The Hartford 2010 Annual Report Download - page 181

THE HARTFORD FINANCIAL SERVICES GROUP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
F-53
5. Investments and Derivative Instruments (continued)
For the year ended December 31, 2009, the net realized capital gain (loss) related to derivatives used in non-qualifying strategies was
primarily due to the following:
• The gain related to the net GMWB product, reinsurance, and hedging derivatives was primarily due to liability model assumption
updates given favorable trends in policyholder experience, the relative outperformance of the underlying actively managed funds as
compared to their respective indices, and the impact of the Company’ s own credit standing. Additional net gains on GMWB
related derivatives include lower implied market volatility and a general increase in long-term interest rates, partially offset by
rising equity markets. For more information on the policyholder behavior and liability model assumption updates, see Note 4a.
• The net loss on the macro hedge program was primarily the result of a higher equity market valuation and the impact of trading
activity.
• The net loss on credit derivatives that purchase credit protection to economically hedge fixed maturity securities and the net gain on
credit derivatives that assume credit risk as a part of replication transactions resulted from credit spreads tightening.
For the year ended December 31, 2008, the net realized capital loss related to derivatives used in non-qualifying strategies was primarily
due to the following:
• The loss related to the net GMWB product, reinsurance, and hedging derivatives was primarily due to liability model assumption
updates and market-based hedge ineffectiveness due to extremely volatile capital markets and the relative underperformance of the
underlying actively managed funds as compared to their respective indices, partially offset by gains in the fourth quarter related to
liability model assumption updates for lapse rates.
• The net loss on credit default swaps was primarily due to losses on credit derivatives that assume credit risk as a part of replication
transactions, partially offset by gains on credit derivatives that purchase credit protection, both resulting from credit spreads
widening significantly during the year.
• The gain on the Japanese fixed annuity hedging instruments was primarily a result of weakening of the U.S. dollar as compared to
the Japanese yen.
In addition, for the year ended December 31, 2008, the Company incurred losses of $46 on derivative instruments due to counterparty
default related to the bankruptcy of Lehman Brothers Inc. These losses were a result of the contractual collateral threshold amounts and
open collateral calls in excess of such amounts immediately prior to the bankruptcy filing, as well as interest rate and credit spread
movements from the date of the last collateral call to the date of the bankruptcy filing.
Refer to Note 12 for additional disclosures regarding contingent credit related features in derivative agreements.
Credit Risk Assumed through Credit Derivatives
The Company enters into credit default swaps that assume credit risk of a single entity, referenced index, or asset pool in order to
synthetically replicate investment transactions. The Company will receive periodic payments based on an agreed upon rate and notional
amount and will only make a payment if there is a credit event. A credit event payment will typically be equal to the notional value of
the swap contract less the value of the referenced security issuer’ s debt obligation after the occurrence of the credit event. A credit event
is generally defined as a default on contractually obligated interest or principal payments or bankruptcy of the referenced entity. The
credit default swaps in which the Company assumes credit risk primarily reference investment grade single corporate issuers and
baskets, which include trades ranging from baskets of up to five corporate issuers to standard and customized diversified portfolios of
corporate issuers. The diversified portfolios of corporate issuers are established within sector concentration limits and are typically
divided into tranches that possess different credit ratings.