The Hartford 2011 Annual Report Download - page 110

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Credit Risk
Credit risk is defined as the risk of financial loss due to uncertainty of obligor’ s or counterparty’ s ability or willingness to meet its
obligations in accordance with agreed upon terms. The majority of the Company’ s credit risk is concentrated in its investment holdings
but is also present in reinsurance and insurance portfolios. Credit risk is comprised of three major factors: the risk of change in credit
quality, or credit migration risk; the risk of default; and the risk of a change in value of a financial instrument due to changes in credit
spread that are unrelated to changes in obligor credit quality. A decline in creditworthiness is typically associated with an increase in an
investment’ s credit spread, potentially resulting in an increase in other-than-temporary impairments and an increased probability of a
realized loss upon sale.
The objective of the Company’ s enterprise credit risk management strategy is to identify, quantify, and manage credit risk on an
aggregate portfolio basis and to limit potential losses in accordance with an established credit risk appetite. The Company manages to
its risk appetite by primarily holding a diversified mix of investment grade issuers and counterparties across its investment, reinsurance,
and insurance portfolios. Potential losses are also limited within portfolios by diversifying across geographic regions, asset types, and
sectors.
The Company manages a credit exposure from its inception to its maturity or sale. Both the investment and reinsurance areas have
formulated procedures for counterparty approvals and authorizations. Although approval processes may vary by area and type of credit
risk, approval processes establish minimum levels of creditworthiness and financial stability. Eligible credits are subjected to prudent
and conservative underwriting reviews. Within the investment portfolio, private securities, such as commercial mortgages, and private
placements, must be presented to their respective review committees for approval.
Credit risks are managed on an on-going basis through the use of various processes and analyses. At the investment, reinsurance, and
insurance product levels, fundamental credit analyses are performed at the issuer/counterparty level on a regular basis. To provide a
holistic review within the investment portfolio, fundamental analyses are supported by credit ratings, assigned by nationally recognized
rating agencies or internally assigned, and by quantitative credit analyses. The Company utilizes a credit VaR to measure default and
migration risk on a monthly basis. Issuer and security level risk measures are also utilized. In the event of deterioration in credit
quality, the Company maintains watch lists of problem counterparties within the investment and reinsurance portfolios. The watch lists
are updated based on regular credit examinations and management reviews. The Company also performs quarterly assessments of
probable expected losses in the investment portfolio. The process is conducted on a sector basis and is intended to promptly assess and
identify potential problems in the portfolio and to recognize necessary impairments.
Credit risk policies at the enterprise and operation level ensure comprehensive and consistent approaches to quantifying, evaluating, and
managing credit risk under expected and stressed conditions. These policies define the scope of the risk, authorities, accountabilities,
terms, and limits, and are regularly reviewed and approved by senior management and ERM. Aggregate counterparty credit quality and
exposure is monitored on a daily basis utilizing an enterprise-wide credit exposure information system that contains data on issuers,
ratings, exposures, and credit limits. Exposures are tracked on a current and potential basis. Credit exposures are reported regularly to
the ERCC and to the Finance, Investment and Risk Management Committee (“FIRMCo”). Exposures are aggregated by ultimate parent
across investments, reinsurance receivables, insurance products with credit risk, and derivative counterparties. The credit database and
reporting system are available to all key credit practitioners in the enterprise.
The Company exercises various and differing methods to mitigate its credit risk exposure within its investment and reinsurance
portfolios. Some of the reasons for mitigating credit risk include financial instability or poor credit, avoidance of arbitration or
litigation, future uncertainty, and exposure in excess of risk tolerances. Credit risk within the investment portfolio is most commonly
mitigated through the use of derivative instruments or asset sales. Counterparty credit risk is mitigated through the practice of entering
into contracts only with highly creditworthy institutions and through the practice of holding and posting of collateral. Systemic credit
risk is mitigated through the construction of high-quality, diverse portfolios that are subject to regular underwriting of credit risks. For
further discussion of the Company’ s investment and derivative instruments, see the Investment Management section and Note 5 of the
Notes to Consolidated Financial Statements. Further discussion on managing and mitigating credit risk from the use of reinsurance via
an enterprise security review process, see the Reinsurance section.
The Company is not exposed to any credit concentration risk of a single issuer greater than 10% of the Company’ s stockholders’ equity
other than U.S. government and government agencies backed by the full faith and credit of the U.S. government. For further discussion
of concentration of credit risk, see the Concentration of Credit Risk section in Note 5 of the Notes to Consolidated Financial Statements.