity market declines and other capital market
volatility, the amount of additional statutory reserves that we are required to hold for our variable annuity guarantees increases at a
greater than linear rate. This reduces the statutory surplus used in calculating our RBC ratios. When equity markets increase, surplus
levels and RBC ratios will generally increase. This may be offset, however, as a result of a number of factors and market conditions,
including the level of hedging costs and other risk transfer activities, reserve requirements for death and living benefit guarantees and
RBC requirements could also increase, lowering RBC ratios. Due to these factors, projecting statutory capital and the related RBC ratios
is complex. If our statutory capital resources are insufficient to maintain a particular rating by one or more rating agencies, we may seek
to raise capital through public or private equity or debt financing. If we were not to raise additional capital, either at our discretion or
because we were unable to do so, our financial strength and credit ratings might be downgraded by one or more rating agencies.
Downgrades in our financial strength or credit ratings, which may make our products less attractive, could increase our cost of
capital and inhibit our ability to refinance our debt, which would have a material adverse effect on our business, results of
operations, financial condition and liquidity.
Financial strength and credit ratings, including commercial paper ratings, are important in establishing the competitive position of
insurance companies. In 2009, our financial strength and credit ratings were downgraded by multiple rating agencies. Rating agencies
assign ratings based upon several factors. While most of the factors relate to the rated company, some of the factors relate to the views
of the rating agency, general economic conditions, and circumstances outside the rated company’ s control. In addition, rating agencies
may employ different models and formulas to assess the financial strength of a rated company, and from time to time rating agencies
have, at their discretion, altered these models. Changes to the models, general economic conditions, or circumstances outside our control
could impact a rating agency’ s judgment of its rating and the rating it assigns us. We cannot predict what actions rating agencies may
take, or what actions we may take in response to the actions of rating agencies, which may adversely affect us.